Supreme Court: In a bunch of appeals against the decision of Delhi High Court regarding interpretation of the Most Favoured Nation (‘MFN’) clause contained in various Indian treaties with countries that are members of the Organisation for Economic Cooperation and Development (‘OECD’), the Division Bench of S. Ravindra Bhat* and Dipankar Datta held that for benefit of same treatment clause in the Double Taxation Avoidance Agreement (‘DTAA’) with OECD members, the date of entering into treaty is the relevant date and not a later date when such country becomes an OECD member:
Most Favoured Nation (MFN) Clause
The Court explained that the MFN clause in such treaties provides for lowering of rate of tax at source on dividends, interest, royalties or fees for technical services (‘FTS’), or restriction of scope of royalty/FTS in the treaty, similar to concession given to another OECD country subsequently.
Background
The instant matter pertains to bilateral treaties of India with Netherlands, France, and Switzerland. The question arose as to
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Whether there is any right to invoke the MFN clause when the third country with which India has entered into a Double Tax Avoidance Agreement (hereafter ‘DTAA’) was not an OECD member yet (at the time of entering into such DTAA); and
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Whether the MFN clause is to be given effect to automatically, or if it is to only come into effect after a notification is issued.
Court’s Analysis
The Court perused the relevant provision including Section 90 of Income Tax Act, 1961 regarding agreement with foreign countries or specified territories.
Analysis of Invoking MFN Clause
The Court expressed that the treaty making power vested exclusively with the Union as per Article 253 of the Constitution of India and relative entries in the Union List, and that entering a treaty is an attribute of sovereignty and such power vests with the Union executive as against the states or concurrent list. It further added that the structure and phraseology of Article 253 clarifies that when a treaty is enacted by law, or enabled through legislation, such provisions become enforceable in India.
The Court referred to Duncan B. Hollis’ paper on ‘Executive Federalism: Forging New Federalist Constraints on the Treaty Power’, State of W.B. v. Jugal Kishore More, (1969) 1 SCC 440; V.O. Tractoroexport v. Tarapore & Co., (1969) 3 SCC 562; Maganbhai Ishwarbhai Patel v. Union of India, (1970) 3 SCC 400; Gramophone Co. of India Ltd. v. Birendra Bahadur Pandey, (1984) 2 SCC 534 to illuminate the law around the treaties in international law and majorly conclude that the treaty terms ratified by the Union do not ipso facto acquire enforceability, pointing towards the Parliament’s exclusive power to legislate upon such conventions or treaties. The Court further cited Union of India v. Azadi Bachao Andolan, (2004) 10 SCC 1 for clearest enunciation of law under Section 90.
The Court reiterated the crux of the above decisions to state that “upon India entering into a treaty or protocol does not result in its automatic enforceability in courts and tribunals; the provisions of such treaties and protocols do not therefore, confer rights upon parties, till such time, as appropriate notifications are issued, in terms of Section 90(1).”
Interpretation of ‘is’
The Court highlighted the High Court’s interpretation of the term ‘is’ in the DTAAs (Clause IV(2)36 of the India-Netherlands DTAA — the other two clauses in relation to France and Switzerland being similar) that it “describes a state of affairs that should exist not necessarily at the time when the subject DTAA was executed but when a request is made by the taxpayer or deductee for issuance of a lower rate withholding tax certificate under Section 197 of the Act. The word ‘is’- is both autological and heterological. An autological word is one that expresses the property that it possesses. The opposite of that is a heterological word, i.e., it does not describe itself”. The Court explained the said interpretation that when request for parity is made by a party seeking DTAA’s aid and the protocol containing a “same treatment”, or in other words, a pull in clause, the court must consider whether at that time the third-party state is enjoying better benefits.
The Court expressed that “Integral to this interpretation is whether the “is a member” means the present tense, which is that the third-party state should be a member of OECD when it enters into DTAA with India.” It further highlighted that the India-Lithuania DTAA was signed on 26-07-2011 and notified on 25-07-2012, the date of membership of Lithuania into OECD was 5-07-2018. Similarly, schedule was shared for Colombia and Slovenia. In all three cases, these ‘third party’ nations who were initially not the members of OECD when they entered into the said treaties and protocols but became the members later.
The Court referred to Jagir Kaur v. Jaswant Singh, (1964) 2 SCR 73, P. Anand Gajapathi Raju v. P.V.G. Raju, (2000) 4 SCC 539 and Vijay Kumar Prasad v. State of Bihar, (2004) 5 SCC 196 to explain the interpretation of ‘is’ and press on its significance and context. The Court concluded that “when a third-party country enters into DTAA with India, it should be a member of OECD, for the earlier treaty beneficiary to claim parity.”
India’s Treaty Practice
Pointing towards the dates on which DTAA were entered into by India with various countries, who were and were not the members of OECD and pointed out that “the Union limited the taxation at source on dividends, interest, royalties, fees for technical services and payments for the use of equipment to a rate lower or a scope more restricted than that provided in the DTAA between India and the Netherlands on the said items of income” and further highlighted the notification dated 30-08-1999 providing certain benefits expressly on different dates for India entered into DTAAs with OECD members and subsequently gave them effect.
The Court pointed out the significant aspects that:
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the date on which the relief of rate of taxation for interest and dividends was specified to be 01-04-1997 and different dates were applied as applicable to definition of fees and technical services, etc.;
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notification under Section 90 was issued on 30-08-1999; and
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the favourable or beneficial treatment was given to other OECD nations on 26-10-1996 (India and Germany), the India-Sweden DTAA entered in force on 25-12-1997, and the India-Swiss Confederation DTAA entered into force on 19-10-1994.
The Court explained that the earlier dates did not result in India automatically extending benefits of Article IV of the India-Netherlands DTAA Protocol to Netherlands, while the relevant provision obliged India to grant the same benefit to Netherlands as granted to other nation in the third-party state’s DTAA or protocol with India. The Court therefore noted that for India-Netherlands DTAA, there was established and clear precedent of behaviour regarding treaty practice and interpretation.
Coming to France, the Court highlighted that the India-France DTAA and protocol came into force on 1-08-1994; with USA on 18-12-1990; with Germany on 26-10-1996, all gave benefits or more favourable treatment to USA and Germany regarding income on dividends, interest, royalties, definition of royalties and fees for technical services. The fact led to notification of changes in the provisions applicable to India France DTAA and protocols in July 2000, and the same pattern was followed in India Netherlands DTAA, reinforcing India’s practise and conduct of giving effect of the subsequent event of a more beneficial arrangement with a third country, to the country which had entered into a DTAA previously, on the basis of a treaty provision, through an express action i.e., a notification under Section 90. It further pointed at the condition in India’s DTAA with UK and Portugal that “by Article 4, technical services (for the purpose of levying tax on income from fees for technical service) applied a condition that the taxpayer could make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.”
The Court explained that “the structure of the main DTAA, and its phraseology, based on negotiations with the countries concerned, i.e., Netherlands, France and Switzerland, also plays a role in the kind of benefits that are assured through it. The structure and terms of other DTAAs might be different; the coverage and definition of certain terms (FTS, permanent establishment, etc.) might be dissimilar.” It further elaborated the requirement of governments concerned to notify the how and when of Protocol being assimilated into domestic legal system but does not assign any time frame. The Court expressed that “inbuilt in the entire eco-system of the DTAAs is the inarticulate premise that assimilation into the domestic legal system is not always within the control of the executive wing which enters into the convention, or signs the protocol and that compelling constitutional and legal requirements have to be satisfied, before its benefits are integrated within the national legal regimes. This consideration, or premise, would equally apply in the case of the India-Switzerland DTAA and its amending Protocol; the requirement of notification of the protocol and a separate amending Protocol, (like in the case of France and Netherlands) is necessary, by reason of Section 90 of the Act. Switzerland cannot claim an exception, based only on the language of the third Protocol.”
Other Countries on DTAA
On respondents’ reliance on decrees/decisions of each of the countries for underlining the terms of treaty practice of the three countries wherein, the government has to extend reciprocity, the Court referred to the said decisions and opined that “the status of treaties and conventions and the manner of their assimilation is radically different from what the Constitution of India mandates.” While coming back to India, they explained that the treaty must be legislatively embodied in law through a separate statute or assimilation through a legislative device.
The Court went on to cite Klaus Vogel in the Treatise Double Taxation Conventions, Vienna Convention on Law of Treaties, International Law Commission’s (‘ILC’) 2018 Draft, International Court of Justice (‘ICJ’), and expressed the wide acceptance that “however precise the treaty text appears to be, the way in which it is actually applied by the parties is usually a good indication of what they understand it to mean, provided the practice is consistent, and is common to, or accepted by, all the parties.”
Conclusion
The Court opined that the treaty practice of Switzerland, Netherlands and France is dictated by conditions peculiar to their constitutional and legal regimes, and concluded that a notification under Section 90(1) is necessary and a mandatory condition for a Court, Authority or Tribunal to give effect to a DTAA or any protocol changing its terms or conditions having the effect of altering the existing legal provisions. The Court clarified that “a stipulation in a DTAA or a Protocol with one nation, requires same treatment in respect to a matter covered by its terms, subsequent to its being entered into when another nation (which is member of a multilateral organization such as OECD), is given better treatment, does not automatically lead to integration of such term extending the same benefit in regard to a matter covered in the DTAA of the first nation, which entered into DTAA with India. In such event, the terms of the earlier DTAA require to be amended through a separate notification under Section 90.” And, for a party to claim benefit of same treatment clause based on DTAA between India and another member of OECD, the relevant date is entering into treaty and not a later date when such country becomes an OECD member.
The Court set aside the Delhi High Court’s reasoning and findings.
[Assessing Officer Circle (International Taxation) 2(2)(2) New Delhi v. Nestle SA, 2023 SCC OnLine SC 1372, decided on 19-10-2023]
Judgment authored by: Justice S. Ravindra Bhat
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