The MFN Twilight Zone in India: Courtesy, Judiciary v. CBDT

[By Sanika Deshmukh and Aditya Garg]

The authors are students of Gujarat National Law University.


Introduction to DTAA & MFN Clause

Double Taxation Avoidance Agreement (DTAA) refers to a tax treaty between sovereign states, undertaken with an intent of fostering trade, while deterring the payment of taxes twice on the same income by taxpayers. It finds application in scenarios wherein an individual is a legal resident of one country, but earns income in another. Such treaties aspire to regulate global trade, and shield the interests of the taxpayers concurrently.

Several DTAAs consist of a ‘Most Favoured Nation’ or MFN clause, which permits greater beneficial treatment in matters surrounding taxation to a resident of the contracting state. It refers to providing equally advantageous treatment to the contracting nation as provided under similar treaties to other nations, as such an MFN clause effectually binds one state to another in connection with favourable treatment afforded by it to any other state in future, as Treaty Partners can avail identical benefits that the other contracting country has subsequently acceded to a third country in its respective agreement. The World Trade Organisation and the Organisation for Economic Co-operation and Development (OECD) have noted that MFN treatment acts as a cornerstone of the multilateral trading system, and intends to ensure that trading partners are treated equally, regardless of other considerations. By ensuring that all the countries receive identical treatment, MFN clauses can create a level playing field for all countries, and promote non-discrimination. This can be vital for bringing underdeveloped nations at par with larger or superior nations.

MFN clauses can be incorporated as an integral part of the treaty during its inception, or subsequently through an amendment protocol. In India, such protocol accomplishes legal validity as a result of past Income Tax Appellate Tribunal and Delhi High Court decisions.

Tug of War in India: Judiciary vs Revenue Authority

 India currently has an MFN clause arrangement with over 10 nations, including Belgium, France, Spain, etc. However, the MFN clause has certainly experienced turbulence and discomfort on the Indian shores, as the clause has debatably failed to receive ‘favourable’ treatment from the Indian taxation authorities. The central controversy with regard to the MFN clause in the Indian scenario has been India’s DTAAs with nations such as France, Netherlands, Spain containing MFN clauses permitting utilisation of benefits identical to those India provide to OECD member nations in future DTAAs. India subsequently signed DTAAs with nations such as Lithuania, Columbia and Slovenia, containing withholding tax rates (WHT) of 5% for dividends. It is pertinent to note that these countries were not OECD members at the time of entering into DTAAs with India, however, the genesis of the controversy can be tracked back to time these third nations attained OECD membership, which attracted shouts of activation of the MFN clause from the Dutch and French authorities, in an attempt of availing the benefit of a lower WHT rate of 5%, contrary to the greater 10% rate provided in their respective treaties.

Judicial position –

 This dispute regarding interpretation of the MFN clause between taxpayers and revenue authorities has attracted involvement of the Indian judiciary, which has notably decided matters encouraging the taxpayer’s position, as evident from a string of decisions.

The Delhi High Court has come to the relief of taxpayers’ interests’ multiple times in the last few years, as the Court notably allowed the benefit of a lower 5% rate to a Dutch corporation on account of activation of the MFN clause in the Indo-Dutch DTAA in light of India’s agreement with Slovenia, in the case of Deccan Holdings B.V. v. ITO . Correspondingly, Delhi HC awarded the benefit of 5% rate to two Swiss corporations on activation of the MFN clause in Indo-Swiss DTAA in backdrop of India’s treaties with Columbia and Lithuania, in Galderma Pharma and M/S Nestle, respectively. Delhi HC’s concrete position in the Optum Global-Concentrix Services judgement of 2021 formed the core for these aforementioned decisions, as therein, base for an argument in favour of activation of the MFN clause was formed. The Delhi HC took into consideration the decree passed by the Dutch authorities in 2012[i], when the issue first arose, wherein, the Dutch interpreted the issue in favour of activation of MFN clause, and the taxation rate to effectively change to 5% from the date nations like Slovenia, Lithuania, Columbia achieved OECD membership. Delhi HC went on to derive the benefit of a lower taxation rate and brought into effect activation of the MFN clause in India’s treaty with Netherlands. Thus, the Delhi High Court has passed a series of decisions supporting the taxpayer’s position.

Revenue’s ‘Rebuttal’ –

However, in contravention to these Delhi HC judgments, The Central Board of Direct Taxation (CBDT)  released a circular on February 3, 2022 in an attempt to clarify India’s stance on the application and interpretation of the MFN clause present in Protocol to India’s DTAAs with certain European nations, and it disclosed that –

Firstly, to  import provisions of any third-nation agreement into the relevant DTAA by virtue of the MFN clause, a government notification pursuant to Section 90 of the Indian Income Tax Act, 1961, as reiterated by the Supreme Court in the Azadi Bachao Andolan case. Thus, favourable provisions present in India’s DTAAs with Slovenia, Lithuania, and Colombia will not find automatic implementation in the DTAAs with France, Netherlands, or Switzerland.

Secondly, the circular states that the norms of interpretation of international treaties prohibit the selective invocation and use of the MFN clause as suggested by these nations in their unilateral documents (reference to the Dutch decree). The circular claims that the European nations[5] had been informed of India’s view regarding interpretation of the MFN clause.

Moreover, the circular further clarified that the MFN clause plainly states that the third State must be an OECD member both at the time the DTAA with India is signed and at the time the MFN clause is applied. Thus, as Slovenia was not an OECD member when it entered into the DTAA with India, extending the MFN benefit on account of Slovenia’s membership would be contrary to the intended results. It also discussed that the dividend tax rates for the DTAAs with Slovenia and Lithuania are divided. If the equity holding is at least 10% a tax rate of 5% is offered, while a tax rate of 15% is offered in all other circumstances. Thus, the CBDT states that selective import is disapproved where any element of these treaties is to be included into India’s agreements with nations that have the MFN clause. It is  inappropriate to employ the MFN clause for deriving benefit of the 5% concessionary rate solely rather than 15% in other circumstances.

The circular is quite contrary to the stand taken by Delhi HC, as the CBDT has taken a notably stricter and narrower view regarding interpretation of the  MFN clause and since the Supreme Court is yet to comment on the matter, it produces greater perplexity with regard to India’s stance on MFN on a global level.

Ambiguous Zone & Distinct manners of Interpretation

Presently, the subject matter of dispute remains – interpretation of the MFN clause present in India’s DTAA with several European nations, in the backdrop of third countries such as Lithuania, Slovenia and Columbia attaining OECD membership after entering into DTAAs with India.

A) Liberal interpretation

 The Delhi HC decided to utilise a much liberal manner of interpretation through its judgments as the court broadly interpreted the word ‘is’ present in the Indo-Dutch DTAA to hold that the term describes the scenario in existence when taxpayers request a lower WHT rate, and not when the treaty is executed. The court also examined the aspect of Netherlands clarifying its stance on the issue, through a  decree favouring the activation of MFN clause in their respective treaty with India as a result of the third countries attaining OECD membership. The court gave effect to the universally-known doctrine of general or common interpretation by taking into consideration this unilateral interpretation by India’s Treaty Partner. The Delhi HC relied on the Supreme Court’s judgement of UOI v. Azadi Bachao Andolan to emphasise on international agreements and various considerations involved in their interpretation. However, what seemed to be a judgement laying down India’s final position on the MFN issue was not the case, as the CBDT lashed out a circular, interpretating the clause in contrast to the spirit of the Delhi HC judgments.

B) Strict interpretation 

 The CBDT decided to employ a stricter sense of interpretation while reading the MFN clause. They contended that unless the third State was an OECD member at the time of signing the treaty, the benefits of India’s agreement with the third State should not be exported to the treaties with Netherlands, France etc., as it would be oppressive in light of India agreeing upon those rates before the third states attained OECD membership. Referring to the General Rule on Interpretation of the VCLT, the Supreme Court of India noted in the Ram Jethmalani case that the general rule of interpretation with regard to treaties and the provisions therein would require that the ordinary meanings of words be given effect, unless the context requires otherwise. The India-Netherlands MFN clause’s grammatical and literal connotation in this scenario indicates that the benefit of the reduced rate would only be available in cases of subsequent Indian treaties, wherein, the other contracting state is an OECD member as of the treaty’s entry into force, as any other interpretation would render the word redundant.

Conclusion & Way Forward

Thus, the circular issued by CBDT despite consistent judgments of the Delhi HC has only heightened the controversy further, as the subsequent GRI Renewable Industries decision somewhat contravened the clarification issued by CBDT.  It laid emphasis on the circular being applicable prospectively from its issuance. Amid these growing tensions, the stage is set for the Apex Court to step in, and culminate the debate. The authors of this blog would like to suggest adoption of harmonious interpretation while reading the MFN clause, and keep in mind the interests of both parties while attempting to strike a balance between the same. It must be taken into consideration that such treaties are drafted by diplomats, thus there may arise ambiguity surrounding the practical meaning of a phrase or word, hence such disputed terms must be interpreted from a combination of legal and diplomatic standpoint. Future deliberations can be avoided by ensuring that DTAAs consist of clear mutually-agreed clauses addressing the course of action in case third states were to join the OECD or any similar forum subsequent to agreeing on terms with India.

 Prima facie, the balance of convenience seems to be in the shareholders/taxpayer’s interests as the Apex court has previously acknowledged the non-binding nature of CBDT circulars on the assesses in Catholic Syrian Bank and UCO Bank. Moreover, CBDT’s position with regard to demand of a separate notification for importing beneficial provisions from other treaties does not find much favour as the drafters had failed to incorporate such a specific requirement in the India-Netherlands DTAA, in contrast with existence of such an express and clear requirement in India’s DTAA with Finland.

However, an authoritative decision by the Supreme Court which enumerates detailed and compact guidelines in an attempt to reconcile the prerogatives of both foreign shareholders and Indian taxation authorities is the need of the hour.

[i] Decree No. IFZ 2012/54M, dated 28 February 2012, issued by Directorate General for Fiscal Affairs of Netherlands.


Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us

Kerwa Dam Road., 
National Law Institute University, Bhopal
Madhya Pradesh, India. 462044​.

write to us at –