October 25, 2023
India's Supreme Court rules 'notification' mandatory to invoke Most Favored Nations clause in India's tax treaties
On 19 October 2023, the Indian Supreme Court (SC) pronounced a significant ruling1 on the applicability of Most Favored Nation (MFN) clause found in some of India's tax treaties as under:
This Alert summarizes the SC ruling and relevant considerations for taxpayers.
In similar litigation, some state High Courts in India have ruled in favor of the taxpayers, concluding that applicability of the MFN clause is automatic and once the tax treaty (which contains the Protocol including the MFN clause) has been "notified," there is no need for the Protocol to be separately notified or for the beneficial provisions of the third State to be separately notified. The High Court in a separate ruling, also extended the benefit of a lower 5% withholding tax rate on dividend income as available in India's DTAAs with Slovenia/Lithuania/Columbia, though these countries became OECD members subsequent to signing of tax treaties.
The issue was submitted to the SC for consideration.
The SC, after consideration of the issue presented, pronounced that to invoke the beneficial provisions of a tax treaty pursuant to the MFN clause, India is required to specifically issue a notification to this effect. Absent a specific notification reflecting consequential amendment, MFN provisions cannot be invoked.
Key findings from the SC ruling are:
Regarding when a third country should be an OECD member whose beneficial treatment is accorded by invoking the MFN clause, the Court held that the verb "is" used in this MFN clause — "third state which is a member of OECD" — is written in the present tense and, thus, to claim the favorable benefits at issue, the third State should be a member of OECD at the time it enters into a tax treaty with India.
Impact of the ruling
This is a significant ruling in the context of interpreting Indian tax treaties. Given that the decision was pronounced by the apex court, it will be regarded as the law of land and binding on all parties.
The SC decision is likely to affect claims that nonresident taxpayers have made regarding restrictive source taxation of interest, royalties, fees for technical services, dividends, etc. by relying on the MFN provisions and its scope as understood by lower courts.
As a binding SC decision, the ruling may impact all pending assessments and related proceedings irrespective of the stage of the particular dispute. It may be necessary to assess the potential effects of the SC decision on previous tax positions taken by taxpayers and withholding agents.
This impact analysis will need to take into account, among other things, potential risks of tax reassessment and applicable time limits, associated interest cost, penal consequences and associated reserves positions in the books.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India)
Ernst & Young LLP (United States), Indian Tax Desk
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
Ernst & Young LLP (United States), Asia Pacific Business Group, New York
Ernst & Young LLP (United States), Asia Pacific Business Group, Chicago
Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1 TS-616-SC-2023, decision dated 19 October 2023.
2 E.g., Netherlands, France, Switzerland, Sweden, Spain, Hungary.
3 For example, India signed a DTAA with Slovenia in February 2005, but Slovenia became an OECD member in July 2010.
4 E.g., certain tax treaties, like the India-Netherlands tax treaty, India-France tax treaty and India-Switzerland tax treaty, wherein notification under Section 90 of the ITL has been issued giving effect to the beneficial treatment of tax treaties entered into by India with US, UK, Germany, etc. For example, Notification SO 693 (E) dated 30 August 1999 reduced the rate/scope of tax under Article 10, 11 and 12 of India-Netherlands tax treaty to give effect to the beneficial rate and scope of tax in the India-Sweden and India-US tax treaties.