Supreme Court Clarifies Most Favored Nation Clause in Tax Treaties: Assessing Officer vs. Nestle SA (2023)

Introduction

Date of the Judgment: 19 October 2023
Citation: 2023 INSC 928
Judges: S. Ravindra Bhat, J., Dipankar Datta, J. (authored by S. Ravindra Bhat, J.)
Can a country automatically claim tax benefits under a Double Taxation Avoidance Agreement (DTAA) when another country, which is a member of the Organisation for Economic Co-operation and Development (OECD), gets more favorable terms in a later treaty with India? The Supreme Court of India recently addressed this complex issue, clarifying the scope and applicability of the Most Favored Nation (MFN) clause in tax treaties. The core question was whether the MFN clause operates automatically or requires a separate notification by the Indian government to take effect.

Case Background

The case involves appeals against decisions of the Delhi High Court concerning the interpretation of the Most Favored Nation (MFN) clause in various Indian tax treaties with OECD member countries. The core issue revolves around whether a lower tax rate or a more restricted scope of taxation agreed upon with one OECD country automatically applies to another country’s DTAA with India.
The dispute arose when several companies, including Steria India, Concentrix Services Netherlands BV, Optum Global Solutions International BV, and Nestle SA, sought to avail the benefits of lower withholding tax rates or more restricted definitions of ‘fees for technical services’ based on the MFN clauses in their respective DTAAs with India.

Timeline

Course of Proceedings

The Authority for Advance Ruling (AAR) initially ruled against Steria, stating that the Protocol to the India-France DTAA could not be treated as part of the DTAA itself and required a separate notification for the MFN clause to be operational. The Delhi High Court reversed this decision, holding that a Protocol is part of the treaty and does not need separate notification.
In the cases of Concentrix and Optum, the revenue authorities issued certificates with a 10% withholding tax rate instead of the 5% claimed by the assessees. The Delhi High Court, relying on its earlier decision in Steria, ruled in favor of the assessees, stating that the MFN clause in the India-Netherlands DTAA applied automatically once the conditions were met.
The revenue department appealed these judgments, leading to the current Supreme Court case.

Legal Framework

The core legal provision is Section 90 of the Income Tax Act, 1961, which empowers the Central Government to enter into agreements with foreign countries to avoid double taxation and to implement these agreements through notifications. The section states:

“The Central Government may enter into an agreement with the Government of any country outside India…for the granting of relief in respect of…income on which have been paid both income-tax under this Act and income-tax in that country…and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.”

The MFN clauses in the DTAAs between India and Netherlands, France, and Switzerland are also crucial. These clauses stipulate that if India enters into a DTAA with another OECD member country providing for a lower tax rate or a more restricted scope of taxation, the same benefit should also apply to the first country.

Arguments

A. Revenue’s Arguments:

• The revenue contended that under Article 253 of the Constitution of India, Parliament has the exclusive power to legislate on treaties, and without enabling legislation, such treaties are unenforceable.
• They argued that India follows a “dualist” practice, where international treaties do not automatically become part of municipal law and require enabling legislation, unlike “monist” countries.
• The revenue relied on Section 90 of the Income Tax Act, 1961, which requires a notification to give effect to any treaty or convention. They argued that the MFN clause cannot be triggered automatically and needs a separate notification.
• The revenue pointed out that after Slovenia entered the OECD in 2010, a protocol was signed between India and France, which was notified in 2012. This, they argued, shows that OECD membership does not automatically grant benefits.
• The revenue highlighted that the 1999 notification for the India-Netherlands DTAA was triggered by benefits given to the USA, Germany, Sweden, and the UK, and not by the mere fact of another country being an OECD member.
• The revenue argued that the High Court’s reliance on executive orders from Switzerland, the Netherlands, and France was erroneous, as these orders cannot bind Indian revenue authorities.
• They contended that the word “is” in the MFN clause signifies the time of signing of the treaty with the third country, not any future date, and that the third country must be an OECD member at the time of signing the treaty with India.
• The revenue argued that the notifications amending existing DTAAs show that they were preceded by negotiations and communications, indicating that there is no automatic applicability of benefits.

B. Assessees’ Arguments:

• The assessees argued that once a DTAA and its Protocol are notified under Section 90(1) of the Income Tax Act, 1961, no further notification is required for subsequent amendments triggered by the MFN clause.
• They contended that the MFN clause in the India-Netherlands DTAA is self-operative and does not require a separate notification.
• The assessees highlighted that the MFN clause in the India-Switzerland DTAA originally required negotiations but was later amended to apply automatically.
• They referred to the MFN clause in the India-Finland DTAA, which requires India to inform Finland authorities and notify beneficial provisions, and the India-Philippines DTAA, which requires countries to inform each other and review provisions.
• The assessees argued that the different language used in DTAAs indicates the intent of the contracting states and cannot be disregarded.
• They submitted that the 1999 notification for India-Netherlands DTAA was unilateral and did not clarify if both states agreed to its contents, unlike bilateral amendments.
• The assessees relied on the Dutch decree of 1998, which clarified that the MFN clause is automatic, and other similar decrees from France and Switzerland.
• They argued that the word “is” in the MFN clause refers to the time when the benefit is invoked, not necessarily when the DTAA was signed, and that the third country need only be an OECD member at the time the benefit is claimed.
• The assessees argued that the revenue’s objection that Lithuania, Colombia, etc., were not OECD members at the time of signing the India-Netherlands DTAA was not the reason given for rejection in the original order.

Submissions Categorized by Main Submissions:

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether a separate notification under Section 90 of the Income Tax Act, 1961 is required to give effect to the MFN clause in a DTAA?
2. Whether the MFN clause operates automatically once the conditions are fulfilled, or does it require a separate notification?
3. Whether the term “is” in the MFN clause refers to the time of signing of the treaty with the third country or any future date?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

The Supreme Court considered various authorities, categorized by legal point:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• Gramaphone Co. of India Ltd v. Birendra Bahadur Pandey & Ors. [1984] 2 SCR 664: Cited to establish that international law is incorporated into national law unless it conflicts with an Act of Parliament.
• Union of India (UOI) & Ors. v. Azadi Bachao Andolan & Ors. 2003 (Supp 4) SCR 222: Cited to affirm that Section 90 empowers the Central Government to issue notifications for implementing DTAAs.
• Ram Jethmalani v. Union of India [2011] 339 ITR 107 (SC): Cited to emphasize that treaties should be interpreted using the ordinary meaning of words.
• Sanofi Pasteur Holding SA v. Department of Revenue [2013] ITR 354 (AP HC): Cited to support the principle of interpreting treaties using the ordinary meaning of words.
• State of W.B. v. Jugal Kishore More 1969 (1) SCR 320: Cited to highlight that treaties require an Act of Parliament for enforcement.
• State of Gujarat v. Vora Fiddali Badruddin Mithibarwala 1964 (6) SCR 461: Cited to show that treaties do not automatically have the force of law in India.
• V.O. Tractoroexport v. Tarapore & Co (1969) 3 SCC 562: Cited to underline that domestic legislation must be construed first, and treaties are relevant if the meaning of the legislation is unclear.
• Maganbhai Ishwarbhai Patel & Ors. v. Union of India & Ors. 1970 (3) SCR 53: Cited to distinguish between the formation and performance of treaty obligations.
• Union of India of India v. Agricas LLP [2020] 14 SCR 372: Cited to emphasize that the State cannot breach a treaty by referring to domestic law.
• Engineering Analysis Centre of Excellence P. Ltd. v. CIT (2021) 432 ITR 471(SC): Cited to support that mere executive position cannot alter the law under the DTAA.
• Director of Income Tax v New Skies Satellite BV (2016) 382 ITR 114: Cited to emphasize that mere executive position cannot alter the law under the DTAA.
• Jagir Kaur v. Jaswant Singh (1964) 2 SCR 73: Cited to explain that the term “is” is fact-dependent and must be read contextually.
• P. Anand Gajapati Raju v. P.V.G Raju (2000) 4 SCC 539: Cited to explain that “is” normally has present signification but can have future or past meaning depending on the context.
• Vijay Kumar Prasad v. State of Bihar (2004) 5SCC 196: Cited to reiterate that “is” refers to the present but can have future or past meaning contextually.
• Section 90 of the Income Tax Act, 1961: Cited as the core legal provision empowering the Central Government to enter into agreements with foreign countries to avoid double taxation.
• Article 253 of the Constitution of India: Cited as the provision granting Parliament the exclusive power to legislate on treaties.
• Vienna Convention on the Law of Treaties, 1969 (VCLT): Cited as a source of customary international law for treaty interpretation, even though India is not a signatory.

Decision

The Supreme Court held that:

• A separate notification under Section 90 of the Income Tax Act, 1961, is required to give effect to the MFN clause in a DTAA.
• The MFN clause does not operate automatically once the conditions are fulfilled; it requires a separate notification.
• The term “is” in the MFN clause refers to the time of signing of the treaty with the third country, not any future date.

The Court set aside the judgments of the Delhi High Court and ruled in favor of the revenue department.

Ratio Decidendi

The ratio decidendi of the judgment is that:

• The MFN clause in a DTAA cannot operate automatically without a separate notification under Section 90 of the Income Tax Act, 1961.
• The term “is” in the MFN clause has present signification and refers to the time of signing the treaty with the third country, not any future date.
• Treaties do not automatically become part of municipal law in India and require enabling legislation or notification for implementation.

Obiter Dicta:

• The Court observed that while international law is incorporated into national law, it cannot override an Act of Parliament.
• The Court noted that India follows a dualist practice, where international treaties do not automatically become part of municipal law.

Flowchart

Ratio Table

Sentiment Analysis

Conclusion

The Supreme Court’s decision in the Assessing Officer vs. Nestle SA case provides crucial clarity on the interpretation and application of the Most Favored Nation (MFN) clause in Double Taxation Avoidance Agreements (DTAAs). The Court’s ruling that a separate notification is required for the MFN clause to be effective, and that the term “is” refers to the time of signing of the treaty with the third country, has significant implications for international taxation in India. The judgment underscores the importance of adhering to the specific language of each DTAA and the Indian government’s notification requirements. It also highlights the dualist approach followed by India, where international treaties do not automatically become part of municipal law and require enabling legislation or notification for implementation. This judgment will likely serve as a key precedent in future cases involving the interpretation of MFN clauses in Indian tax treaties.