Some of the Double Tax Avoidance Agreement (DTAA) contains an MFN clause (Most Favoured Nations clause). As per this clause, one country agrees to accord to another country a treatment that is no less favourable than the one which it accords to other or third countries. Some of the DTAA entered by India do contain an MFN Clause.
The MFN clause and whether the advantageous provisions of such DTAA might be utilised or not could be a matter if the country becomes an OECD member after India has entered into the DTAA with that country. In this regard, recently, the Delhi High Court (High Court) in the case of Concentrix Services Netherlands BV vs ITO (TDS) WP(C) 9051/2020 had to examine this issue with respect to an MFN clause present in the India-Netherland DTAA.
Facts of the case
The taxpayer, the resident of the Netherlands, had a wholly-owned subsidiary in India. During the Fiscal Year (FY) 2020-21, its Indian subsidiary proposed to distribute dividends. With the abolishment of the Dividend Distribution Tax (DDT), the dividend was taxable in the hands of the taxpayer i.e. shareholder. Hence, the taxpayer made an application under section 197 of the Income-tax Act, 1961 (IT Act) with the Tax Officer for the issuance of a lower withholding certificate. The taxpayer requested the Tax Officer to grant a lower withholding rate of 5%. The taxpayer contended that while the India-Netherland DTAA provided taxing dividend at 10%, in terms of the MFN clause it was entitled to apply the tax rate mentioned in India-Slovenia DTAA / India-Lithuania DTAA / India-Columbia DTAA which is 5%.
However, the tax officer was of the view that in absence of any specific notification to extend the benefit of the lower tax rate of 5% to India-Netherland DTAA, the same cannot be applied automatically. Hence, the tax office issued a lower withholding certificate at the rate mentioned in the India-Netherland DTAA i.e., 10%.
High Court’s Ruling
The High Court allowed the taxpayer’s claim of a 5% withholding rate and thereby directed the revenue authorities to issue a fresh certificate with the following observations:
- A perusal of Article 10 of the India-Netherlands DTAA would show that when dividends are paid by an Indian Company to a resident of the Netherlands, they may be taxed in the Netherlands. However, such dividends can also be taxed in India provided the recipients are beneficial owners of the dividends and the tax rate does not exceed 10% of the gross amount of such dividends.
- The protocol forms an integral part of the DTAA. Therefore, no separate notification is required, in so far as the applicability of provisions of the Protocol is concerned.
- The protocol incorporates the principle of parity between the India-Netherlands DTAA and the tax treaties executed thereafter quathe rate of withholding tax or the scope of the tax treaties in respect of items of income concerning dividends, interest, royalties, fees for technical services or payments for use of equipment. The principle of parity kicks in only if:
- the third State with whom India enters into a DTAA is an OECD member;
- India should have, in its DTAA, executed with the third State, limited its rate of withholding tax, on subject remittances, at a rate lower or a scope more restricted, than the rate or scope provided in the subject DTAA.
On fulfilling the aforesaid conditions, the same rate of withholding tax or scope as provided in the DTAA executed between India and the third State would apply to the subject DTAA. The same rate or scope shall be applicable from the date on which the DTAA between India and the third State comes into force.
Therefore, the argument of revenue authorities that the beneficial provisions contained in the DTAAs, executed prior to or after the coming into force of the India-Netherlands DTAA (i.e., 21 January 1989), could not be made applicable to the recipients of remittances covered under the subject DTAA, despite the concerned third State being an OECD member, is completely misconceived and contrary to the plain terms of the protocol appended to the subject DTAA.
- The construct of protocol is such that in certain cases there could be a gap between the dates on which the DTAA is executed between India and the third State and the date when such a third State becomes a member of the OECD. The limit on the lower rate of tax or the scope more restricted contained in the DTAA executed between India and the third State can only apply when the third State fulfils the attribute of being a member of the OECD. The word “is” provided in the MFN clause of the DTAA describes a state of affairs that should exist not necessarily at the time when the subject DTAA was executed but when a request is made by the taxpayer or deductee for issuance of a lower rate withholding tax certificate under section 197 of the IT Act.
- The Netherlands interpreted the protocol appended to the DTAA in a manner that the lower rate of tax in the India-Slovenia DTAA will be applicable on the date when Slovenia became a member of the OECD i.e., from 21 July 2010, although, such DTAA came into force on 17 February 2005. Therefore, participation dividends paid by Companies resident in the Netherlands to an Indian resident will bear a lower withholding tax rate of 5%. Since one of the contracting states i.e., the Netherlands has interpreted the protocol in a particular way (as above), in the fitness of things, the principle of common interpretation should apply to ensure consistency and equal allocation of tax claims between the Contracting States.
With the abolition of the DDT regime, the dividend is now taxable in the hands of shareholders. This Ruling will help non-resident shareholders to evaluate whether the DTAA between India and their residence contains an MFN clause or not. If yes, relying on this Ruling, a shareholder could consider applying the concessional rate mentioned in other DTAAs executed post-entering of the DTAA by India.
While this decision pertains to dividends, it could be relevant for other sources of income – interest, royalty, and fees for technical services, subject to the MFN clause contained in such a DTAA. One should read the language of the MFN clause before placing reliance on this decision. This Ruling could be beneficial not only where investment is from the Netherlands but also where investment is coming from France, Switzerland etc. having similar MFN clauses in their DTAAs with India.
- The High Court’s reliance on the decree passed by the Netherlands was to maintain consistency in the interpretation of the provision of the tax authority and courts of the concerned country. Hence, one should not lose sight of the decision/decree in the other country while applying the MFN Clause. If the other Country had denied the benefits, then the Indian authorities could follow the same. Thus, apart from analyzing the MFN clause and making complete reliance on this decision, the taxpayer should also evaluate the judicial precedents in that other jurisdiction.