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In a landmark decision, the Supreme Court of India recently rendered its highly anticipated judgment in the case of Assessing Officer v Nestle (MFN Judgment)[1]. The court sided with the tax authority, rejecting the claims of non-residents seeking preferential treatment, including a reduced tax rate or a more limited scope of taxation on dividends, interest, royalty, or fees for technical services (FTS) based on the Most Favored Nation (MFN) clauses embedded in India's double taxation avoidance agreements (DTAA). Although the ruling specifically pertained to India's DTAA with France, Netherlands, and Switzerland, its implications extend across all of India's DTAA arrangements. Notably, the Supreme Court's insights on the notification requirements for enforcing an MFN clause are poised to trigger broader ramifications, potentially reshaping the landscape of non-resident taxation practices in India.
Separate Notification Requirement:
One of the pivotal findings of the Supreme Court's ruling is the necessity of a separate notification under Section 90(1) of the Income Tax Act, 1961, for availing the benefits of MFN clauses. The court emphasized that such notifications are mandatory to give effect to any DTAA or its protocol that alters existing provisions of the law. This decision marks a departure from previous interpretations, with the court asserting that legislative action is essential to make DTAAs binding on Indian nationals.
The court reasoned that, despite the exclusive power of the Union to enter into DTAAs, the Parliament holds the authority to enact them into law. Without such enactment, DTAAs do not automatically bind Indian nationals. Unilateral orders from foreign governments were deemed unreliable for interpreting DTAAs in India, highlighting the distinction in the assimilation process between countries and the legislative action required in India. The court reinforced the practice of issuing a separate notification under section 90 to ensure the proper incorporation of MFN benefits into the tax treaties.
Time of OECD Membership:
The Supreme Court also addressed the timing of OECD membership for a third country to qualify for MFN benefits. It clarified that the phrase "is a member" implies present significance, emphasizing that the third country must be an OECD member at the time of entering into a DTAA with India. This clarification sets a stringent standard for the application of the MFN clause, ensuring that the benefit is linked to the contemporaneous OECD membership of the third country.
Conclusion and Implications:
In addressing concerns, the Supreme Court has examined two critical issues. Firstly, it explored the applicability of the Most Favored Nation (MFN) clause when the Third State involved in a Double Taxation Avoidance Agreement (DTAA) with India was not an OECD member during the agreement's inception but later became one when the taxpayer seeks benefits under the MFN clause. Secondly, the Court scrutinized whether the advantages under an MFN clause automatically come into effect upon the occurrence of the triggering event or necessitate a distinct notification for their application.
Contrary to prior judgments favoring taxpayers, the Supreme Court, in its decision, has overturned these rulings. It asserts that residents in an MFN jurisdiction can only claim the benefits of the MFN clause if the Third State was already an OECD member at the time of entering into the DTAA with India. Furthermore, the Court clarified that even if the conditions of the MFN clause are met, the benefits do not automatically apply. Instead, a separate notification from the Indian tax authority, explicitly extending the MFN clause's benefits upon the triggering event, is indispensable for taxpayers to avail themselves of these advantages.
The Supreme Court's ruling represents a significant departure from previous decisions by lower courts and tribunals. The decision's binding nature on lower courts and taxpayers establishes a precedent for interpreting DTAAs, particularly in cases where claims were previously made based on a different understanding.
Taxpayers are advised to verify that the Government of India has formally notified the relevant MFN clauses and the consequent changes before making claims for benefits. The ruling's impact extends to ongoing and pending cases, necessitating a reevaluation of claims made under the previous understanding upheld by lower courts.
References:
[1] Assessing Officer v Nestle SA, Civil Appeal no. 1420 of 2023