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Supreme Court rules notification to be mandatory to invoke most favored nations clause
This tax alert summarizes a recent Supreme Court (SC) decision in a batch of appeals [1] (Taxpayers), wherein the SC set aside the underlying favorable Delhi High Court (HC) decisions [2] and examined the following two issues:
- whether the most favored nations (MFN) clause is to be given effect to automatically or it comes into effect only after a notification is issued; and
- Whether there is any right to invoke the MFN clause with respect to provisions of the third country with which India has entered into a Double Tax Avoidance Agreement (DTAA or treaty), which was not an Organisation for Economic Co-operation and Development (OECD) member at the time of entering into such DTAA.
The SC ruled that in order to give effect to a DTAA or any Protocol changing its terms or conditions, which has the effect of altering the existing provisions of law, notification under Section 90(1) of the Indian Tax Laws (ITL) is necessary and mandatory. Unlike other countries, mere signing or ratification of a treaty does not become enforceable in India, as exclusive power to legislate the treaties entered into by India lies with the Parliament. Accordingly, the legislation is required to give effect to the treaty if it affects the rights of citizens or modifies the Indian law. Even with reference to MFN clause already agreed as part of an existing treaty, the beneficial provisions entered into with third country cannot be made applicable automatically unless a notification is issued. The treaty practice of India in relation to DTAAs and their Protocols suggests that any subsequent beneficial provision signed with other OECD member state is extended to earlier treaty beneficiaries only by way of a notification.
On the aspect of the time period when a third country should be an OECD member in order to apply the beneficial treatment accorded to such country by invoking MFN clause, the SC held that the expression “is” in the sentence “third state which is a member of OECD” of MFN clause, has a present significance and derives the meaning from the context. Therefore, if a party seeks to avail the benefits of a “same treatment” clause based on the existence of a DTAA between India and another third country which is an OECD member state, the relevant date is the initial treaty signing date with India and not any subsequent date when that third country becomes an OECD member.