Sudin Sabnis and Yogesh Kale of Nangia Andersen LLP discuss the implications of a recent circular issued by the government of India regarding most favored nation clauses in tax treaties.
Over the past several decades, though India has entered into tax treaties with over 90 countries, the interpretation of various provisions of such treaties has continued to be subject to protracted litigation. Although tax treaties are bilateral agreements on which there is ample international material regarding the principles applicable to their interpretation, the courts of the respective treaty partner countries generally interpret the treaties in light of their own jurisprudence and settled principles.
However, as one of the avowed purposes of entering into a tax treaty is the equitable allocation of taxes on transactions that are taxable in both contracting states, the principle of “common interpretation” ought to be followed. Accordingly, official announcements by various countries setting out their understanding and interpretation of tax treaties may be used as aids to interpretation by other countries.
In India, the principle of “common interpretation” has not been used very often, but Indian courts have from time to time relied on foreign rulings and persuasive material, including technical explanations.
The Delhi High Court recently ruled in favor of the appellant taxpayer in Concentrix Services Netherlands B.V. v. ITO (TDS) [TS-286-HC-2021] on the issue of the interpretation of a most favored nation (MFN) clause. In this case, the taxpayer company (a tax resident of the Netherlands) sought to apply a lower rate of tax, as prescribed in the Indian tax treaties with Slovenia, Lithuania and Colombia, in relation to the dividend that it earned from its Indian subsidiary, relying on the MFN clause in the India–Netherlands tax treaty.
Referring to a unilateral decree issued by the Kingdom of the Netherlands (specifying that by virtue of the MFN clause the benefit of the lower rate of tax under the India–Slovenia tax treaty would apply) and resorting to the principle of common interpretation, the High Court upheld the taxpayer’s contention that as the said countries were members of the Organization for Economic Cooperation and Development (OECD) on the date of the transaction, the benefit of the lower rate under those treaties could be imported into the India–Netherlands tax treaty, even though thecountries were not OECD members on the dates on which the respective Indian tax treaties entered into force nor on the date on which the MFN clause became effective.
This case is now before the Supreme Court of India, which will decide whether an interpretation of a tax treaty based on a unilateral document issued by another country can really be considered a common interpretation.
Following on the heels of the Dutch decree, the Swiss Federal Department of Finance clarified its legal position on the MFN clause in the India–Switzerland tax treaty, adopting a similar logic to the one issued by the Dutch decree.
“Common interpretation” would generally refer to an interpretation of a tax treaty which is in line with the scope and object of the tax treaty agreed during the treaty negotiation process. A tax treaty negotiation process generally takes into consideration multiple facets, and the relevant ones in the context of an issue relating to an interpretation of a tax treaty should be considered.
The Vienna Convention of the Law of Treaties, 1969 provides that treaty interpretation should consider the object and purpose of the tax treaty and should take into account interpretational tools (e.g. treaty negotiation documents, etc.). Unilateral interpretations of a contracting state by way of a decree may certainly have persuasive value if they reflect the “common understanding” achieved during the treaty negotiation process, but they may not be binding upon the other contracting state.
Although courts generally tend to adopt the rationale of rulings delivered by foreign courts based on the context and scope of the tax treaty, cases may occur where a country could issue an interpretation which may not be commensurate with the understanding of the other contracting state. In such cases, a resolution by way of a mutual agreement procedure or bilateral discussions between the respective states should generally be adopted to clarify the issue in the interests of taxpayers.
The Delhi High Court decision, followed by the Swiss clarification, prompted India’s Revenue Department, and its Central Board of Direct Taxes (CBDT), to release an elaborate clarificatory circular (CBDT Circular 3/2022) on the interpretation of MFN clauses. Together with the decrees/clarifications issued by the Netherlands and Switzerland, the circular also addresses a similar official bulletin issued by France.
The circular states that the documents were issued by these governments without any bilateral consultation with India and are not aligned with the scope and object of the relevant tax treaty. Such documents, in the view of the circular, therefore have no binding force and can, at most, be considered the views of the respective governments regarding tax liability in their countries.
The circular further states that, on a plain reading of an MFN clause in a tax treaty concluded between India and another state (the first state), it is clear that, in order for such a clause to apply, the third state (i.e., the country with which India completes a tax treaty after the treaty with the first state has been signed or entered into force) has to be an OECD member at the time its treaty with India was concluded, as well as at the time the relevant transaction occurred.
Referring to extant Indian jurisprudence on interpretation of tax treaties and the relevant provisions of Indian tax law, the circular further mentions that a tax treaty or an amendment thereto is implemented in India only after its notification in the official gazette.
The circular also provides that all the following conditions must be satisfied before a lower rate/restricted scope in a treaty between India and a third state (OECD member) is imported into a treaty with an MFN clause (i.e., the treaty with the first state):
The circular, being clarificatory in nature, gives rise to a host of questions for taxpayers who have already taken a stance based on interpretational documents issued by various countries. Some companies, for example, have applied for certificates for lower rates of withholding tax to be issued by tax authorities, claiming beneficial tax rates on the basis of the principles of the Delhi High Court ruling (discussed above), some have filed writ petitions, and others have claimed refunds in their tax returns.
Taxpayers in the jurisdiction of the Delhi High Court may not be immediately impacted by the circular, given the binding precedent of High Court rulings and the fact that the circular provides that it will not affect the implementation of any court orders that are favorable to taxpayers on this issue. It will be interesting to see, however, how other courts react to this issue in future cases.
Further, while tax officers are sure to use the circular to their benefit in the cases pending before them, it will be interesting to see if taxpayers can challenge the circular’s binding force in the courts, as they are currently able to do with any other circular issued under Indian tax law.
Lastly, considering that India has perhaps no other way of declaring its interpretation of the provisions of the tax treaties and has clarified its stance to the respective countries (albeit without any response from them), one will have to wait and see whether the circular plays a role in developing the concept of “common interpretation” in future cases.
While litigation on the applicability of common interpretation has not yet been settled, this circular may trigger a new series of cases.
While the clarifications issued by some countries on interpretation of their respective tax treaties with India seem to be favorable to taxpayers, the fundamental differences between these countries and India cannot be ignored. These countries are capital exporting countries, whereas India is a capital importing nation. Taking that into consideration, the loss of revenue incurred by these countries by extending the benefit of concessional tax rates is far less than the loss India would suffer if it followed suit.
It is also important to note that the various concerns that arise when an OECD member country and a non-OECD member country negotiate a tax treaty should always be considered.
The MFN clause is found in the protocols appended to the Indian tax treaties. In many cases, the protocols are negotiated and concluded at the time the main treaties are signed, and are therefore notified along with the treaties. Where there is an amendment, it is notified by the government of India after its bilateral conclusion.
In light of this, it is perplexing why the circular specifies that a separate notification has to be issued by India before the benefits of the treaty with the third state will be imported into the treaty with an MFN clause (the treaty with the first state). In July, 2016, the Delhi High Court in Steria (India) Ltd. v. Commissioner of Income Tax [(2018) 165 DTR 89] observed that the protocol provisions complete the text of a treaty, and sometimes even alter it, and that legally it is a part of the treaty with binding force equal to that of the principal treaty text.
The Revenue Department should thus urgently clarify whether the protocols/amendments already notified would be considered as satisfying the condition for notification set out in the circular. If they do not, then the Revenue should, as soon as possible, issue the relevant notifications.
While the first three conditions laid down in the circular may appear to be reasonable, the last condition (the requirement for a separate notification) does not really tally with the government’s “ease of doing business in India” initiative and the Revenue’s objective of “certainty for the taxpayers,” unless addressed as a priority.
In the meantime, all eyes are now on the Supreme Court!
Views expressed are personal.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Sudin Sabnis is a Partner and Yogesh Kale is a Director with Nangia Andersen LLP.
