Conditions to be satisfied for availing the lower rate or restricted scope of source taxation due to the virtue of Most favoured Nation (‘MFN”) Clause

Double Taxation Avoidance Agreements (“DTAA”) were entered into by India with Slovenia, Colombia and Lithuania which provide for lower rate of source taxation with respect to certain item of income (e.g., Dividend) however when such DTAA’s were entered into by India, these countries were not members of Organisation for Economic Co-operation and Development (“OECD”). Decrees/publications/bulletins were issued by other nations like France, Netherlands wherein they had interpreted that the lower rates were applicable to them due to the MFN Clause benefit. Central Board of Direct Taxes (“CBDT) thus vide Circular No. 3 of 2022 dated 03.02.2022 has issued the following clarifications in order to remove ambiguities and avoid litigation about importing the MFN benefit of lower rate or restricted scope of source taxation into the already entered DTAA’s with India:

• The decree/publication/bulletin issued by one country without consultation with another country shall not form the part of applicability of MFN clause and thus it shall not be binding over the DTAA prevailing between the countries and these decree/publications/bulletins will not curtail the tax liability. Further, a selective import of concessional rates under MFN Clause shall not be permitted.
• The subsequent treaty should be entered into by India after the signature/entry into force of the treaty between India and such other country which has an MFN Clause. The concessional rate or restricted scope will thus then be applicable from the date of entry into force of the DTAA with such subsequent entity.;
• The subsequent treaty entered into by India should be with a state who shall be a member of the OECD at the time of signing the treaty;
• India limits its taxation rights in the subsequent treaty in relation to rate or scope of taxation in respect of the relevant items of income; and
• A separate notification has to be issued by India, importing the benefits of the subsequent treaty into the treaty of such state having the MFN Clause, as required by the provisions of sub- section (1) of Section 90 of the Income Tax Act, 1961(“Act”).

Wherein all the conditions mentioned above in Point 2 to Point 5 are satisfied, the lower rate/restricted scope in the subsequent treaty can be imported into a treaty of an OECD member having the MFN Clause. The CBDT, further clarified that wherein case any decision by any court has been given in the favour of Tax Payer on the aforementioned issue, this circular shall not be binding over the decision of the court.

In case of Concentrix Services Netherlands B.V. v. Income Tax Officer TDS & Anr, the Hon’ble Delhi High Court had held that the MFN clause in the protocol of DTAA is an integral part shall be read with the DTAA itself and benefit of MFN clause has to be extended without any separate notification. Further, the country should be a member country of the OECD on the date when the taxation is triggered for a non-resident to avail the MFN clause if that member countries DTAA agreement is more beneficial. Similar positions were also taken in the case of M/s Nestle SA and Deccan Holdings B.V. basis the above judgement. However, due to the issuance of the notification by the CBDT, this persuasive benefit of this ruling shall not be available going forward.

Source: Circular No. 03/2022

Aayush Singh, Associate, SW India