In a recent judgment, the SC ruled that a notification under Section 90(1) is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a DTAA, or any protocol that has the effect of altering the existing provisions of law. This judgement upsets the steady views on automatic enforcement of MFN Clause.

Mr. S. Ramanujam (Chartered Accountant), critically analyses the SC ruling in Nestle SA & Others. The author gives an overview of the MFN clause, need for the same and its significance. He apprises that the SC deliberated on the issues, whether the MFN Clause is to be given effect automatically or if it is to only come into effect after a notification is issued by the Government. The author opines that retrospective tax as suggested by media reports based on SC ruling may lead to dispute under Bilateral Investment Trade Agreements. He remarks that the Revenue authorities will have to address various questions of the affected parties before it can reap the monetary benefits resulting from the SC ruling.

“Tremors at Most Favoured Nations – Once Friendly, Now Unfriendly!”

INTRODUCTION :  If by reading the title , any reader mistakes this article as a `political one’ – talking about the contemporary happenings around India’s relationships with foreign Countries (including the diplomatic standoff with a long term friend), the author  begs their pardon and clarifies at the outset that he neither has the knowledge nor intention to stray from his chosen field of taxation  and his endeavour here is only to highlight the impact of a new SC ruling in Nestle’s Case pronounced last week. Though the company (one of the litigants in this case) is a Swiss Company, having a huge market share in` Baby food ‘(besides various other confectionary items) the verdict in this case which went against it, is not a kid – stuff that could be brushed aside, without much discussion.    

In the international arena, what is being witnessed in the other parts of the world also need to be looked at in this context. Nations living at close proximity to each other  peacefully till now, suddenly find themselves at cross purposes and become enemy nations to each other. This sudden change Impacts all, both common people as well as  big corporates – like the MNCs which operates all across the globe, Before setting up business in another country, they study a lot about the other Country’s environment – their  belief  and commitment to the rule of law, Political and other risks including  possible territorial aggression by its neighbours, the labour laws, the laws regarding free trade and a stable Central bank monitoring all the inflows and outflows of monetary trade etc. The foreign Companies expect a congenial and stable environment, including clear laws, good redressal systems in case of disputes,etc. Having been assured by the Former FM that as far as possible, laws enacted to collect revenues will not be made applicable with retrospective effect, many of the foreign companies did not look at India as a Country - a risky one to establish / run businesses. The recent SC Judgment referred above brought home another dimension to this issue - a boat can be rocked, not necessarily by the government alone!

Newspaper reports reveal that this judgment will make many MNCs cough up to Rs 11000cr by way of taxes retrospectively the law being pronounced now, upsetting many steady views that held the field till date. In this article few critical aspects found in this judgment are highlighted to make the readers understand the impact of this judgment.     

Need for MFN clause and its significance:

(i) Background behind   enactment of treaties:

With the ever-growing international trade, Countries have carefully crafted their Fiscal and economic policies in such a way that it gives a great assurance to the businessmen operating from one Country to explore the opportunities that lie by investing in other Country. In this context the DTAA entered between Countries helps the flow of trade in a big way. A Treaty is an agreement entered between two or more independent nations. There are well established international models developed over the years providing for clarity and guidance in mitigating or reducing the burden of taxation in respect of Income emanating from One Country to another person operating from the other Country, popular among them being the OECD model and the UN Model. As an eminent author put it. "These are bilateral agreements where the Countries concerned evaluate the sacrifice and the advantage which the treaty binges for each Country including the tax foregone and the compensating advantage.” Simply put, treaties bring the investors a great deal of confidence to carry their trade across the globe, that too, in an organised manner.

As stated already Treaties are international agreements, having their base grounded on Contract Act. Just like in other normal agreements, DTAA also can be expanded, modified, substituted, altered etc, so long as the Contracting parties agree. However if  the two Governments  wants to revise or enter into afresh treaty, there need to be lot of consultations between the Key personnel of the Countries, which many times spill over many years before the fresh agreements  are finally concluded and signed afresh. In the light of the above various governments  started evaluating  how to shorten the time that is normally taken to revise or modify a treaty  The governments felt the  need for a shorter version of changes to the treaty that need to be carried out urgently so that action is  taken, without much delay. These are called protocols that are exchanged between Countries and made a part of the Treaty Itself though notification. In essence, these Protocols signed between the Countries modify certain articles in the DTAA already entered between the Countries and are usually notified effective from particular date in the respective Countries. With many Countries, the Government of India has entered into protocol l- viz; UK, France, Germany, Netherlands, Slovenia, Lithuania, Columbia, and  Others – all coming many years after the First DTAA is signed ad curiously, some of them too contain MFN Clause.

What is MFN clause?

CBDT Circular Issued 3-2-2022 Extract –

Clarification regarding the Most – favoured nation (MFN) Clause in the protocol To India’s DTAAs with certain Countries:

The protocol  to India’s DTAAs with some of the   countries, especially European States and OECD members (The Netherlands , France, the Swiss confederation , Sweden, Spain and Hungary) contains a provision referred to as the Most –Favoured Nation (MFN) Clause. Though each MFN clause has a different formulation , the general underlying proposition is that after the signature / entry in force (depending on the language in the MFN clause ) of the DTAA with the first State, India enters into a DTAA with another OECD member State, wherein India limits its Source taxation rights in relation to certain items of income (such as dividends, interest income, royalty, fees for Technical services, etc) to a rate lower or a scope more restricted than the scope provided for these incomes in the DTAA with the First State, such beneficial treatment should also be extended to first State.

……………

NOTE:

(The Contents of this long circular (Only a small portion is reproduced above) is fully approved in this Judgment by the Hon'ble SC, though the issue disputed in these appeals pertains to 6 or 7 assessment Years before the date of issue of this Circular)   

Thus, one can infer the following from the above Extract:

(i) Countries enter into DTAA with other Counties periodically providing for concessional rate of tax on certain types of Income or eliminating double taxation of income in both the Countries.

(ii) There could be situations where new Countries are formed from the existing one or some other times, additional concessions are given to some countries (forming a block) so that trade with these Countries move at faster pace.

(iii) The MFN Clause – provides that if a country enters into a new Treaty with any other Country providing for concession of tax rates on certain income as stated above, then the sae beneficial treatment to be provided to the Country which has the MFN clause in the existing Treaty itself.

The issues that were raised in these appeals by the Department before the Hon’ble SC (broadly) are:

(i) whether there is any right to invoke the MFN clause when the third country with which India has entered into a Double Tax Avoidance Agreement (hereafter ‘DTAA’) was not an OECD member yet (at the time of entering into such DTAA).

(ii) whether the MFN clause is to be given effect to automatically or if it is to only come into effect after a notification is issued by the government:

Litigant’s case history    

A. In Steria India   case -  (refence to Indo – French Treaty)

(i) Here the Company contended before  the Authority of Advance Ruling( AAR ) that in terms of the protocol to the India-France DTAA, the more restrictive part of the definition of fee for Technical services appearing in the DTAA between India - UK should considered as forming part of the Indo – France DTAA as well this was due to article 7 of the protocol (MFN Clause ).

(ii) The AAR disagreed with the contention and held that the protocol could not be considered as forming part of the DTAA itself and the restriction is only  on  rates  and the 'make available clause’ in the Indo -UK agreement could not be read into the expression – 'Fee for technical services' in the Indo – French treaty  unless it is notified as such by the Indian government through separate notification. The AAR also rejected the other contention that t in view of the Article 7 of the Protocol, (MFN Clause) the same can be straight away operationalised.  

On a challenge before the Delhi HC, the HC held that there is no need for a separate notification as protocol is considered as part of the Treaty itself.

B. Second litigant – applicability of Indo – Netherlands Treaty as amended by protocol having MFN clause.

Here two Indian subsidiaries of a Netherlands Company declared dividends and sought concessional rate of TDS on the Dividends by stating that due to FMFN clause they are entitled to this concession as India has already entered into DTAA with certain other Countries provide for lower TDS on dividends. This application was rejected, and the companies contested this in Delhi HC.

Here the Delhi HC upheld the contention of the assessee and held that once India enters into a DTAA with a third Country providing for lower withholding tax, then automatically the MFN clause kicks in and there is no need for further notification to be  issued for this purpose.  

C. Third litigant – Nestle SA - Indo-Swiss Treaty:

Delhi HC allowed the assesse’ s case by looking at the amendments made through three protocols signed between the countries.

SC Judgment:

While analysing the facts and after looking at the other precedents laid down earlier by itself, The Hon`ble SC in an elaborate judgment in Nestle SA [TS-616-SC-2023] held as under: (some edited excerpts)

“The principles in the decisions discussed above may thus be summarized:

(i) The terms of a treaty ratified by the Union do not ipso facto acquire enforceability.

(ii) The Union has exclusive executive power to enter into international treaties and conventions under Article 73 [read with corresponding Entries - Nos. 10, 13 and 14 of List I of the VII Schedule to the Constitution of India] and Parliament, holds the exclusive power to legislate upon such conventions or treaties.

(iii) Parliament can refuse to perform or give effect to such treaties. In such event, though such treaties bind the Union, vis a vis the other contracting state(s), leaving the Union in default.

(iv) The application of such treaties is binding upon the Union. Yet, they "are not by their own force binding upon Indian nationals".

(v) Law making by Parliament in respect of such treaties is required if the treaty or agreement restricts or affects the rights of citizens or

others or modifies the law of India.

(vi) If citizens’ rights or others’ rights are not unaffected, or the laws of India are not modified, no legislative measure is necessary to give effect to treaties.

(vii) In the event of any ambiguity in the provision or law, which brings into force the treaty or obligation, the court is entitled to look into the international instrument, to clear the ambiguity or seek clarity.

………………

With respect to the cases involving the three treaties applicable to the three litigants, the Court held:

In the opinion of this court, the status of treaties and conventions and manner of their assimilation is radically different from what the Constitution of India mandates. In each of the said three countries, every treaty entered into the executive government needs ratification. Importantly, in Switzerland, some treaties have to be ratified or approved through a referendum. These mean that after intercession of the Parliamentary or legislative process/procedure, the treaty is assimilated into the body of domestic law, enforceable in courts.

However, in India, either the treaty concerned has to be legislatively embodied in law, through a separate statute, or get assimilated through a legislative device, i.e., notification in the gazette, based upon some enacted law (some instances are the Extradition Act, 1962 and the Income Tax Act, 1961). Absent this step, treaties and protocols are per se unenforceable.

In sum, whilst considering treaty interpretation, it is vital to take into account practice of the parties. There is no dispute that treaties constitute binding obligations upon them signatories. Yet, like all compacts, how the parties to any specific instrument view them, give effect to its provisions, and the manner of acceptance of such conventions or compacts are in the domain of bilateral relations and diplomacy. Much depends upon the relationship of the parties, the mutuality of them interests, and the extent of co-operation or accommodation they extend to each other. In this, a range of interests combine. The issue of treaty interpretation and treaty integration into domestic law is driven by constitutional and political factors subjective to each signatory. Therefore, domestic courts cannot adopt the same approach to treaty interpretation in a black letter manner, as is required or expected of them, while construing enacted binding law. The role of practice which is, as the previous discussion demonstrates, not bilateral or joint practice, but practice by one, accepted generally by the international community as operating in that particular sphere, which is relevant, and at times determinative.

This court is of the opinion that the treaty practice of Switzerland, Netherlands and France are dictated by conditions peculiar to their constitutional and legal regimes.

CONCLUSION:

In the light of the above discussion, it is held and declared that:

(a) A notification under Section 90(1) is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a DTAA, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law.

(b) The fact that a stipulation in a DTAA or a Protocol with one nation, requires same treatment in respect to a matter covered by its terms, subsequent to its being entered into when another nation (which is member of a multilateral organization such as OECD), is given better treatment, does not automatically lead to integration of such term extending the same benefit in regard to a matter covered in the Date of the first nation, which entered into DTAA with India. In such event, the terms of the earlier DTAA require to be amended through separate notification under Section 90.

(c) The interpretation of the expression “is” has present signification. 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, after entering into DTAA with India, such country becomes an OECD member, in terms of India’s practice.

The birds that flew away – Courtesy AAR   rulings of   the past:

In this context, it is worthwhile to look at the past cases where MFN clauses were interpreted favourably (!) in favour of the assesses and those decisions have become Final due to AAR rulings. It  may be remembered that under    sec 245 S, the advance rulings pronounced by the Authority is (i)  binding on the applicant (ii) in respect of the transaction in relation to the ruling which is sought (ii)On the principal CIT or CIT Or tax authorities subordinate to him in respect of the applicant and the said Transaction. 

Some Of the interesting cases Decided in the past By AAR / ITAT while interpreting MFN clauses are tabulated below:

Note: The Chapter Dealing with AAR has been made inoperative from 1-4-2021

Whether the SC ruling in Nestle’s Case will trigger international dispute / arbitration?

Mutual agreement procedure (MAP) – whether can be invoked in these cases?

Normally disputes between the parties covered under DTAA are resolved through mutual agreement procedure (MAP) where the Competent authorities in the two Contracting states discuss and try to resolve the Dispute on Hand. the model convention Provided in article 25 provides for following guidelines:

(i) Disputes where one of the parties’ residents in a State is of the view that tax liability that has arisen in his case is not in accordance with the Treaty provisions.

(ii) The Taxpayer can approach the Competent authority, irrespective of the Remedies available under domestic law ‘

(iii) The case must be presented within 3 years from the date of notification of the action resulting in taxation.

(vi) The Competent authorities would make all efforts to arrive at a satisfactory solution within a reasonable time.

(v) If The Competent authorities are unable to arrive at a satisfactory solution, then the matter can be referred to arbitration.

(vi) Any agreements reached between the Competent authorities shall be implemented irrespective of any time limits under the Domestic laws.

Note: GOI has issued Guidance and also Introduced a Rule 44G as to the procedure to be followed for raising issues under MAP (see guidance dated7-08-2020 and rule 44G)

Bilateral Investment Trade Agreements (BIT):- Whether arbitration under these agreements can arise in these cases?

One possible outcome in the aftermath of this SC decision that can happen is further Disputes that can arise by Invoking Bilateral Investment Trade Agreements (BIT) between the Countries taking the matter to international arbitration. India lost few cases   recently as in the case Of Dabhol power corporation (Enron) White Industries Australia limited, Vodafone, Cain Energy and so on. In the light of the above happenings, there is a new move by India to remove arbitration clauses in the BIT. Another attempt is to remove Tax disputes from the purview of Bilateral Agreements 

New developments In Treaty Modification – India has ratified  multilateral Convention to implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI)The MLI will modify India’s tax treaties to curb revenue loss through treaty abuse and base erosion and profit shifting strategies by ensuring that profits are taxed where substantive economic activities generating the profits are carried out. The MLI will be applied alongside existing tax treaties, modifying their application in order to implement the BEPS measures. (See press Note dated 02-07-2019.)

Conclusion:  Many questions that remain to be further resolved - like the usefulness of MFN clause added in the Treaties- what real purpose it serves? can this be considered as equivalent to an enabling resolution passed in the General body of shareholders of a company allowing the Management to borrow funds for operation by setting up a huge limit so that lot of flexibility is allowed to the Management to run the Business (without repeatedly approaching them)? If this is so, then the next question is why there is a need for separate notification to apply MFN clause? For the international Investor, the question is – can the Doctrine of indoor Management will not apply to Indian government (Doctrine of Indoor management refers to the Procedures that need to be followed by a company  under the Articles of Association with regard to the transaction proposed to be entered,  which the other party can presume to have been carried out by the Company to the fullest extent ) 

These questions will linger in the minds of legal experts for a long time as there may be further steps to conquer by the tax Authorities before the Tax recovery of Rs 11000 cr as estimated by the press Reports are recovered.

Question: In The international tax Dispute arena, are there more steps to climb after the SC verdict (before taxes can be recovered?)