Case Analysis Assessing Officer Circle (International Taxation) 2(2)(2) New Delhi v. Nestle SA, 2023 INSC 928
Introduction
The Supreme Court of India recently delivered a landmark verdict on the Most Favored Nation (MFN) clause within the context of Double Taxation Avoidance Agreements (DTAA). This analysis delves into the case of Assessing Officer Circle (International Taxation) 2(2)(2) New Delhi v. Nestle SA, highlighting its background, key controversies, and the subsequent Supreme Court ruling.
Background of the Controversy
The purpose of a double taxation avoidance agreement (DTAA) between multiple nations is to create regulations for the allocation of taxing rights in order to avoid the double taxation of income. To make sure that different DTAAs provide the same benefits, the contracting states can decide to include an MFN clause in their agreements. A resident of one DTAA is entitled to treatment that is at least as advantageous as that accorded to a resident of another nation under another DTAA, according to the MFN clause.
The Delhi High Court’s rulings in this round of appeals concern the interpretation of the Most Favoured Nation (MFN) clause in a number of Indian treaties with OECD member nations (hereafter referred to as “OECD”). In the event that one OECD nation grants a concession to another in the future, this article permits that country to reduce its rate of taxes at source on profits, interest, royalties, or fees for technical services (henceforth ‘FTS’), or to limit the scope of royalty/FTS under the treaty. Here we have three examples of bilateral treaties: one with the Netherlands, one with France, and one with Switzerland. The main questions that arise are
(1) whether the MFN clause can be invoked even though the third country with which India has signed a Double Tax Avoidance Agreement (DTAA) was not yet an OECD member when the DTAA was entered into and
(2) whether the MFN clause is to be automatically enforced or if it is to be enforced after a notification is sent.
Facts
In this new round of appeals by special leave, one of the initial judgements that has been contested is one that concerns Steria India. Steria argued before the Authority for Advance Ruling (“AAR”) that the narrower meaning of the term “fees for technical services” in the India-UK DTAA should be considered as being part of the India-France DTAA in light of Clause 7 of the Protocol to the India-France DTAA. According to the challenged decision, the AAR did not agree with Steria. The court determined that the Protocol did not constitute an integral element of the DTAA. Additionally, it was determined that the Protocol’s limitations were solely meant to cap the rates of taxation at source for the defined items. A notification under Section 90 of the Income Tax Act, 1961 issued by the Union Government was necessary to incorporate the more restrictive provisions of the India-UK DTAA into the India-France DTAA. Without this, the ‘make available’ clause from the India-UK DTAA could not be read into the expression ‘fee for technical services’ in the India-France DTAA. Put simply, the AAR rejected Steria’s argument that the immediate operationalization of Clause 7 of the Protocol did not necessitate any extra notification. After being challenged in a writ petition by Steria in the High Court, the decision was reversed. The court agreed with Steria that a Protocol is an integral component of the treaty and that it does not need to be notified separately in order for the MFN clause to apply. Hence, the major issue in Steria pertaining to the interpretation of the MFN clause in the Protocol to the India-France DTAA was whether the Union needed to provide a separate notification in order for the MFN clause to be applied. The High Court overturned the AAR’s decision that, although meeting all MFN clause requirements, the benefit could not be taken advantage of without a direct notification from the Indian government to that effect.
Next, we have the details of the India – Netherlands DTAA, which was signed on January 21, 1989, and announced on March 27, 1989. A later notification dated 30.08.1999 updated this DTAA. The parties involved in the matter who filed writ petitions with the High Court were Concentrix Services Netherlands BV, Optum Global Solutions International BV, and their Indian subsidiaries, in which Concentrix Services Netherlands BV held 99.99% of the shares while Optum Global Solutions International BV distributed dividends. Consistent with the subject DTAA read with the Protocol, Concentrix India and Optum India submitted separate applications in 2020 under Section 197 of the Act, requesting certificates allowing them to deduct withholding tax at a lower rate of 5%. A certificate showing the required withholding tax rate of 10% was issued on 16.09.2020 and another on 04.01.2021, respectively. The certificates were good until March 30, 2021, in both instances. In both circumstances, the certificates’ validity period ended on March 31, 2021. Concentrix requested access to the respondents’ records and copies of relevant order sheets (pertaining to the processing of its application preferred under Section 197 of the Act) through an email dated 17.09.2020. Concentrix’s accountants made the request. The certificate’s refusal to authorise the 5% withholding rate was also investigated. On 01.10.2020, the respondent applied to the appellant (henceforth “the revenue”) for reasons in order to defend its certificate. The revenue provided justification for the withholding tax rate of 10% in its message dated 22.01.2021, in response to a comparable request from Optum Netherlands. Concentrix Ne and Optum Ne, both of whom felt wronged, took their cases to the Delhi High Court in an effort to resolve the matter by constitutional means.
Both times, the assessees argued that the revenue had to pay the lesser rate of 5% because the relevant event – the terms of the DTAA and the Protocol—regarded the wording of the DTAA and the following Protocol. It was argued that the India-Netherlands DTAA should automatically apply the reduced rate or restricted scope from any other DTAAs that India has engaged into with OECD member countries. The reasoning behind this came from a clause in the Protocol’s preface that said, among other things, that the Protocol “shall form part an integral part of the Convention” (here meaning the DTAA). Contrary to the revenue’s position, it was contended that no new notification was necessary for the application of the DTAA’s provisions (which followed the India-Netherlands DTAA). Decisions from the Karnataka High Court in Apollo Tyres Ltd. v. Commissioner of Income Tax, International Taxation[1], and another decision from the Delhi High Court in EPCOS Electronic Components S.A. v. Union of India[2] were cited as supporting evidence.
The Delhi High Court allowed the writ petitions in its impugned judgement, citing the following reasoning: “15. A bare perusal of Clause IV (2) shows that it incorporates the principle of parity between the subject DTAA and the Conventions/DTAAs executed thereafter qua the rate of withholding tax or the scope of the Conventions in respect of items of income concerning dividends, interest, royalties, fees for technical services, or payments for use of equipment [in short “subject remittances”].”
16. Here are the conditions that must be met before the principle of parity may be applied:
i. Firstly, the third state that India negotiates a Convention or DTAA with must be an OECD member.
ii. Secondly, the rate or scope of withholding tax on subject remittances should have been limited in India’s Convention/DTAA with the third state to a lower rate or more restricted than what was given in the subject Convention/DTAA.
17. After the conditions mentioned above are met, the subject DTAA will be subject to the same withholding tax rate or scope as the existing Convention/DTAA between India and the third state, effective from the date of the convention’s entry into force.
17.1. Hence, we find it utterly illogical and contradictory to the plain language of Clause IV (2) of the protocol attached to the subject DTAA that the revenue’s contention that the recipients of remittances covered by the DTAA could not be entitled to the advantageous provisions found in Conventions/DTAAs executed either before or after the DTAA’s effective date (i.e., 21.01.1989) is wholly without merit.
17.2. It should be noted that while the revenue stands to benefit, Clause IV (2) is structured in a way that, in some instances, could cause a delay between the dates of the Convention/DTAA execution between India and the third state and the date on which the third state becomes an OECD member. The third state must be an OECD member for the lower tax rate or more limited scope provisions of the Convention or DTAA that India and the third state have signed to be applicable.
17.3. It is important to note that the word “is” used in the following section of Clause IV (2) in relation to the third states with which India has entered into Conventions/DTAAs following the subject DTAA’s execution “… which is a member of the OECD…” is heavily emphasised in support of the revenue.
Our interpretation of Section 17.4 of the Act is that the taxpayer or deductee must have met certain requirements before a reduced rate withholding tax certificate can be issued, and not only at the time the subject DTAA was executed. A term can be autological and heterological at the same time. A word that conveys its own characteristics is called an autological word. In contrast, a heterological word does not define itself, which is its opposite. Things like “English,” “Noun,” and “Word” are instances of autological terms. As mentioned before, heterological words are ones that don’t define themselves, can take on several forms, or can be interpreted in different ways. The word “long” is an instance of a heterological term. Just because it isn’t a long word doesn’t mean it describes itself.17.5. Given the above, looking at how the other contracting state, the Netherlands, has interpreted the clause is the best way to understand the Contracting States’ aim when they drafted Clause IV (2) of the protocol.
6. The judgement then looked at the Dutch executive decree that was issued under the Protocol as a way to interpret how to handle the event in question, which was the admission of another country to the OECD that had an existing DTAA with India (or where an existing OECD country entered into a DTAA with India).
7. The court’s decision in Concentrix was later upheld in the likewise-controversial case of Nestle SA v. Assessing Officer Circle (International Taxation). The clauses of the India-Switzerland DTAA and its three protocols were taken into account by the Delhi High Court in the revenue’s appeals in the Nestle case. Decisions made by the High Court have adhered to the stance outlined in Steria and Concentrix, and the other judgements that are now being challenged here have comparable facts.
Analysis
Overview
According to Article 253 of the Constitution and the relevant items in the Union List (List I, VII Schedule), sovereignty over treaty making is exclusively bestowed to the Union. Sovereignty includes the ability to enter into treaties, and Article 73 of the Constitution establishes that this authority does not rest with the states but with the Union executive. This authority does not extend to the shared (concurrent) domain within the distribution of administrative powers under the Constitution. From the wording and structure of Article 253, it is crystal clear that treaty provisions become enforceable in India only when they are made into law or made possible by laws that include them.
The treaty has two lives, according to Duncan B. Hollis’s research. While during the day it is a product of international law that establishes broad substantive and procedural standards that the treaty must follow, at night it is more of a domestic document. When interpreted domestically, the treaty takes the form of a body of law and acquires the binding power of the nation-state that ratified it.
In the case of W.B. State v. Jugal Kishore More[3], the court determined that although the executive branch can negotiate extradition treaties with foreign states, such treaties can only be implemented through parliamentary acts. Without statutory authority, the executive branch cannot arrest an alien in the country and send him to another country. Also, this court noted in State of Gujarat v. Vora Fiddali Badruddin Mithibarwala[4] that, as stated in Article 253 of the Indian Constitution, the terms of a ratified treaty do not automatically become law in India, unlike in other countries. It is necessary to pass legislation whenever a treaty modifies or adds to existing laws, impacts subject rights, or establishes a basis for the enforcement of obligations between the treaty-making state and its subjects in municipal courts. This also applies to treaties that raise or spend money, grant new powers to the government that can be recognised by municipal courts.
In the decision that was published as V.O. It was emphasised by this court in the case of Tractoroexport v. Tarapore & Co that “16. Another well accepted principle might be considered. Treaties, international protocols, and conventions do not have the same effect or operational force in this country as they do in some continental countries unless domestic legislation is passed to achieve a specific goal, such as in England. After Parliament passes a law, the next step is for the courts to examine the text of the law and determine how to understand its meaning. Even though they do not fulfil the treaty commitments, legislative enactments must be given effect to if their words are clear and unambiguous. When Parliament’s words are ambiguous and open to several interpretations, the significance of the treaty, protocol, or convention becomes apparent. The rationale for this is that, given two equally valid interpretations, the one that is most in line with treaty requirements will take precedence. The phrases used in an Act were to be understood in the same way they were in municipal law, even though the Act was intended to implement a scheduled convention. Barras v. Aberdeen Steam Trawling & Fishing Co. Ltd.[5] is a relevant case to review.
The decision of the Privy Council in Attorney-General for Canada v. Attorney-General for Ontario (which had made certain remarks in the context of a rule applicable within the British Empire) was adopted by this court in Maganbhai Ishwarbhai Patel v. Union of India[6].
When it comes to this matter, the most important ruling is the one in Maganbhai Ishwarbhai (supra). “It will be essential to keep in mind the distinction between (1) the formation and (2) the performance, of the obligations constituted by a treaty, using that word as comprising any agreement between two or more sovereign States,” the author notes as relevant considerations. It is a well-established practice within the British Empire that treaties are made by the executive branch, but treaty obligations, if they involve changing domestic legislation, must be passed by the legislature. Within the Empire, the provisions of a properly ratified treaty do not, unlike in other countries, enjoy the force of law simply because of the treaty. In order to fulfil treaty obligations that require changes to existing laws, the current government must consider whether or not to seek parliamentary approval for the relevant statute or statutes. Without a question, Parliament has constitutional oversight over the executive branch. However, it is undeniable that the executive branch is solely responsible for creating treaty obligations and approving their quality and form. These points are well-taken within the framework of our constitutional system. Once enacted, these laws bind the state in relation to other parties to the contract, but Parliament has the option to refuse to enforce them, putting the state in default.
The matter was addressed more directly in the concurring opinion of J.C. According to Shah, J. (who cited Oppenheim’s International Law, 8th Edition): “…treaties that impact private rights and, generally, treaties that modify common law or statutes require parliamentary assent through an enabling Act of Parliament in order to be enforced by English courts.” Therefore, legally enforceable treaties that are part of international law do not become domestic law unless specifically authorised to do so by the legislature.
A treaty’s binding effect is, in theory, limited to the signatory states and has no bearing on the subjects of those states. Treaties can typically only have effect upon States because International Law is mostly a law between States only. As previously noted by the Permanent Court of International Justice, this Rule can be changed by the treaty’s explicit or implicit provisions, making its provisions self-executing. Otherwise, if treaties include provisions that affect the rights and responsibilities of the subjects, courts, officials, and the like of the contracting states, those states must follow their municipal law to ensure that these provisions are enforced.
“80…According to Article 73, subject to the provisions of the Constitution, the executive power of the Union extends to the matters with respect to which the Parliament has power to make laws,” Shah, J. added, citing Articles 253 and 73. In times of peace or conflict, our Constitution does not make legislation a prerequisite for entering into an international treaty. The Constitution grants the President the authority to exercise the executive branch of the United States. When it comes to international affairs, the State’s executive branch is competent to represent the nation and enter into obligations that are legally obligatory on the state through conventions, treaties, and other agreements. However, Indian citizens are not automatically bound by the responsibilities that arise from the agreements or treaties. Parliament has the authority to pass laws pertaining to treaties as stated in Entries 10 and 14 of List I of the Seventh Schedule. When a treaty or agreement affects state laws or acts to limit the rights of people or others, however, the exercise of that ability to make laws is required. The agreement or treaty can be implemented without the requirement for legislative action if it does not infringe upon the rights of citizens or other parties whose rights can be legally challenged.
46. Here is what was noted in the case of Gramaphone Co. of India Ltd. v. Birendra Bahadur Pandey:
To the extent that rules of international law do not contradict with acts of parliament, the doctrine of incorporation acknowledges that they are integrated into and treated as part of national law. Local law has precedence over international law, whether or not there is a Community of Nations. If Parliament rejects an international law principle, the national courts cannot uphold it. If international law does not contradict domestic law, then domestic courts will uphold it. If there is a dispute between national law and international law, the national court must apply national law because it is an organ of the national state and not international law.
So, to summarise the holding in the decisions we’ve already covered:
(i) There is no automatic assumption of enforceability of a treaty’s provisions once the Union ratifies it;
(ii) The signing of foreign treaties is reserved exclusively for the Union’s executive branch, and
standards outlined in Article 73 [see to Related Entries – Nos. 10, 13, and 14 for context].
members of Parliament and those named in List I of Schedule VII to the Indian Constitution, maintain that sole authority to enact laws pertaining to these treaties or conventions.
(iii) Parliament has the authority to decline to carry out or implement such treaties. If it happens,
Whilst these treaties obligate the Union with respect to the other state or states that have entered into them,
Default by the Union.
The Union is bound by the application of these treaties (iv). Still, they “are not just their own legal authority that is binding on citizens of India.
(v) Parliament must pass laws pertaining to these accords if
When an agreement changes the legislation, limits the rights of individuals, or both,
Asian nation.
(vi) In the event that the rights of citizens or third parties are not preserved, or if Indian law is not treaties to take effect, no act of legislature is required.
(vii) Should the relevant statute or law be unclear as to what triggers the international instrument, such as a treaty or an obligation, the court has the authority to review it.
To remove the uncertainty or look for the answers. The case of Union of India (UOI) v. Azadi Bachao Andolan[7] provides the most explicit interpretation of Section 90 in the statute. This court has held the following, in addition to reviewing the decisions of multiple high courts (e.g., Visakhapatnam Port Trust v. Commissioner of Income Tax, Davy Ashmore India Ltd. v. Commissioner of Income Tax, Leonhardt Andra Und Partner, Gmbh v. Commissioner of Income Tax, R.M. Muthaiah v. Commissioner of Income Tax, and Arabian Express Line Ltd. of United Kingdom v. Union of India):
Parts 4 and 5 of the Act are specifically stated to be “subject to the provisions of this Act,” which would encompass Section 90 of the Act. There is no longer res integra regarding the resolution of a discrepancy between provisions of the Income Tax Act and notifications issued under Section 90.
After reviewing these judgements, it is evident that the Indian judiciary has reached a unanimous decision that section 90 is meant to give the Central Government the authority to announce the conditions of a double taxation avoidance agreement and put them into action. When that occurs, the terms of the agreement will still be binding on all circumstances where they are applicable, regardless of whether they conflict with the Income Tax Act. We agree with the reasons behind the decisions that have come to our attention. There was no point in making those sections “subject to the provisions” of the Act if the legislature’s intention was not to depart from the general principles of chargeability to tax under section 4 and ascertainment of total income under section 5 of the Act. The objective of merging these two sections with the clause is to allow the Central Government to issue a notification under section 90 to implement the DTAs. This would mean that the provisions of the Income Tax Act would no longer apply when it comes to determining chargeability to income tax and total income, as long as the DTAC terms are inconsistent.
The respondents’ argument, which was considered by the High Court (i.e. it is completely nonsensical to claim that the challenged circular No. 789 contradicts the Act’s provisions. We have already established that Circular No. 789 qualifies as a circular under section 90; hence, it is required to have the legal effects anticipated by subsection (2) of section 90. That is to say, with respect to assessees covered by the DTAC, the circular will take precedence over the Income Tax Act, 1961, even if the two are in conflict.
We think the argument is completely wrong. We have previously shown that Section 90, along with its predecessor in the 1922 Act, was added to the law book so that the government could swiftly negotiate and execute a DTAC. Taking into consideration the respondents’ argument that the powers wielded by the Central Government under section 90 constitute delegated legislative powers, it remains unclear why a delegate of legislative power does not always possess the authority to give exemptions. Parliament and state legislatures have enacted numerous acts that explicitly grant the executive branch the authority to grant conditional or unconditional exemptions from the statutes’ terms. For instance, there are exemptions from taxation even in fiscal laws such as the Central Excise Act and the Sales Tax Act. References to relevant sections include Section 5A of the Central Excise Act, 1944 and Section 8(5) of the Central Sales Tax Act, 1956. thus, the argument that a legislative power delegate cannot use the exemption authority under a fiscal act cannot be accepted.
In light of the foregoing, it is clear that the legal position is that a treaty or protocol’s provisions do not confer rights upon parties until the necessary notifications are issued in accordance with Section 90(1), and that a treaty or protocol’s entry into force does not automatically render it enforceable in courts and tribunals.
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When it comes to India’s DTAA agreements, the MFN clause usually states that if India signs another DTAA with an OECD member country that offers preferential tax treatment, then the first DTAA’s participating country should get the same treatment, either after the agreement is signed or when it enters into force.
Controversy emerged when India offered a reduced dividend income tax rate in DTAAs with Slovenia, Lithuania, and Colombia. These nations did not become members of the OECD when the agreement was inked, but they did so afterwards. Because of this, the tax authorities in India and the MFN countries (which include Switzerland, the Netherlands, and France) were at odds. The Delhi High Court sided with the MFN countries, who had sought benefits from the day these non-OECD countries joined the OECD, according to their unilateral claims. The High Court ruled that the countries’ treaties with India activated the MFN clauses; these countries had already concluded their treaties with India before joining the OECD. The benefits were automatically applied through the MFN clauses in the treaties, without any additional government notification being necessary.
The Indian tax authorities responded by issuing a circular outlining the conditions that must be satisfied before the MFN provision takes effect. These conditions must be met in order for the DTAA with the MFN clause to be implemented: the third country must be an OECD member when India signs the DTAA with them; the DTAA with the third country must have a favourable scope of taxation; and a separate notification must be issued to import this beneficial taxation into the DTAA with the MFN clause.
Previous decisions have established that MFN clauses in agreements with MFN Countries or similarly worded clauses are self-operational, eliminating the need for an additional notification. It is crucial to note that, in the context of the circular, the MFN clause in the DTAA with the MFN Countries does not require a separate notification for its operation, unlike the India-Finland DTAA. Consequently, an important question emerges: does the MFN clause automatically apply or does the Indian government need to issue a notification to incorporate it into domestic law and confer its benefits?
Supreme Court ruling in Brief
When the Indian tax authorities appealed the Delhi High Court’s rulings, the Supreme Court had a chance to decide two important questions: first, whether a separate notification was required to include these benefits into the DTAA with the MFN Countries, and second, whether the MFN clause applied when third countries were not OECD members when their DTAAs entered into force.
The Supreme Court ruled that in order to apply any DTAA or its protocol that changes current legislative provisions, a fresh notification is required, according to Section 90(1) of the Income Tax Act, 1961 (“ITA”). According to the Supreme Court’s reasoning, although the Union has the sole capacity to engage into DTAA, the Parliament has the sole power to make these agreements a law. In the absence of such legislation, the DTAA provisions will not automatically apply to citizens of India. When such accords alter Indian law or affect citizens’ rights, legislative action is critical. If the law or citizens’ rights are not changed, then no legislation is needed. Since other countries’ assimilation processes vary greatly from India’s legislative-driven method, the Supreme Court also stressed that DTAA cannot be interpreted based on unilateral orders and decrees from other countries. It is customary in India to apply the advantages of the MFN clause after a separate notification has been issued under Section 90 of the ITA; the Supreme Court has ruled that this practice cannot be challenged.
The Supreme Court made it clear in its decision that the word “is a member” implies present importance when discussing whether the third country must be an OECD member when its DTAA comes into force. Thus, in order for the previous DTAA recipient to assert the MFN clause’s applicability, the third nation must be an OECD member while DTAAing with India.
The Delhi High Court has already ruled in favour of taxpayers from the MFN countries, allowing them to claim a lower dividend tax rate. A major precedent for the interpretation of DTAAs has been set by this Supreme Court decision, which is binding on lower courts and taxpayers.
This decision by the Supreme Court goes against previous decisions made by other High Courts and tribunals that did not hold that a notification was necessary. Since the MFN clause is automatically informed with the DTAA, earlier interpretations suggested that India informs every DTAA. But the Supreme Court gets it: the MFN clause changes the DTAA it is in via its functioning. For this reason, it is necessary to provide an additional notice in order to make this change effective.
With the Supreme Court’s approval of the tax authorities’ circular, which states that a separate notification is needed to activate the MFN clause, the authorities’ position is strengthened. They can now pursue individuals for unpaid taxes who used the MFN clause to claim a lower dividend tax rate. Taxpayers from MFN countries, on the other hand, will suffer as a result of the verdict, since it will prevent them from taking advantage of the reduced tax rates that were previously claimed under the MFN provision and will ignore their reasonable expectations.
Conclusion:
Although the Supreme Court’s decision makes the application and enforcement of the MFN clause in India’s DTAAs more transparent and consistent, it could discourage investments from MFN countries in India. This risk is caused by the potential elimination of advantageous tax rates. Therefore, the Indian government must thoroughly investigate the possible consequences and respond swiftly. To reduce negative impacts and maintain a positive, incentive-based environment that boosts investor confidence and foreign investment, several steps are necessary.
[1] W.P. No.31738 of 2016 (T-IT)
[2] 2019 SCC OnLine Del 9113: (2020) 316 CTR 126
[3] (1969) 1 SCC 440
[4] 1992 Supp (2) SCC 554
[5] [1933] A.C. 402
[6] 211 (11) SCC 463
[7] 2011 (8) SCC 1
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Author Details: Arya Hartalkar, 4th year student, B.A.LL.B Honours in Adjudication and Justicing, MNLU, Nagpur.
Author Bio
