MNCs may have to recalibrate after SC denies double taxation benefits unless notified by law of the land

SC, DTAA, MFN and income tax

Multinational Companies (MNCs) will have to redo their Return on Investment (ROI) and cost benefit analysis as a result of the Supreme Court’s recent ruling on Double Taxation Avoidance Agreements (DTAA), experts said. The ruling was given on an appeal filed by the Income Tax Department.

Last week, the Supreme Court ruled that parties cannot avail of benefits under DTAA unless Indian tax authorities explicitly notify it. Simply put, the apex court has held that even if India enters into a DTAA with a nation, one cannot avail of benefits under it, unless it is woven into the country’s laws by a notification. Countries enter into DTAA to avoid taxation on the same income by two countries, if a person or a company earns income in country A from an investment in country B, tax will have to be paid only in one country depending on the terms of DTAA.

The court ruled this while interpreting the Most Favoured Nation (MFN) clause in the DTAA treaties between India and the Netherlands, France, and Switzerland. The MFN clause provides for lowering of rate of taxation at source on dividends, interest, royalties or fees for technical services (FTS). As per the MFN clause, when a country gives trade concessions to a member country of the Organization for Economic Cooperation and Development (OECD), it must be given to all. However, the SC was called upon to decide on whether the MFN clause is applicable to a third country, which was not an OECD member when India entered the agreement, but became a member at a later date.

The SC has also held that “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.”

As a result of this judgment, Foreign Portfolio Investors (FPIs) from the Netherlands will be subject to 10 percent withholding tax rather than 5 percent withholding tax, thereby reducing their RoI from India. The Netherlands and France have consistently been in the top 10 FPIs of 2023.

Rohit Jain, Managing Partner at law firm Singhania & Co said “This will increase cost of repatriation i.e. capital return becomes costlier as higher tax incidence will have to be factored in. Dutch / French / Swiss companies doing business in India and companies considering setting up new businesses in India will have to redo the cost benefit and ROI analysis.”

“The judgment will have a swift and immediate impact on global businesses who are earning revenues or are required to pay monies for cross border transactions subject to tax. For global recipients, they will have to contend with an increased rate of taxation on their incomes,” opined Pallav Pradyumn Narang, Partner at Chartered Accountants firm, CNK.
Noting that the judgment is itself based on a principle of law and not on foreign relations with these countries, Sonam Chandwani, Managing Partner KS Legal & Associates said “This ruling could prompt a re-evaluation of tax strategies and structures, potentially affecting the flow of investments and services. The emphasis on explicit notifications may also lead to demands for greater clarity in future tax treaties to avoid such ambiguities."

Authorities may consider reassessment

Experts have also said that the authorities may even consider reassessing taxation on past transactions owing to this judgment.

“Previously executed transactions, based upon the earlier held norms, will come back into the limelight and will invite reassessment notices from the tax department,” Narang said while noting that the party remitting the income will now have to recalibrate the system to update it with the new tax rate.

Similarly, Vishesh Malviya, Partner at Rashmikant and Partners said, “It may adversely impact companies, which have already taken benefits of such rates of taxes, as the Income tax authorities may re-open cases in view of the judgment.”

How did the case reach SC?

In 2021, the Delhi High Court held that no separate notification is required to be passed by the government for parties to avail of the benefits under DTAA. The Income Tax Department filed an appeal against this judgment. At the SC, the IT Department argued that India follows the “dualist” practice, which means that international treaties and conventions are not, upon their ratification, automatically assimilated into municipal law (i.e. the national legal system) but would require enabling legislation. This is in contrast to those countries which are “monist”, wherein the treaty provisions are enforceable like municipal law, and are to be given equal weight by courts. The court accepted the department’s arguments.