Referring to our update on Application of MFN clause under a tax treaty : Relevance of a third country being a member of OECD on the date of signing of tax treaty and whether a specific notification required to make MFN effective (Delhi High Court) dated May 3, 2021, and Clarity on Application of MFN clause in view of the recent CBDT circular (Pune Tribunal) dated March 1, 2022 we had tried to throw highlight on the following key issues surrounding the Application of MFN clause based on the Delhi HC ruling and the CBDT circular:
1. Whether a specific notification would be required to give effect to a protocol containing MFN clause or being a protocol it is an integral part of the tax treaty and no separate notification is required?
2. When the third country (with which India has signed a favorable agreement) should be a member of OECD-on the date of their signing of tax agreement with India? Any time before applying MFN clause?
The Delhi High Court had off course ruled in favour of the tax payer on the above issues while the Pune Tribunal had held that :
- there is no requirement to separately notify a Protocol to a tax treaty to make its provisions effective, given that the Protocol is an integral part of the tax treaty.
- Circular does not bind tribunal, and cannot have retrospective effect unless specified expressly
The debate had reached with the Apex Court (Supreme Court) of India in the case M/s Nestle SA wherein the Hon’ble SC of India overturned various HC rulings by holding that issuing a notification under Section 90 to give effect to any treaty or convention is necessary.
To accentuate the summary of arguments from both the parties and observation of the Hon’ble Supreme Court are as follows:
Revenue’s Contentions
- As per Article 73 and Article 253 of the Indian Constitution, the Union has exclusive executive power to enter international treaties and conventions. The Parliament holds the exclusive power to legislate upon such conventions or treaties. India follows the ‘dualist’ practice, which means that international treaties are not automatically assimilated into the national legal system upon their ratification and they would require enabling legislation.
- Section 90 of the Act requires the issuance of a notification to give effect to a treaty or a convention, and mere entering into a treaty convention or protocol cannot give rise to any right under the taxation laws.
- On the interpretation of the term ‘is’ contained in the protocol, it signifies the time when the provisions of the treaty are to be applied, and the MFN clause clearly demonstrates that the third state is required to be an OECD member as on the date of the signing of the treaty and not on any future date.
Taxpayer’s Contentions
- Section 90 only requires notification of a treaty or protocol and does not mandate each clause of such agreement to be further notified separately. The MFN clause is typically an integral component of a protocol and, hence, an inherent element of a treaty already notified.
- Specific DTAA (like the India-Finland DTAA) requires India to notify Finland about the beneficial provision entered with the third state whenever the MFN clause gets triggered. However, the India-Switzerland DTAA does not require negotiation to give the benefit of a reduced rate of tax and requires notification in case of restricted scope. The use of different language in the DTAA by the two contracting states is indicative of their intent and cannot be disregarded whilst interpreting their terms. The MFN clause ‘shall also apply’ under this current convention is automatically in operation.
- The absence of a unilateral notification cannot override the clear language of an MFN clause that provides for automatic application.
- The Karnataka HC in Apollo Tyres Ltd. had considered the protocol to the India-Netherlands DTAA to be an integral part of the tax treaty, and no separate notification was required. The taxpayer’s contention was that since this decision was not challenged, the issue had attained finality.
Supreme Court’s Analysis and Observations
The Hon’ble SC of India analyzed that:
- Entering into a treaty is an attribute of sovereignty, and the power to do vests solely with the Union executive which can be traced to Article 73 of the Constitution. However, the structure and phraseology of Article 253 leaves no doubt that when a treaty is enacted by law, or enabled through legislation, which assimilates it, such provisions are enforceable in India. If a treaty demands changes to existing law, impacts citizen rights, or necessitates new legislation for enforcement or financial matters, legislative action is required.
- The Supreme Court, placing reliance on the decisions of various HC5 stated that India entering a treaty or protocol does not result in its automatic enforceability in Courts and Tribunals; the provisions of such treaties and protocols do not, therefore, confer rights upon parties until appropriate notifications are issued under Section 90(1) of the Act.
- The Court noted that India has issued separate notifications to give effect to an MFN clause for India’s DTAA with France and the Netherlands. It stated that there are established and clear precedents of behavior in relation to a treaty practice and its interpretation. This was uncontested and is a matter of record. The Court also discussed the language in the India-Canada DTAA for the application of the MFN clause, which does not require separate notification still the notification is issued to apply the clause.
- Article 31 of General Rule on Interpretation of Vienna Convention on Law of Treaties, 1961 (VCLT), the principle of interpretation conveys that the treaty interpretation relies on subsequent agreements, practices and international law and collectively shaping its understanding and application. Accordingly, the treaties need to be read more liberally with its intention rather than actual words.
- The expression ‘is’ has a present signification and it derives meaning from the context. Moreover, given this interpretation, the conclusion is that when a third-party country enters into DTAA with India, it should be a member of the OECD, in order for the second state to claim parity.
Ruling of the Supreme Court:
- Section 90(1) notification is mandatory for a Court, Authority, or Tribunal to give effect to a DTAA or its protocol, altering the existing provisions of law.
- The provision stipulating ‘same treatment’ in a DTAA or protocol with one nation does not automatically apply the same benefit when another nation receives better treatment. In such cases, the earlier DTAA terms must be amended through a separate Section 90 notification.
- The term ‘is’ has a present meaning. Therefore, for a party to claim benefit of a ‘same treatment’ clause, based on entry of DTAA between India and another state which is member of OECD, the relevant date is entering into treaty with India, and not a later date, when, such country becomes an OECD member after entering into DTAA with India.
Our Comments
The SC ruling, being the law of land and binding on all, is an important development in terms of interpretation of DTAAs and is a significant advancement in the way DTAA provisions may be interpreted in India. The SC has concluded that notification is necessary and a mandatory condition for a court, authority or tribunal to give effect to a DTAA, or any protocol changing terms or conditions, which has the effect of altering the existing provisions of law. In absence of notification, one may not be able to claim any benefit which MFN clause may provide. In view of the SC ruling, by relying on MFN clauses, Indian practice supports a consistent pattern of issuing a notification even for a consequential amendment of an agreed protocol. Further, in view of the SC ruling, the expression ‘is’ has a present signification and for MFN trigger, the third country had to be a member of OECD as at the relevant date of entering into its treaty with India rather than it being OECD member when MFN provision is applied.
The SC decision is likely to impact the claims which the taxpayers have made in respect of restrictive source taxation of interest, royalty, fees for technical services, dividend etc. by relying on MFN provisions and its scope as understood by lower courts.
Being a binding SC decision, the ruling may impact all pending assessments and related proceedings irrespective of stage of its pendency. It may be necessary to assess the potential effects of the SC decision on previous tax positions taken by taxpayers – particularly, considering the favorable decisions of lower courts. It would also be important to examine Revenue’s approach to the past cases that were settled.
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Regards
Tirthesh Bagadia
Partner
Bagadiya & Jain
www.bagadiyanjain.com
https://mailchi.mp/98e65d5a6281/sc-rules-on-mfn-application-to-tax-treaties?e=9eb06328bd
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