On India’s approach to the Most Favoured Nation status – Supreme Court’s decision on tax treaties clarifies India’s Most Favoured Nation approach

Source: The post on India’s approach to the Most Favoured Nation status is based on the article “Supreme Court’s decision on tax treaties clarifies India’s Most Favoured Nation approach” published in “Indian Express” on 2^nd November 2023.

UPSC Syllabus Topic: GS Paper 2 International relations – Bilateral, regional and global groupings and agreements involving India and/or affecting India’s interests.
GS Paper 3 Indian Economy – Mobilisation of resources (Taxation)

News: The article discusses how tax treaties between India and other countries can change over time due to legislative and economic changes. It mentions a recent Supreme Court ruling regarding the Most Favored Nation (MFN) provision in these treaties and the impact on investors.

Most Favoured Nation: It’s a principle in international trade. It means if a country gives trade benefits to one partner, it must give the same benefits to all other partners. This ensures equal treatment in trade.

For more details on Most Favoured Nation, read here

What was the MFN controversy?

As per tax treaties signed by India, India had agreed that if it gave any new OECD member country a lower tax rate, that rate would automatically apply to existing OECD members (France, the Netherlands, and Switzerland) due to the MFN clause.

In 2020, India changed how it taxed dividends from companies. The treaties India separately negotiated with new members of OECD gave investors from these countries a relative advantage due to lower tax rates.

Now, investors from France, the Netherlands, and Switzerland also started to look for lower tax rates benefits from India. However, the controversy arose over the question of whether the lower tax rates should automatically apply to the three countries without any formal notification.

In this case, Delhi High Court ruled that no formal notification was needed, and benefits can be given immediately to investors from the 3 countries as well.

However, SC reversed this ruling.

The Supreme Court held that to give effect to the MFN provision in the DTAA, notification under Section 90(1) of the Income Tax Act is necessary and mandatory. Thus, the Court advocated the doctrine of dualism wherein international law is not enforceable domestically till it is transformed into municipal law through enabling legislation.

What is the recent Supreme Court (SC) ruling regarding the Most Favored Nation provision?

MFN Clause Invocation: To invoke the MFN clause in a Double Tax Avoidance Agreement (DTAA), the country in question must have been an OECD member when the treaty with India was signed. Treaties signed with countries which joined the OECD later, cannot invoke the MFN.

Notification Requirement: A formal notification was required for any change due to the MFN clause in a DTAA. It doesn’t take effect automatically.

Therefore, Companies, like those in the Netherlands receiving dividends from India, can’t claim lower tax rates based on treaties with later OECD members, such as Slovenia. They must adhere to the original treaty rate.

What are the major issues with the Most Favored Nation (MFN) provision?

Unilateral Interpretations: Countries like France, the Netherlands, and Switzerland issued decrees unilaterally to apply lower tax rates retrospectively when new OECD members joined. This unilateral approach can create uncertainty and potential conflicts.

Impact on Investors: The MFN issue directly affects investors. Changes in tax treaty terms can have a significant impact on their tax liabilities and investment decisions.

Tax Treaty Shopping: Investors exploit MFN provisions for more favorable tax treatment. This behavior can lead to unequal treatment and distortions in tax revenues.

Inconsistencies Among Treaties: Varying MFN provisions and interpretations in different treaties add complexity and ambiguity to the tax landscape.

What should be done?

Clarity and Notification: Establish clear and standardized notification requirements when invoking MFN to reduce ambiguity and potential disputes.

Regular Treaty Reviews: Periodically review tax treaties to assess their economic benefits and relevance in changing economic circumstances.

Global Cooperation: Promote international cooperation and coordination on tax treaty issues to achieve consistency and fairness across jurisdictions.

Independent Judicial Oversight: Ensure the presence of independent judicial members in bodies responsible for tax treaty rulings, such as the Board of Advance Ruling, to enhance transparency and fairness.

Terminology used:

The Double Taxation Avoidance Agreement (DTAA): It is a pact between two nations. Its purpose is to prevent individuals from being taxed twice on income from both their home and host countries. Without DTAA, one might be taxed twice on the same earnings.

For more details on DTAA, read here

Question for practice:

What are the various issues surrounding the Most Favored Nation provision in tax treaties? Suggest measures to tackle the same.