The Hon'ble
The Apex Court ruled that a Notification under Section 90(1) of the Income-tax Act, 1961 (IT Act) is a necessary condition to give effect to a DTAA or any Protocol issued under the relevant DTAA (such as the MFN clause), to seek benefit of any beneficial clause extended to a third country DTAA. Also, the MFN clause can be invoked only if the third country was an
What is an MFN clause, its relevance, and the present dispute?
Before we proceed to discuss the ruling of the Apex Court, it is important to understand the concept of MFN with reference to DTAA and evolution of this dispute.
Concept
If a country (first state) incorporates an MFN clause in its DTAA with any country (second state), it obligates upon itself to extend beneficial treatment to the second state, which the first state has agreed with a third state at a later date. The benefit is extended only if the DTAA with the third state has been entered into after the DTAA with the second state has been executed. Generally, a reduced rate of tax or a restricted scope for taxation is agreed between the first and the third state, which benefit is extended to the second state. Thus, with the MFN clause, even though the reduced rate of tax or restricted scope for taxation was not agreed upon in the first instance between the first state and second state, the same is extended pursuant to such MFN clause.
Background of the controversy
One of the reasons for the current controversy to arise is that
The Hon'ble
As the claim for applicability of reduced rate of tax raised concerns (leading to litigation till the
- Decrees/ bulletin are unilateral actions taken by the treaty partners and do not represent a shared understanding.
-
In order to seek benefits, the third state should be an
OECD member on the date of entering into the DTAA as well as on the date when the benefit is being sought. - A Notification under Section 90(1) of the IT Act is a condition precedent to seek benefit under the MFN clause.
Ruling of the Hon'ble
a) Whether the MFN clause applies even if the third state with which
b) Whether the MFN clause in a DTAA can be invoked only through a separate notification or whether such provision operates automatically once a preferential tax rate benefit is extended to a third state?
Ruling of the Apex Court:
A) Requirement of being an
The interpretation adopted by the
B) Is there an automatic enforceability of a Protocol to the DTAA?
To arrive at a conclusion on this issue and to demonstrate that there was an established and clear precedent, of behavior, in relation to treaty practice and interpretation, the Apex Court deep dived into the India-Netherlands DTAA5 protocol and notifications. It observed that the Protocol to India-Netherlands DTAA incorporated an MFN clause to allow for lower tax rate and restricted scope with respect to dividends, interest, royalty, and fees for technical services, when
The Apex Court accordingly held that so far as India-Netherlands DTAA is concerned, there is an established and clear precedent, of behavior, in relation to treaty practice and interpretation. This was not contested and is a matter of record. It should be noted that similar notifications were not issued under the India-Netherlands DTAA, when
Basis the above discussion, the Apex Court held that entering into a treaty or a protocol does not result in its automatic enforceability. The treaty concerned has to be legislatively embodied in law, through a separate statute, or gets assimilated through a legislative device, i.e., notification in the gazette, based upon some enacted law. Absent this step, treaties and protocols are per se unenforceable. Accordingly, any benefits to be availed under the MFN clause should necessarily be backed by a notification to give effect to the Protocol/ change in terms of the DTAA.
Our thoughts
Though this ruling of the Apex Court has put to rest a controversial issue concerning MFN clause and given a finality to the issue; the implications can have far-reaching impact on the taxpayers and the manner in which each DTAA is interpreted. It will certainly impact entities/ individuals who would have either not paid taxes or paid taxes at a lower rate of tax by seeking a benefit under the MFN clause. This will have an impact on the pending assessments, and may also trigger initiation of re-assessment proceedings, wherever the limitation period permits.
The fact remains that on a literal reading and the treaty interpretation as has been prevailing, a taxpayer by seeking a benefit, pursuant to the MFN clause, has not committed any default or tax avoidance. Thus, it would be interesting to see if the Indian Government will now issue the required notifications retrospectively to allow the taxpayers to take benefit of the MFN clause.
Footnotes
1. Assessing Officer vs
2. TS-286-HC-2021DEL
3. TS-446-HC-2021DEL-
4. The other fact pattern discussed by the Apex Court was in the case of
5. Similar discussion was also taken in the case of India France DTAA and India Switzerland DTAA
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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