Introduction
In the tax treaties entered by India with countries such as Netherlands, France, Swiss Confederation, and Sweden, India has agreed for Most Favoured Nation clause (‘MFN clause’) with the treaty Partner. The MFN clause finds presence in the protocol to the tax treaty, which forms an integral part of the tax treaty[1]. The objective of entering into MFN clause is to ensure that party to one tax treaty provides equal treatment as provided in tax treaty entered later with other countries in terms of scope of taxation and rate of taxation. The scope of MFN clause agreed in different treaties varies depending upon the agreement reached between the respective parties.
Lately, in the context of dividend income, the applicability of MFN clause has been a subject matter of dispute between the taxpayers and the Revenue authorities. The taxpayers have argued that MFN clause is applicable on dividend income received by Netherlands and French shareholders, and as a result, the dividend income is taxable in India at the rate of 5% (provided in tax treaty with Slovenia) instead of higher rate of 10% provided in respective treaties.
The High Court of Delhi has decided the above matter in favour of the taxpayers[2]. The Revenue authorities have preferred SLP against said Orders which is pending for consideration before the Supreme Court. The Revenue authorities have also clarified their stance by issuing a circular[3].
This article attempts to explain the controversy and the key arguments which in authors’ view weigh in favour of both the taxpayer and the Revenue authorities.
Controversy on applicability of MFN clause
To understand the controversy, let us take an example of India-Netherlands tax treaty. Article 12 of the said tax treaty grants source country the right to tax dividend income of the shareholder at a maximum rate of 10%. The MFN clause of India-Netherlands tax treaty, agreed as part of the Protocol to the said tax treaty, reads as follows:
If after the signature of this convention under any Convention or Agreement between India and a third State which is a member of the OECD India should limit its taxation at source on dividends, interests, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, then as from the date on which the relevant Indian Convention or Agreement enters into force the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also apply under this Convention.
[Emphasis Supplied]
India has entered into tax treaties with countries such as Slovenia, Colombia and Lithuania which provides for a lower rate of source taxation on dividend income of 5%. Said tax treaties were entered by India after entering into tax treaty with Netherlands. However, at the time of entering into said tax treaties, the third countries (i.e., Slovenia, Colombia and Lithuania) were not OECD member countries. The countries became member of OECD later.
The taxpayers have argued that for claiming benefit of MFN clause, the country needs to be an OECD member country at the time when the applicability of MFN clause is being tested. Whereas the Revenue authorities have taken a position that the third country need to be OECD member country at the time of entering into tax treaties with said countries and if a country becomes OECD member later, the MFN clause will not be applicable.
In addition, the Revenue authorities have also taken a position that for applicability of MFN clause, a separate notification must have been issued by India importing the benefit of second treaty into the first tax treaty. In absence of notification, MFN clause is inapplicable.
Taxpayer v. Revenue – Strength assessment
Date when the third country should be OECD member
On this aspect, their lies arguments both in favour of the Revenue and the taxpayer.
Argument in Revenue’s favour
The Revenue may contest that once MFN clause is agreed, India remains mindful of the impact which a subsequent treaty may have on the earlier treaties entered by India due to MFN clause. India may agree to offer lower rate of source taxation to a non-OECD member country considering the economic condition of said country and India’s relations with said country. One of the critical factors for agreeing for lower rate of taxation is the fact that the country is not a member of OECD. Had this been an OECD member country, India may not have agreed for lower rate considering the ripple effect on other treaties.
Therefore, for applicability of MFN clause, the third country must be an OECD member country at the time of signing of tax treaty with said country. Interpreting the MFN clause to be applicable otherwise will lead to absurdity and produce effects which were not intended at the time of entering into tax treaty.
Arguments in taxpayer’s favour
- The word ‘is’ as used in the phrase ‘which is a member of the OECD’ appearing in MFN clause to India-Netherlands tax treaty, describes the state of affairs that should exist when the request is made by taxpayer for lower withholding and not when the tax-treaty was executed (in the case of Concentrix Services Netherlands B.V. v. ITO[4]).
- MFN clause is inserted in the Netherlands tax treaty to treat all OECD members on an equal footing. As a result of MFN clause, it is binding upon India to accord equal treatment among the OECD network countries, irrespective of when they became OECD member. If India denies said benefit, India is not fulfilling its commitment towards Netherlands. If the intention was not to make Slovenia treaty applicable by inter play of MFN clause, a separate clause would have been agreed between India and Slovenia stating that the rights granted under said treaty will be required to be revisited if Slovenia becomes an OECD member country.
- It is an accepted principle that treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose[5]. To understand the ordinary meaning which can be accorded to the MFN clause, reference can be made to the uniform interpretation given by other countries by way of unilateral statements issued by them. France, Netherlands and Swiss Confederation, all three countries have issued unilateral statements stating that post entering of treaties with Slovenia, the rate of dividend tax will be reduced to 5%.
- The MFN clause does not lay emphasis upon the third country being an OECD member country at the time of signing tax treaty. If the intention of the parties was to impose such a condition, specific mention in this respect must have been made in the MFN clause. In such scenario, the above would have read as ‘if under any Convention, Agreement or Protocol signed after 1-9-1989, between India and a third State which is a member of the OECD at the time of signing this agreement’. Importing words/ phrases in the text of the treaty which are not expressly mentioned is against the principles of interpretation of tax treaty.
Requirement for notification
It is an accepted principle that protocol forms an integral part of the tax treaty. Once a tax treaty is notified, the protocol to the tax treaty also gets notified and stands applicable. There is no requirement for separate notification for applicability of MFN clause.
Therefore, in authors’ view, there is no need for a separate notification for applicability of MFN clause.
Concluding remarks
As analysed, there exists good arguments both in favour of taxpayer and the Revenue. In authors’ view, applying the principles of treaty interpretation, the case weighs more in favour of the taxpayer. Nevertheless, the tussle before the Apex Court will be an interesting one to watch out for. Considering the tax impact of the debate, a pro-active analysis must be conducted by MNEs paying dividend to group companies in countries with which India has agreed for MFN clause such as Netherlands, France, Swiss Confederation, and Sweden.
[The authors are Principal Associate and Senior Associate, respectively, in Direct Tax Team at Lakshmikumaran and Sridharan Attorneys, New Delhi]
[1] Steria India Ltd. v. Commissioner of Income Tax [2016] 72 taxmann.com 1 (Delhi), Commissioner of Income Tax v. ISRO Satellite Centre [2013] 218 Taxman 74 (Kar).
[2] Concentrix Services Netherlands B.V. v. ITO (2021) 127 taxmann.com 43 (Delhi); Cotecna Inspection SA v. ITO [2022] 136 taxmann.com 368 (Delhi); Deccan Holdings BV v. Income Tax Office [2021] 133 taxmann.com 94 (Delhi).
[3] Circular No. 3 of 2022.
[4] (2021) 127 taxmann.com 43 (Delhi).
[5] Article 31(1) of Vienna Convention.
