Some MNCs may face tax heat as SC clears air on MFN applicability

Multinationals from the most-favoured jurisdictions such as the Netherlands, Switzerland, and France, which have been taking advantage of lower taxation applicable to other nations that signed tax treaties with India at a later stage, might have to pay additional levies to the Indian tax authorities.
 

The Supreme Court on Thursday settled the long-standing issue regarding the applicability of the most favoured nation (MFN) clause, denying the lower withholding tax rates on dividend payouts and other relevant remittances as interpreted earlier by these countries.
 

The MFN status allows further easing of tax rates if India offers a lower rate through a subsequent treaty with another nation, provided that other nation is also a member of the Organization for Economic Co-operation and Development (OECD). The clause is to maintain tax parity with the OECD nations. Under the treaty, India offers favourable tax treatment with the Netherlands, France, and Switzerland, which are also members of the Organisation for Economic Co-operation and Development (OECD). The country restricted its right to withhold taxes on dividends paid to 10-15 per cent under the MFN clause.
 

The issue emerged when India signed treaties with other nations, including Slovenia, Lithuania, and Colombia, and fixed a lower rate (5 per cent withholding tax). These nations became OECD members much later and after signing treaties with India. However, Dutch and Swiss jurisdictions argued over lower taxes, citing the MFN clause of equal tax treatment and put out unilateral directives modifying the concession rates offered to them under their respective treaties.

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Following this, many companies withheld a lower tax of 5 per cent while remitting the dividend to their foreign shareholders. This, however, did not go down well with the tax department.
 

The CBDT in 2022 had clarified conditions to take benefit of the MFN clause, the most important being that the third state should be an OECD member at the time of signing and a separate notification is required to import benefits of MFN into the existing treaty. Many treaty partners do not favour this interpretation and give automatic effect to MFN.
 

“Many taxpayers had taken a concessional tax rate for remittances such as royalties and fees for technical services and for dividends after April 1, 2020 (after abolishing dividend distribution tax). The decision of the apex court will have wide repercussions for the industry and could result in millions of dollars of additional tax revenue for the government,” said Amit Maheshwari, tax partner, AKM Global, a tax firm.

The decision would also entail revival of pending matters in the form of fresh action by the tax authorities by initiating proceedings, raising demands or denying lower withholding tax in respect of remittances made in the past. This may not go down well with tax treaty partners, he said.

The Supreme Court held that a government notification was mandatory for a judicial authority to give effect to a Double Taxation Avoidance Agreement or any protocol changing its terms and conditions, which has the effect of altering the existing provisions of law.

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Sudhir Kapadia, national tax leader, EY, said: “The SC decision, though unfavourable for taxpayers, provides certainty on this long-standing issue. Henceforth, only the tax rates prescribed in the relevant tax treaty (with the country of residence of recipient of such income from India) will apply and the contention that a lower rate, if any, prescribed in tax treaties with OECD countries entered into subsequently will apply to existing treaties no longer holds good.”