In the case of Koninklijke Philips N.V.[1] (Taxpayer), a tax resident of The Netherlands, the issue was whether interest received on income tax refund should be subjected to tax as per India-Netherlands (I-NL) double taxation avoidance agreement (DTAA), read with the most-favored nations (MFN) clause. While granting the refund, including interest, the Indian tax authority deducted taxes at source and remitted the balance amount to the Taxpayer.
The MFN clause of the I-NL DTAA provides that, if India enters into a DTAA on a later date with a third country which is an OECD member, providing a beneficial rate of tax or more restrictive scope for taxation of dividend, interest, royalty etc., a similar benefit should be accorded under the I-NL DTAA as well.
It may be noted that the India-Italy DTAA exempts interest income if the payer of interest is a government/local authority, while such exemption is not available in the I-NL DTAA. The Taxpayer contended that interest on income tax refund is a debt claim received from the Indian government and, hence, is exempt from tax in India pursuant to application of the MFN clause of the I-NL DTAA read with the restricted scope of taxation of India-Italy DTAA.
The Taxpayer also relied on the Madras High Court (HC) ruling in the case of Ansaldo Energio SPA[2] wherein, in the context of the India-Italy DTAA, it was held that interest on income tax refund is a “debt claim” payable by the revenue.
On the above issue, the Tribunal ruled that the beneficial provision of the restricted scope of taxability of interest under India-Italy Treaty is available to the Taxpayer under the I-NL DTAA by virtue of the MFN clause. Tribunal noted that protocol to a treaty is an integral part of the treaty. By bringing the MFN Clause in the Protocol to the I-NL DTAA, two countries have negotiated between themselves for the application of more restrictive scope of taxation on certain incomes, including interest vis-à-vis its treaty with India. Consequently, no tax was required to be deducted on interest while remitting it to the Taxpayer and hence, directed the tax authority to grant the refund of the tax deducted at source (TDS) already deducted.
