Direct Tax Alert - CBDT clarifies on applicability of MFN Clause

Background

India’s has a significant Double Tax Avoidance Agreement (DTAA) network with several countries, with some DTAA’s containing a Most Favoured Nation (MFN) clause. As per the said clause, if India enters a DTAA on a later date with a third country which is an OECD member, providing a beneficial rate of tax or restrictive scope for taxation, a similar benefit will be available to the first country. A question on applicability of MFN clause arises when a country becomes an OECD member after entering a DTAA with India. This issue has been a matter of litigation in India over the last few years. Recently, the Delhi High Court in case of Concentrix Services Netherlands BV¹ has examined this issue and held that the MFN clause shall be applicable from the date when the third State became an OECD member country. Please click here to read our alert on the ruling in detail.

Further, with respect to the applicability of India’s MFN clause, certain countries have issued decree/bulletin/publication as under:

• Netherland - the Directorate General for Fiscal Affairs, International Fiscal Affairs, Netherlands (Decree No. IFZ2012/54M dated 28 February 2012) ("the decree")²;
• France - the French Official bulletin for Public Finances – Taxes (Bulletin Officiel des Finances Publiques-Impots) published by DGFIP on 4 November 2016 (“the bulletin”)²; and
• Switzerland - the publication by the Federal Department of Finance, the Swiss Confederation on 13 August 2021 ("the publication")³.

Representations were received by the Central Board of Direct Taxes (CBDT) from taxpayers and tax officials seeking clarity on India’s stand on application of MFN clause. In this respect, recently, CBDT has issued a Circular⁴ clarifying the conditions that should be satisfied to avail the benefit of MFN clause in the protocol to India’s DTAAs.

We, at BDO in India, have summarised this Circular and provided our comments on its impact hereunder:

Applicability of the decree / bulletin / publication

• These decree/bulletin do not represent the shared understanding on MFN clause and have no binding force as far as interpretation of MFN clause in the respective DTAA is concerned.
• Since these decree/bulletin were passed without any discussion or consultation with the Government of India, it would not have any effect on curtailing the tax liability that is payable to the Government of India under the respective DTAA.

Conditionality for the third country being an OECD member on the date of conclusion of DTAA

• There is a requirement that the Third Country is to be an OECD member both at the time of conclusion of the DTAA with India as well as at the time of applicability of the MFN clause. Therefore, it is clarified that for applicability of MFN clause, the Third Country has to be an OECD member country on the date of conclusion of the DTAA with India.
• India's DTAA with the Third Country cannot be imported into the India-Swiss DTAA unless the Third Country was an OECD member at the time of signing that DTAA.

Application of concessional rates / restricted scope from the date of entry into force of the DTAA with Third Country and not from the date Third Country became an OECD member

• The intention of MFN clause in a Protocol of DTAAs is not to give benefit of India's DTAA with the Third Country which was not an OECD member when India entered into DTAA with it. For this, reliance is placed on Ram Jethmalani & Others⁵.
• MFN clause mandates the application of lower rate from the date of entry into force of Indian DTAA with a Third Country.
• The decree/bulletin/publication has no application so far as taxation liability of a person in India is concerned.

Requirement of notification under section 90 of the Income-tax Act, 1961 (IT Act)

• Under section 90(1) of the IT Act, DTAA or amendment to DTAA are implemented after its notification in the Official Gazette. For this, reliance is placed on Azadi Bachao Andolan⁶.
• India has not issued any notification importing the benefit of DTAA with Slovenia, Lithuania and Colombia to DTAA with The Netherlands, France or Swiss Confederation.

No selective import of concessional rates under the MFN Clause

• India's DTAA with Slovenia and Lithuania consist of a split rate of tax for dividend. The beneficial rate of 5% dividend income is applicable only if the company receiving dividend holds directly at least 10% of the company paying the dividends.
• Even though The Netherlands, France and the Swiss Confederation have taken this into account in their decree/bulletin/publication by providing that 5% rate will be applicable only when the condition of 10% ownership is satisfied, there is no sound rationale/basis provided for the selective import on account of not switching to 15% tax rate in other cases

Conditions to be satisfied for applying MFN clause

The applicability of the MFN clause and benefit of lower rate or restricted scope of source taxation rights provided in India's DTAAs with the Third Countries will be available only when all the following conditions are satisfied:

1. The second DTAA is entered into after the signature / Entry into Force (depending upon the language of the MFN clause) of the DTAA between India and the First Country
2. The second DTAA is entered into between India and a Country which is an OECD member at the time of signing the DTAA with it
3. India limits its taxing rights in the second DTAA in relation to rate or scope of taxation in respect of the relevant items of income; and
4. A separate notification has been issued by India, importing the benefits of the second DTAA into the DTAA with the First Country, as required by the provisions of section 90(1) of the IT Act

BDO Comments

The Circular provides that in case of a taxpayer, where there is any decision by any court on this issue favourable to such taxpayer this circular will not affect the implementation of the court order in such case. However, it is silent whether this exception will be limited to only that particular year for which the Court has given its ruling or to all the years. Furthermore, the exception is granted to only a Court order and not Tribunal/First Appellate Order/Tax Order. Hence, it needs to be seen whether the concluded matters which have not travelled to High Court could be selected for revision by the Commissioner.

Further, it is pertinent to note that this Circular will impact even a situation where the second DTAA is executed with an OECD member country, but the said DTAA is not notified by India, in light of the fourth condition. Thus, the beneficial tax rate/scope mentioned in the second country shall not apply automatically.

While the Circular is binding on a Tax Officer, the taxpayer can contend that it is not applicable to it and thereby if the above-mentioned conditions (especially fourth condition) are not satisfied, the benefit of DTAA should not be denied.