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Supreme Court ruling on the Most Favoured Nation clause likely to withhold benefits for taxpayers

17 Nov 2023

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The Supreme Court recently delivered a judgment denying lower rates and narrower scope of taxation to non-residents claiming benefits under Most Favoured Nation clauses if the third state was not an OECD member when India signed the DTAA with it. The judgment lays down the law in India on interpretation and application of DTAAs and is likely to have far-reaching consequences for non-resident taxation in India.
Partner: Meyyappan Nagappan, Associates: Vibhore Batwara, Shweta Mallya and Himanshu Raghuwanshi.

The Supreme Court of India (Supreme Court) recently delivered its much-awaited judgment in the case of Assessing Officer v Nestle (MFN Judgment).1 The Supreme Court ruled in favour of the tax authority, denying benefits to non-residents claiming a lower rate or a narrower scope of taxation on dividends, interest, royalty or fee for technical services (FTS) basis the MFN clauses present in India’s double taxation avoidance agreements (DTAA). While the judgment was in the context of India’s DTAA with France, Netherlands, and Switzerland, it lays down the law for interpreting and applying MFN clauses in all of India’s DTAAs. Moreover, the Supreme Court’s observations with regard to notification requirements for enforcing an MFN clause are likely to cause a ripple effect that can go far beyond the interpretation of MFN clauses and may fundamentally impact non-resident taxation in India.

The Dispute and the Ruling

India’s DTAAs with a number of jurisdictions contain MFN clauses that require India to restrict its taxing rights with regard to dividends, interest, royalty and FTS to the extent restricted in its DTAAs with other OECD member states (Third State).2 However, there has been a long-standing dispute between the taxpayers and the tax authority with regard to the point at which the Third State’s membership to OECD is to be tested. The tax authority maintained that the Third State needs to be an OECD member at the time it enters into the DTAA with India, whereas, the taxpayers have insisted that the Third State needs to be a member of the OECD only when the taxpayer claims the benefit under the MFN clause.

In this regard, the Supreme Court addressed the following issues: (1) Whether the MFN clause may be invoked when the Third State with which India entered into a DTAA was not an OECD member at the time of entering into the DTAA but is an OECD member when the taxpayer is claiming the benefits under the MFN clause; and (2) Whether the benefit under an MFN clause can be claimed automatically upon the happening of the trigger event or whether a separate notification is required for such benefit to apply.

The Supreme Court has set aside lower court judgments that ruled in favour of taxpayers3 and has held that (i) taxpayers resident in MFN jurisdiction can claim benefit of the MFN clause only if the Third State was a member of the OECD when it entered into the DTAA with India, and (ii) even upon satisfaction of the requirements of the MFN clause, it does not apply automatically, since a separate notification by Indian tax authority specifically extending the benefits of the MFN clause upon happening of the trigger event is required for taxpayers to avail the benefits of the MFN clause.

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