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| CBDT clarifies the legal interpretation of the MFN clause |
To bring parity in the tax treatments for the Organisation for Economic Cooperation ad Development (OECD) member nations, the concept of Most Favoured Nation (MFN) is prevalent under International tax laws. MFN is an international concept in a tax treaty that entitles the eligible tax residents to adopt the beneficial treatment (by way of a lower rate or restricted scope) accorded to a third country (OECD members). However, the matter of interpretation of the MFN clause has always been a matter of discussion not just domestically but across countries.
Before analyzing the Central Board of Direct Taxes (CBDT) circular, it is paramount to highlight the common interpretational issues arising from the MFN clause:
Issue
Post-April 2020, dividend taxation has been shifted in the hands of shareholders. Typically, for non-resident shareholders, dividend taxation is as per the provisions of the Indian Income-tax Act, 1961, or relevant tax treaties. Indian Tax Treaties typically have a tax rate of 10%-15% for dividends. However, in some Treaties, the rate can be reduced to 5% based on the MFN Clause.
India's Double Taxation Avoidance Agreement (DTAA) with the Netherlands, France, the Swiss Confederation, Sweden, Spain, Hungary, etc., contains protocol providing the MFN clause. Though each MFN clause has a different formulation, the general underlying provision is that if after the signature of the DTAA of the first contracting state, Indian enters into a DTAA with another OECD member state, wherein India limits its source taxation rights (either scope or rate) in relation to certain items of income (such as dividends, interest income, royalties, fees for technical service, etc.), then such beneficial treatment would also be extended to the first-mentioned state.
After the DTAA with the aforementioned European Nations, India has entered into treaties with Slovenia, Lithuania, and Columbia, providing beneficial provisions. All these three nations are members of the OECD. However, none of these nations were members of OECD at the time of entering into the DTAA with India by various European nations like Netherlands, France, Swiss Confederation, Sweden, etc.
The common interpretational questions that arise are as follows:
- Whether the other contracting state should be an OECD member nation at the time of signing DTAA with India or the benefit can be extended even where the other contracting state becomes OECD member country subsequent to signing DTAA with India;
- Whether a separate notification under Section 90 shall be required for importing such beneficial provision in the DTAA or such provision can be imported automatically.
Countries like the Netherlands and France had earlier issued decree/bulletin/Publication declaring that the tax rate on dividends under respective DTAAs will stand modified under the MFN clause after India entered into DTAA with Slovenia, which became an OECD member on 21 July 2010. Furthermore, such beneficial provision will be applicable retrospectively from the date Slovenia became a member of the OECD. After the Netherlands and France, the Swiss Confederation also issued a unilateral publication providing that the India-Swiss Confederation DTAA shall stand modified after India entered into DTAA with Lithuania and Colombia, and such beneficial provisions will be applicable retrospectively from the date these countries have become OECD Members.
Taking reference from these decree/bulletin/Publications, recently, the Delhi High Court (HC), in a writ petition in the case of Concentrix Services Netherlands BV Vs ITO (TDS) and ANR1 and Optum Global Solutions International BV Vs DCIT and ANR2 held that there may be a hiatus between the dates on which the DTAA is executed between India and the third country and the date when such third country become a member of OECD. However, the aforementioned conditions should not exist necessarily when the subject DTAA was executed but when a taxpayer intends to avail the benefit. Furthermore, where protocol provides for the MFN clause, no separate notification shall be required to extend beneficial provisions of India's DTAAs with Slovenia, Lithuania, and Columbia.
CBDT's clarifications on the interpretation of the MFN clause
Taking account of the precedents set by the courts on the applicability of the MFN clause, the CBDT, on 3 February 2022, issued a clarification on the legal interpretation adopted by India on the applicability of the MFN clause. We have enlisted below synopsis of the CBDT circular:
- It has been clarified that for the applicability of the MFN Clause, the third state has to be an OECD member on the date of the conclusion of DTAA with India.
- The unilateral decree/bulletin/Publications do not represent a shared understanding of India and the respective treaty partners and would have no binding force. At best, these unilateral decree/bulletin/Publication only represent the views of the respective governments for providing relief from the respective country's tax.
- A government notification under Section 90 shall be required to import provisions of any third country into the concerned DTAA by virtue of the MFN clause. The provisions will not be applied automatically.
- The DTAAs with Slovenia and Lithuania contain split tax rates for the dividend. A tax rate of 5% is provided if the capital holding is at least 10%, and the tax rate of 15% is provided for other cases. The CBDT provides that without prejudice to the above, where any provision of these treaties is to be imported in India's treaties with the countries with the MFN clause, selective import would not be allowed. Where a beneficial rate of 5% is imported, the tax rate of 15% should also be made applicable for other cases.
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1. W.P.(C) 9051/2020
2. W.P.(C) 882/2021, CM Appl. 2302/2021
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Our Comments
Basis the circular, the beneficial tax rate of 5% would not be available for the abovementioned tax treaties. It is interesting to note that the circular specifies that where the taxpayer has received a favorable order, the circular will not affect the implementation of the court order. From a taxpayer's perspective, the courts interpreted the MFN clause favorably, whereas the circular has a contrary view. This could now lead to long-drawn litigation as taxpayers would have already adopted this position based on various decisions of the Delhi High Court. Also, there have been various decisions that have held that the application of the MFN clause is automatic (unless the Treaty provides for the issuance of notification), and various decisions have granted the benefit of MFN clauses. The CBDT circular mentions that government notification is required for importing provisions of any third country into the concerned DTAA by virtue of the MFN clause is also contrary to the settled position of law.
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