May 03, 2024

MFN Clause in India-Spain DTAA invoked !!

Most favored nation (‘MFN’) clause in few of the DTAA(s) that India has with other countries, and its operation, has been a subject matter of interpretation by the Hon’ble Apex Court in Assessing Officer (International Taxation) v. Nestle SA,[1] very recently. Prior to that, it seemed settled that once India enters into a DTAA with another country, which prescribes for beneficial tax treatment in respect of rate or scope for a particular type of income, such beneficial treatment will automatically be accorded to tax residents of a country that has a DTAA with India containing an MFN clause concerning such type of income. However, the Hon’ble Apex Court, after navigating through principles of international law, has inter alia declared that there would be no automatic conferment of benefit unless the DTAA containing the MFN clause is suitably amended which is notified as per Section 90 of the Income-tax Act, 1961 (‘Act’).[2]

This particular view was based on the treaty practice which was evident in light of the amendment to India-Netherlands DTAA as a result of MFN clause contained therein. To elaborate, the MFN clause in the India – Netherlands DTAA, inter alia provided that after the signing of this DTAA, if India entered into a DTAA with another country[3] that provided a lower rate or restricted scope as far as taxation of “royalty” and “fees for technical services” (‘FTS’) was concerned, then as from the date on which the latter DTAA enters into force, the same rate or scope as contained therein would also apply under the India – Netherland DTAA. Thereafter, the India – Netherlands DTAA was specifically amended with effect from April 01, 1997 and inter alia the definitions of the terms “royalty” and FTS as contained in India – USA DTAA were substituted in place of the already existing definitions in India – Netherlands DTAA.[4] In that view of the matter and as a result of the decision of the Hon’ble Apex Court, the MFN clause contained in all the DTAAs that India has with other countries, except India-Netherlands DTAA, was rendered a dead letter in the absence of identical amendments to such DTAAs.

Very recently, the Government of India, through a Notification dated March 19, 2024[5] has invoked the MFN clause in the India – Spain DTAA, thereby reducing the erstwhile tax rate of 20% on FTS and certain kinds of “royalty” income to 10%. This invocation is specifically based on the lower rate of tax on FTS and “royalty” as provided for in India – Germany DTAA, which provides for 10% rate on FTS and royalty since its entering into force on October 26, 1996. This event, which has taken place after almost 26 years, certainly raises the question whether there existed any treaty practice that Government of India canvassed before the Hon’ble Apex Court in the first place[6]?  Nevertheless, it may be noted that while the rate of tax has been reduced, there is no alteration in the definition of the terms of “royalty” or FTS as contained in India – Spain DTAA.

[1] Assessing Officer v. Nestle SA., [2023] SCC OnLine SC 1372, [Order dated October 19, 2023 (Supreme Court)].

[2] Review petition is pending before the Supreme Court of India.

[3] Organisation for Economic Cooperation and Development member.

[4] It was the substituted definition of the term FTS, which prescribed incremental conditions to be satisfied, such as the “make available” clause, which became a subject matter of dispute between the taxpayers and income tax authorities owing to the wider definition of FTS in the Act and the overriding effect of DTAAs over the Act.

[5] Notification No. 33/2024 dated March 19, 2024.

[6] The domestic tax rate on royalty / FTS as provided in Section 115A of the Act has been increased to 20% (plus applicable surcharge and cess) vide Finance Act, 2023. Therefore, the reduction of tax rate from 20% to 10% in the India-Spain DTAA will be beneficial to the recipient, offering a more favorable tax treatment.




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