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Ratification of MFN clauses: Deterrent for foreign participation in India?

[Prithvi Kapoor is a penultimate year student of law at MIT-WPU, School of law in Pune]


A most favoured nation (MFN) clause is an ever-important provision which forms a part of a double taxation avoidance agreement (DTAA). The MFN clause provides that residents of a nation which is a party to a DTAA must receive the same benefits if the contracting nation subsequently enters into a DTAA with a third country with more favourable treatment to the residents of that third country.

A division bench of the Indian Supreme Court delivered its decision in Assessing Officer Circle (International Taxation) (2)(2)(2) v M/S Nestle SA (Nestle SA) wherein the Supreme Court held that an MFN clause is only effectuated by a notification issued u/s 90(1) of the Income Tax Act, 1961(“IT Act”) which empowers the central government to give effect to tax treaties, as opposed to an automatic trigger of the clause. This decision has drawn criticism from various quarters citing, inter alia, an increased tax liability for various foreign entities. This blog piece aims to understand the impact of the decision on whether foreign participants will prefer to choose India as an investment destination in lieu of tax benefits, and how the decision will affect investors who invested in India under the assumption that the MFN clause is already in operation.

Supreme Court’s decision: A conservative interpretation adopted

The crux of the dispute in Nestle SA is that a DTAA was signed between India and Switzerland in 1994. Subsequently, India signed a DTAA with Lithuania in 2011, Nestle SA, a resident of Switzerland, claimed that by virtue of the MFN clause in the India-Switzerland DTAA(tax treaty between the two nations which inter alia envisages that residents of both the nations are not taxed twice, and provides tax benefits to residents of both the nations ), a lower tax rate of 5% on dividend income which was ascribed in the India-Lithuania DTAA should be extended to Swiss residents as well. The Delhi High Court (DHC) agreed with the reasoning of the Swiss taxpayers, however, an appeal was preferred by the tax authorities before the Supreme Court.

Various judgments (Steria India & Concentrix Services) of the DHC were assailed before the Supreme Court in Nestle SA, wherein the DHC held that no separate notification is required u/s 90(1) of the IT Act to reap the benefits of the subsequent DTAA signed with the third state.

A division bench of the Supreme Court found the reasoning unsatisfactory and reversed the judgments of the DHC, holding that in order for a resident of the state to seek the benefits of a DTAA signed between India and a third nation, a notification u/s 90 of the IT Act is mandatory, and there is no automatic trigger of the same. The Supreme Court accepted the submission of the Revenue that the position in India is so that the rights and liabilities of third parties do not operate on their own and require an intervening action by the union.

The Supreme Court backed its reasoning by applying various principles of treaty interpretation and used the dualist school of thought in international law, which believes that international treaties must be integrated into domestic law by way of an act of parliament.  The Supreme Court inter alia held, that terms of the treaty ratified by the union do not ipso facto gain enforceability, parliament, in its own wisdom has the power to refuse to give to a treaty if it deems so, furthermore, treaties are binding upon the union, however treaties by themselves are not binding upon Indian Nationals.

Furthermore, the Supreme Court also held that benefits ascribed in the DTAA with the third state can only be extended to other residents if the third state is a member of the Organization for Economic Cooperation (OCED) on the date on which the DTAA with the third state was entered into.

It is respectfully argued that the Supreme Court has erred in its interpretation of section 90 of the IT Act, section 90 of the IT Act by itself is an all-compassing provision which talks about the power of the central government to enter into treaties with other nations, including but not limited to DTAAs, this provision does not discuss or make mention of individual ratification of each provision contained within a treaty. In fact, while recording Nestle SA’s submission, the Supreme Court has seemingly accepted the submission that u/s 90(1) of the IT Act individual ratification of each and every provision of the tax treaty is not required.

An MFN clause is a part of the protocol document, which can be viewed as an addendum to the DTAA which may be signed at a subsequent date. It is pertinent to note that both the DTAA and protocol undergo ratification between the contracting states, firstly the DTAA undergoes ratification, and then secondly the protocol which contains the MFN clause undergoes ratification. Therefore it is argued that a third ratification is unnecessary and nugatory, furthermore, the Karnataka High Court has held that a protocol forms an integral part of a DTAA and in order to trigger the MFN clause, no additional ratification under section 90 of the IT Act is required. Hence, it is argued that since both the DTAA and the Protocol undergo ratification separately, it itself shows the requisite intention of the contracting states and the third state to execute the MFN clause.

It is furthermore argued that the court has interpreted the matter from the perspective of domestic law while ignoring international law obligations. It is respectfully argued that the court has ignored a fundamental principle of international law, that is pacta sunt servanda, which means that treaties entered into between nations are compulsorily binding upon each and must be executed in good faith. Adding the extra layer of issuance of notification u/s 90 of the Income Tax Act, 1961 to give effect to a provision in the DTAA undermines the principle, gives the tax authorities the exclusive power to select at will whether or not to give effect to the MFN clause or not.   

Therefore, as a result of the decision, tax authorities will have the power to cherry-pick which provision of a treaty to enforce and which not to, which could in turn endanger India’s obligations under international law and undermine the doctrine of reciprocity under international law. 

Impact of the decision: Uncertainty amongst foreign investors, reopening of completed assessments and a lot more uncertaint

The decision in Nestle SA will have far-reaching consequences for stakeholders. The decision is a setback for individuals who invested in India in good faith and under the assumption that the MFN clause is in operation under the India-Netherlands DTAA, such individuals will now be subjected to an increased tax burden, which is inequitable in nature since they were under the genuine impression that the MFN clause was operational in light of the DHC judgements. 

Given that benefits of the India-Lithuania DTAA are not extendable to the India-Switzerland DTAA until a notification is issued u/s 90 of the Income Tax Act, 1961, as mentioned above, reports suggest that companies have been served tax demands aggregating to 11,000 crore. The implication of this is retrospective taxation and possible reopening of completed assessments. Experts suggest that a one-time window should be opened for taxpayers to make voluntary payments without interest or penalties, however, it is argued that additionally, the tax department could reopen completed assessments as an alternative.

As a consequence of the decision, it is reported that various entities could face a tax demand, resulting in liability by way of retrospective withholding taxes, furthermore, this will result in the re-opening of completed assessments. Section 147 of the IT Act, vests powers with the Assessing Officer (AO) to order for reassessment of a completed assessment if the AO has reason to believe that any income has escaped assessment. Since individuals and companies made investment decisions in India under the impression that the MFN clause is in operation and thereby availed of the benefits, their assessments would display the benefits incorporated, resultantly certain income would escape assessment in lieu of absence of notification u/s 90 of the Income Tax Act, 1961 by the government, and being subject to section 147 and allied provisions.

Furthermore, the decision is likely to trigger section 201 of the IT Act, which holds that if a taxpayer in India doesn’t deduct tax in accordance with the IT Act, then they shall be an assessee-in-default and be liable to pay the tax with applicable interest. Herein taxpayers have deducted tax in lieu of the MFN benefit in the India-Lithuania under good faith, however with the decision in Nestle SA, until the notification under section 90 is issued giving effect to the MFN, the benefits are still not extended, therefore, the likelihood of section 201 being trigger still exists.


The Supreme Court’s decision comes as a departure from the settled points of view taken by various high courts in the nation. Therefore, the decision casts shadows on favourable tax treatment to non-residents and could hamper investment decisions.

Furthermore, a petition seeking review of the decision in Nestle SA has been filed before the Supreme Court. It is argued that by virtue of the review petition filed in Nestle SA, the Supreme Court finds itself in a similar position as that of 2003, the year in which the court pronounced the celebrated judgment of Azaadi Baccho Andolan, and the court has the opportunity to correct its course and redefine Indian tax jurisprudence. Therefore, it is exhorted that the court harmoniously and liberally interpret section 90 and the operation of MFN clauses to do away with the notification u/s 90 of the Income Tax Act, 1961 in order to make India a tax-friendly jurisdiction.



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