'Most Favoured Nation' Clause – Insight from India’s perspective

The Most Favoured Nation’s (MFN) origin can be traced back to the international trade agreements of the World Trade Organization (WTO). Under WTO agreements, countries cannot discriminate between their trading partners. Likewise, in the context of tax treaties, the MFN clause is typically placed in the ‘protocols’ to tax treaties to ensure that residents of a particular country should not be treated less favorably in comparison to residents of other countries or a group of other countries. By virtue of the MFN clause in several Indian tax treaties, the tax rate or the scope/coverage of tax is restricted to rates/scope present in other beneficial tax treaties.

India’s tax treaties with some Organisation for Economic Co-operation and Development (OECD) member States such as the Netherlands, France, the Swiss Confederation, Sweden, Spain, and Hungry contain MFN clauses of varying scope in the protocols to the concerning treaties. Even certain non-OECD States, such as Saudi Arabia and the Philippines, contain the MFN clause. The applicability of the MFN clause in Indian tax treaties has been subject to litigation. Till the recent past, the application of the protocol to tax treaties (and therefore, consequent application of MFN clause) was generally considered automatic and was not dependent upon any further action by the respective governments. Furthermore, an exception to this appears in India’s tax treaties with the Philippines and Switzerland, where a specific enabling action is required from the respective governments to give effect to the MFN clause.

In 2014, the Authority for Advance Ruling (AAR) in the case of Steria (India)1 Ltd, construed the protocol to the India-France tax treaty in a restricted manner, suggesting that the protocol can be used for interpreting provisions of the tax treaty but not for importing words, phrases or clauses from other tax treaties that are not already present in the base tax treaty. However, within a short span of the pronouncement of the ruling by AAR, another ruling was pronounced by the Mumbai Tribunal in case of IATA BSP India2,which upheld the applicability of the MFN clause present in the protocol to India-France tax treaty, restoring the time-tested principles for interpretation of a tax treaty. Furthermore, the Delhi High Court in the case of Steria (India)3 also held that the protocol is an integral part of tax treaty and it will have equal effect as that of articles contained in the tax treaty.

Furthermore, it is pertinent to note that the Circular mentions that in case a taxpayer has obtained a favorable ruling from any court, the Circular should not affect the implementation of the court order in such a case. However, there is not much clarity on whether the Circular only refers to past decisions or future decisions. It is expected that the Supreme Court of India (Apex Court), would mostly address this controversy, providing much-awaited certainty on the same.

Accordingly, there was uncertainty about whether the beneficial treatment can be borrowed from a tax treaty with such a country that was not an OECD member at the time when the bilateral treaty was negotiated and instead became an OECD member later. In this regard, a unilateral decree/ bulletin issued by the Netherlands and France stated that the tax rate on dividends under the respective tax treaty with India stood modified under the MFN clause after India entered into a tax treaty with Slovenia. However, by applying the principle of parity and the principle of common interpretation with reference to a decree issued by the Dutch authorities, the High Court has granted the benefit of a lower withholding tax rate of 5% to dividends received by a Dutch tax resident from an Indian subsidiary company.

  • The Central Board of Direct Taxes (CBDT) of India has recently released a Circular4 dated 3 February 2022, wherein it has clarified its stance regarding the interpretation of the MFN clause. The Circular provides that benefit of a lower rate and restricted scope under the MFN clause will be extended only when all the below conditions are satisfied cumulatively:
  • The unilateral decree of a treaty partner does not represent a shared understanding of the applicability of the MFN clause.
  • The third State (the country whose lower restricted tax rate is to be considered) has to be an OECD member at the time of signing its treaty with India.
  • The benefit shall only be available after the date of entry in force with the third State, not from when it became a member of OECD.
  • India issues a separate notification under the Income Tax Laws for importing the favorable benefits of the third State treaty into the original treaty.

Accordingly, only if all the conditions mentioned above are satisfied, then the lower rate or restricted scope in the tax treaty with the third State is imported into the tax treaty with an OECD State having MFN clause from the date as per the MFN clause in the tax treaty, after following the due procedure under the IDTL. Typically, a circular issued by CBDT is binding on the tax officer and not on the taxpayer or Tribunal or other Appellate Authorities. It is pertinent to note that the tax authorities, specifically at the lower level, would place reliance on the said circular and deny the tax treaty benefit by importing the MFN clause.

It is imperative to note that even after the circular, the Pune Tribunal, in the case of GRI Renewable Industries S.L.5 held that no separate notification by India is required to secure the benefit of the MFN clause under the India-Spain income tax treaty. The Tribunal stated that the circular overlooks the plain language of the IDTL as seen in contrast to the language of the protocol, which treats the MFN clause as an integral part of the tax treaty. Furthermore, the Circular issued by the CBDT is binding on the tax authority, and also, the Circular cannot be applied retrospectively as it is disadvantageous to the taxpayer for taking benefit conferred by the treaty. Similarly, the Delhi High Court, in the case of Saint Gobain India Ltd6 has granted interim relief to the taxpayer by allowing the French shareholder to receive dividends after the deduction of tax at 10% under protest. The Delhi High Court specified that half of the tax withheld shall be subject to the judgment of the Court.

Furthermore, it is pertinent to note that the Circular mentions that in case a taxpayer has obtained a favorable ruling from any court, the Circular should not affect the implementation of the court order in such a case. However, there is not much clarity on whether the Circular only refers to past decisions or future decisions. It is expected that the Supreme Court would mostly address this controversy regarding India (Apex Court), which will provide much-awaited certainty on the same.

1. Steria India [TS-5588-HC-2016(DELHI)-O]
2. IATA BSP India [2014] 46 taxmann.com 150 (Mum. – Trib.)
3. Concentrix Services Netherlands B.V. ITO (W.P.(C) 9051/2020)
4. CBDT Circular No. 3/2022, dated 3 February 2022
5. GRI Renewable Industries S.L [TS-79-ITAT-2022(PUN)]
6. Saint Gobain India Ltd W.P.(C) 9316/2022 & CM APPLs.27903-27904/2022

Tax Street June 2022