The Most Favored Nation (MFN) Clause, a provision in Double Tax Avoidance Agreements (DTAA), ensures equal treatment for residents in contracting states. Recent controversies have arisen regarding the activation of MFN clauses by non-residents. The Supreme Court’s ruling in the Nestle SA case provides crucial insights into this issue.
What is an MFN Clause?
The MFN Clause is a provision in a Double Tax Avoidance Agreement (‘DTAA’) that ensures that the residents in a contracting state receives the same treatment that the other contracting state offers to the residents of any third state.
If other contracting state provides a lower tax rate or other favourable tax treatment to a third state, the contracting state must receive the such beneficial treatment, provided that the residents meet the relevant conditions.
Such MFN clauses have been existing in DTAAs entered into by India, for more than 40 years.
What is the controversy?
Recently, disputes arose on the date from which the benefits under the MFN clause can be claimed by the non-resident (residents of the first state). The Supreme Court, in its judgment in Nestle SA [Civil Appeal No 1420 of 2023, decision dated 19 October 2023] has clarified that the MFN clause cannot be brought into operation by the Taxpayers unless a notification is issue by the Central Government extending the operation of the beneficial treatment to residents of the first State.
Issue Involved
India and the Netherlands entered into a DTAA in 1989. Subsequently, both countries signed a protocol featuring an MFN clause in 2012. India later signed a DTAA with Lithuania in 2013. At the time of this agreement, Lithuania did not hold OECD membership. It subsequently attained OECD membership status in 2018. Under the MFN Clause, the favourable tax treatment that India offers to residents of Lithuania, as per the terms of the Lithuania DTAA, can be extended to residents of the Netherlands.
The question involved was whether India is obligated to issue a notification to amend the India-Netherlands DTAA to incorporate the new provisions.
Also, there was a question regarding the effective date for granting this favourable treatment—either from the date the DTAA was initially signed with Lithuania i.e., 2013 or from the date when Lithuania became an OECD member i.e., 2018.
Positions taken by Industry before the SC decision
Based on the decision of Hon’ble Delhi High Court in the case of Steria India ([2016] 72 taxmann.com 1 (Delhi)) and Concentrix Services ([2021] 127 taxmann.com 43 (Delhi)), the following positions were followed:
- When a DTAA is notified, the protocol, which is an integral part of that DTAA, automatically becomes applicable.
- When the protocol contains an MFN Clause or the principle of parity, there is no need for a separate notification to incorporate the beneficial provisions of the DTAA signed with the third state.
- The MFN Clause is triggered automatically when the third country becomes an OECD member after signing the subject DTAA with the second country.
Supreme Court Decision in the case of Nestle SA in [2023] 155 taxmann.com 384 (SC)
Notification: The Supreme Court held that a notification under Section 90(1) is necessary and mandatory. It is a condition that must be fulfilled for a court, authority, or tribunal to give effect to a DTAA or any protocol that alters its terms and conditions, thus affecting the existing provisions of law. The Court emphasized that merely because a provision in a DTAA or Protocol with one nation requires the same treatment in a specific matter, subsequent to its initial signing when another nation receives preferential treatment, this does not automatically lead to the integration of such provision to extend the same benefit in the context of the DTAA of the first nation. In such a scenario, the terms of the earlier DTAA need to be amended through a separate notification under Section 90.
Relevant date: To claim the benefit of the MFN clause, based on the DTAA between India and the third state that is an OECD member, the relevant date is the date when the treaty was entered into with India, not a later date when that country becomes an OECD member.
Impact
The court’s decision also affects claims made by taxpayers under MFN clauses in treaties that India has signed with other countries. Also, this will significantly restrict the scope of benefits claimed under MFN clauses.
It will be interesting to see if the Indian government issues notifications for taxpayers to receive the benefit of MFN clauses for treaties that have been signed by India previously.
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