Recently, High Court of Delhi has accepted Writ Petition in the case of Societe De Participations Financieres ET Industrielles Spafi (French Shareholder) vs. Assistant Commissioner of Income Tax & ANR. (W.P. (C) 9316/2022 & CM APPLs. 27903-27904/2022) and has issued notice challenging CBDT’s MFN Circular No. 3 of 2022 wherein it has been submitted by the assessee that CBDT has exceeded its jurisdiction by laying down conditions for invocation of the MFN clause.
Understanding MFN Clause
India has entered into DTAA’s having an MFN clause with various countries. The Protocol to the DTAA’s with said countries (‘relevant DTAA’) provide that if under any DTAA between India and a third State (‘subsequent DTAA’), India limits its taxation to a lower rate or a more restricted scope than the rate or scope provided in the relevant DTAA, the same rate or scope as is applicable in the subsequent DTAA shall also apply under the relevant DTAA.
MFN clause is usually found in Protocols and Exchange of Notes to DTAAs. Once this clause is part of a treaty, the residents of contracting states get equal treatment as is being given to resident of other (third) states.
The intention of MFN clause in tax treaties is:
- granting of lower rate on specified income and/or;
- restricting the scope of income and/or;
- other benefit in terms of allowance of expenses in case of business income
MFN clause, as forming part of protocol, is an integral part of the tax treaty. Dr. Klaus Vogel in his Commentary on Double Tax Conventions mentions-
“……As previously mentioned, (final) protocols and in some cases other completing documents are frequently attached to treaties. Such documents elaborate and complete the text of a treaty, sometimes even altering the text. Legally they are a part of the treaty, and their binding force is equal to that of the principal treaty text. When applying a tax treaty, therefore, it is necessary carefully to examine these additional documents”
A typical MFN clause in any Indian DTAA reads as under (reproduced from Protocol IV(2) of the India-Netherlands treaty–
“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.”
Thus, in view of the above, while examining the tax liability of Royalty / FTS under the relevant provisions of the DTAA, it would also be critical to examine whether the DTAA has an MFN clause or not.
Conditions Stipulated in Circular No. 3/2022 and our comments
In the circular it has been clarified that the applicability of the MFN clause and benefit of the lower rate or restricted scope of source taxation rights in relation to certain items of income (such as dividends, interest income, royalties, Fees for Technical Services, etc.) provided in India’s DTAA with the third states (OECD Member) will be available to the treaty with an MFN clause (treaty with the first state) only when all the four conditions are met. The conditions are being discussed here with respect to the act, DTAAs and the prior judgments of the High Courts:
|
S. No. |
Condition | Our comments |
| 1. | The treaty with the third state is entered into after the signature/ Entry into Force of the treaty with an MFN clause (treaty between India and the First State); | The text of the above India-Netherlands treaty, explicitly mentions that the benefit of the MFN clause shall be extended only if India enters into an agreement with a third state (member of OECD) after signature of the India-Netherlands treaty.
Hence, it seems that the CBDT clarification in this regard is likely to hold good in appeals or before the courts. |
| 2. | The second treaty is entered into between India and a State which is a member of the OECD at the time of signing the treaty with it; | A plain reading of the above protocol doesn’t seem to suggest that the third state should be a member of the OECD at the time that the treaty between it and India is signed as well as at the time of applicability of the MFN clause.
Further, the High Court of Delhi in Concentrix Services Netherlands B.V. v. Income-tax Officer (TDS) P.(C) NOS. 9051 OF 2020 AND 882 OF 2021 AND CM APPL. NO. 2302 OF 2021 APRIL 22, 2021 had held that the principle of common interpretation was to be applied in the interpretation of DTAAs. Further, reliance was placed by the HC on the interpretation of the other contracting State, i.e., the Netherlands which had interpreted clause IV (2) to hold that “the lower rate of tax set forth in the India-Slovenia Convention/DTAA will be applicable on the date when Slovenia became a member of the OECD, i.e., from 21-8-2010, although, the Convention/ DTAA between India and Slovenia came into force on 17-2-2005.” (emphasis supplied) The plain reading of the protocol and more so, the judgment of the Delhi HC seems to cover the issue squarely and in view of the same, the clarification from CBDT is not likely to withstand, if challenged. |
| 3. | India limits its taxing rights in the second treaty in relation to rate or scope of taxation in respect of the relevant items of income; and | This condition will, in any case, be a pre-requisite for the import of MFN clause into a treaty and availing the benefit of the same. Hence, it is unlikely to be contested and, therefore, doesn’t require in-depth interpretation/analysis. |
| 4. | A separate notification has been issued by India, importing the benefits of the treaty with the third state into the treaty with MFN clause. | The text of the protocol and the provisions of section 90(1) of the Income-tax Act, 1961 contain no explicit mention of the requirement of a separate notification for importing the benefits of the MFN clause.
In Steria (India) Ltd. vs. CIT, [2016] 386 ITR 390 (Del) the High Court of Delhi held that “protocols and in some cases other completing documents are frequently attached to treaties…Legally they are part of the treaty, and their binding force is equal to that of the principal treaty text. When applying a tax treaty, therefore, it is necessary carefully to examine these additional documents. Therefore, the conclusion of the AAR that clause 7 of the Protocol, which forms part of the DTAA between India and France, does not automatically become applicable and that there has to be a separate notification incorporating the beneficial provisions of the DTAA between India and UK as forming part of the India- France DTAA is not agreeable.” (emphasis supplied) In view of the provisions of section 90 and the above judgement of the Delhi HC, it seems that this condition might not be acceptable before the adjudicating authorities. |
Issues regarding applicability of MFN are being litigated at various judicial levels. As a Circular is binding on tax authorities and not necessarily on taxpayers and therefore it has been clarified in circular that in the case of a taxpayer there is any decision by any court on this issue favourable to such taxpayer, then the circular will not affect the implementation of the court order in such case.
Disclaimer: This document has been prepared for academic use only and to share the same with the fellow professionals and all concerned. Though every effort has been made to avoid errors or omissions in this document yet they may creep in inadvertently. The author shall not be responsible for any damage or loss to any one, of any kind, in any manner due to this article. The author shall also not be liable or responsible for any loss or damage to any one in any matter due to difference of opinion or interpretation in respect of the text. It is suggested that to avoid any doubt(s), the user should verify the contents of this article independently.
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