DTAAs not to be Enforced without Central Govt. Notification u/s 90 of Income Tax Act: Supreme Court in MFN Case [Read Judgement]

In the significant ruling related to Most Favoured Nation case, where appeal filed by revenue against Nestle SA,  a two-judge bench of Justice Ravindra Bhat and Justice Dipankar Datta of Supreme Court has held that a Double Taxation Avoidance Agreement (DTAA) cannot be given effect to by a court, authority or a tribunal unless it has been notified by the Central Government under Section 90 of the Income Tax Act, 1961.

The appeals before the apex court stemmed from decisions made by the Delhi High Court regarding the interpretation of the Most Favoured Nation (MFN) clause in various Indian treaties with countries that are members of the Organisation for Economic Cooperation and Development (OECD).

This clause aims to reduce the tax rates on dividends, interest, royalties, and fees for technical services (FTS), or limit the scope of royalty/FTS in the treaty, in a manner similar to what is offered to another OECD country at a later date. The specific bilateral treaties in question involve India with the Netherlands, France, and Switzerland.

The main issues revolve around whether it is possible to invoke the MFN clause when the third country with which India has a Double Tax Avoidance Agreement (DTAA) was not an OECD member at the time of the DTAA's establishment and whether the MFN clause is automatically applied or requires a separate notification.

One of the cases in this appeal batch concerns Steria India, where the issue was whether a separate notification by the Indian government was needed for the MFN clause's application. The Authority for Advance Ruling (AAR) had initially ruled that the Protocol should not be considered part of the DTAA itself, and a separate notification was required. However, the High Court reversed this decision, considering the Protocol as an integral part of the treaty.

Another set of facts involves the India-Netherlands DTAA, which was amended in 1999. The respondent assesses, Concentrix Services Netherlands BV and Optum Global Solutions International BV, applied for a withholding tax certificate, but the issued certificates had a higher tax rate. The assesses argued that, based on the DTAA and Protocol's language, the lower rate of 5% should apply automatically without the need for a separate notification.

In both cases, the assessees argued that based on the language of the DTAA and the subsequent Protocol, India was obliged to apply the lower 5% tax rate. They asserted that since India had DTAAs with other OECD member countries, the lower rate from those agreements should automatically be applicable to the India-Netherlands DTAA. This interpretation was rooted in the Protocol's preface, which stated that the Protocol is an integral part of the Convention, referring to the DTAA.

Contentions of Revenue / Appellant

The revenue, represented by ASG Shri N. Venkatraman, contended that the challenged judgments are unsustainable. They argued that, according to the Indian Constitution, particularly Articles 253 (in conjunction with Entries 13, 14, and 15 of List I of the Seventh Schedule), only Parliament has the exclusive authority to legislate on treaties and conventions with other nations. These treaties can only be established through the executive power of the Union and require Parliamentary legislation to be enforceable. India follows the "dualist" approach, meaning that international treaties and conventions do not automatically become part of domestic law upon ratification and necessitate enabling legislation, unlike "monist" countries where treaty provisions are directly enforceable as domestic law.

ASG Shri N. Venkatraman refers to previous judgments to emphasize that in India, conventions or events arising from conventions do not automatically come into effect without the enactment of enabling legislation, especially in terms of creating rights and responsibilities for third parties.

According to the counsel, the Section 90 mandates the issuance of a notification to activate any treaty or convention, and the argument is that, without specific legislation, entering into a treaty or convention does not automatically confer rights under tax laws.

In the context of the Most Favoured Nation (MFN) clause, even when India enters into a treaty or convention with an OECD member country, a notification is still required to give effect to this clause. Simply put, the fact that India entered into Double Tax Avoidance Agreements (DTAAs) with countries later becoming OECD members does not automatically extend identical treatment to tax residents of the Netherlands, France, and Switzerland.

The revenue also argued that without notification, tax administrators would find it difficult to verify claims. The impugned order's reliance on executive orders and decrees from Swiss, Dutch, and French authorities is seen as problematic since these unilateral orders cannot bind Indian Revenue Authorities.

In the case of Nestle, a review of the India-Switzerland DTAA's first and second protocols demonstrates that, without notification as per Indian law, they could not have been applied. The plain and literal reading of the India-Netherlands MFN clause suggests that the reduced rate benefit applies only when the other state is already an OECD member when the treaty comes into effect.

Furthermore, the notifications amending existing DTAAs for the three countries revealed that they were issued in response to benefits granted to countries other than the Netherlands, France, and Switzerland. These subsequent notifications were triggered by changes in tax rates and the treatment of specific types of income and their respective definitions. These notifications resulted from negotiations between India and the involved countries and demonstrated the necessity of such notifications, highlighting that benefits granted to other OECD members cannot be automatically applied.

In response to the linguistic interpretation of the word "is" in the challenged judgments, it was argued that the assessees used Article 10 and other Articles of the DTAAs to suggest that "is" denotes when the treaty provisions should be applied. They also referred to the dynamic interpretation of Article 3(2), which allows considering the definition in domestic law when a term isn't defined in the DTAA. However, the ASG contends that these arguments overlook the fact that the word "is" can have different meanings (present, past, or future) depending on the context in which it's used.

Contentions of the assessees/Respondents/Nestle SA

The respondent's position is that when a Double Taxation Avoidance Agreement (DTAA) and its Protocols, including the Most Favoured Nation (MFN) clause within a specific Protocol, have been properly notified under Section 90(1) and come into force, there is no additional legal obligation to separately notify subsequent amendments to the DTAA. They argue that Section 90 only requires notification of the entire treaty or protocol, not individual clauses, especially when amendments are automatic consequences of a self-operating MFN clause.

The essence of their argument is based on the wording of Section 90, which doesn't demand separate notifications for clauses within an already notified agreement, except when amendments arise from bilateral negotiations. They contend that the MFN clause in the India-Netherlands DTAA's Protocol imposes no separate notification requirement.

The respondent's counsel points out that the nature of the MFN clauses in India's DTAAs with the Netherlands and Switzerland differs. While the India-Switzerland DTAA initially required negotiations to activate beneficial provisions with other OECD members, this requirement was removed through a notification, making the MFN clause operate automatically, similar to the India-Netherlands MFN clause.

Additionally, they highlight that in some DTAA Protocols like the India-Finland and India-Philippines agreements, there is an explicit obligation for both countries to inform each other and review provisions when the MFN clause is triggered.

The respondent rebutted the revenue's claim that treaties with other OECD countries didn't activate the MFN clauses for the three countries in question. They argue that unilateral notifications, such as the one dated 30.08.1999, which restricted the scope of FTS, don't represent bilateral agreements. They assert that these notifications lack mutual agreement between both states, unlike bilateral amendments, such as the India-Netherlands DTAA in 2012, which had specified entry-into-force dates and clear bilateral agreements.

They also highlighted the Netherlands' stance on the matter dating back to 1998, as clarified in a Dutch decree by the Secretary of Finance. This decree supported the automatic application of the MFN clause for every favourable provision resulting from a DTAA with another OECD country. They argued that even in the Netherlands, a notification is required to extend MFN benefits to the India-Netherlands DTAA, and the decrees issued were meant to prevent ambiguity, reflecting Dutch authorities' interpretation rather than statutory notifications.

Furthermore, they explained the Dutch parliamentary endorsement required for DTAA approval and how this process results in formal decrees, similar to French and Swiss orders and decrees, which were acknowledged in relation to the OECD membership of Lithuania, Slovenia, and Colombia.

Counsel argued that the word "is" in Article 10(1) of the India-Netherlands DTAA is crucial in addressing the revenue's objection that Slovenia, Lithuania, and Colombia must be OECD members at various stages. The revenue implies that "is a member of OECD" in the MFN clause implies continuous membership. However, if we accept this strict interpretation, it would also apply to Article 10(1), which uses the same "is" ("is a resident"). But it's evident that to benefit from Article 10, an assessee only needs to be a resident of India/Netherlands for the specific year they seek the benefit. Therefore, "is" in the MFN clause should similarly mean that Slovenia, etc., need to be OECD members only when the MFN clause is invoked.

Interpretation of ‘is’ by the Apex Court

Relying on the observations in the cases of Jagir Kaur v. Jaswant Singh and P. Anand Gajapati Raju v. P.V.G Raju, the bench observed that “it is clear that the expression “is” has a present signification and it derives meaning from the context. Given this interpretation, the conclusion is 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”.

The bench observed that the issue of treaty interpretation and treaty integration into domestic law is driven by constitutional and political factors subjective to each signatory. Therefore, domestic courts cannot adopt the same approach to treaty interpretation in a black letter manner, as is required or expected of them, while construing enacted binding law. The role of practice which is, as the previous discussion demonstrates, not bilateral or joint practice, but practice by one, accepted generally by the international community as operating in that particular sphere, which is relevant, and at times determinative.

Further stated that “This court is of the opinion that the treaty practice of Switzerland, Netherlands and France is dictated by conditions peculiar to their constitutional and legal regimes. Could it conceivably be argued that in the event of failure of the Swiss Confederation to secure the requisite majority in a referendum or approval by the Swiss Parliament, or in the absence of approval by both houses of the States General in Netherlands, a DTAA provision or trigger event could nevertheless be assimilated into executive decrees? The answer is obviously in the negative. Likewise, the treaty practice in India points to a consistent pattern of behaviour when the signatory to an existing DTAA, points to the event of a third state entering into OECD membership, and a resultant trigger event, the beneficial effect given to the later third-party state has to be notified in the earlier DTAA, as a consequential amendment, preceded by exchange of communication (and perhaps, negotiation) and acceptance of that position by India. The essential requirement of a notification under Section 90 of the consequences of the trigger (or causative) event cannot be undermined.”

Ruling of the Court

Considering the submissions and analysis of the facts and statutory provisions, the apex court concluded that: “

1. 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, which has the effect of altering the existing provisions of law.

2. The fact 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.

3. The interpretation of the expression “is” has present signification. Therefore, for a party to claim benefit of a “same treatment” clause, based on entry of DTAA between India and another state which is member of OECD, the relevant date is entering into treaty with India, and not a later date, when, after entering into DTAA with India, such country becomes an OECD member, in terms of India’s practice.”

The Court declared that the reasoning and findings in the challenged orders are invalid and are overturned. Consequently, the revenue's appeals are successful and are granted. No costs are awarded, and all pending applications, including those seeking intervention, are resolved.

To Read the full text of the Order CLICK HERE

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