Budget 2024: Interpreting tax clauses crucial for success of MFN

In the realm of international taxation, clarity and consistency in interpreting tax treaties are crucial for businesses, particularly foreign investors navigating multiple jurisdictions. However, differences in treaty interpretations between countries often lead to disputes that can linger unresolved for years, impacting investor confidence and operational efficiency.

The Hon’ble Supreme Court’s recent decision in the case of Nestlé SA case has brought these challenges into the light again as it questioned the principles of treaty interpretation that were previously considered settled.

Challenge associated with differential treaty interpretations

The Nestlé SA case exemplifies the complexities inherent in treaty interpretation, particularly concerning the application of the "Most Favoured Nation" (MFN) clause. This clause allows taxpayers to benefit from more favourable provisions of one treaty when compared to another treaty with the same country.

While adjudicating the matter, the Hon’ble Supreme Court held that a separate notification is required to be issued under the Income-tax Act, 1961 ('Act') to give effect to the tax treaty or to its Protocol changing terms and conditions that alters existing provisions of the law. Further, it also held that MFN clause in a tax treaty does not automatically apply benefits from a later tax treaty with an OECD country. To extend those benefits, the earlier treaty must be amended through a separate notification under Section 90 of the Act.

In the decision, the Hon’ble Supreme Court also held that the relevant date for another state to be a member of OECD would be the date of entering into tax treaty with India, and not at a later date when the country becomes OECD member.

This decision had wide ramifications on treaty interpretation and various treaty benefits that taxpayers have historically availed, especially in the context of ‘make available’ criteria under fees for technical service. A key takeaway from the ruling is the necessity for specific notifications from the tax policy administration under the Act to implement treaty protocols, especially in the context of the MFN clause.

Uncertainties in the tax outflows for past transactions

There is currently no clarity on the impact of the decision on the taxpayers who have already made claims based on MFN clause provisions, resulting into various uncertainties such as:

1. Risk of payer being treated as representative assessee or agent, especially if recovering taxes from the recipient proves to be impractical or impossible, even in case where the payers have applied a NIL/ lower withholding tax rates based on the tax orders from the department.

2. Initiation of withholding tax proceedings by the tax authorities for non-deduction or short deduction of taxes resulting into potential interest and penal consequences.

3. Potential disallowance of expenses and the risk of reassessment due to non-deduction or short deduction of taxes.

4. Initiation of assessment/reassessment proceedings on the recipient for non-payment or underpayment of taxes.

5. Initiation of penalty proceedings on the payee for underreporting of income.

Expectations from the new government

To address and resolve past tax disputes, the government could consider establishing comprehensive guidelines under a settlement scheme. A settlement scheme would create a structured approach to encourage taxpayers to voluntarily settle their outstanding tax liabilities by providing them with a one-time window. The potential benefits from the scheme could be as under:

Relief from Interest and Penalties: One of the key features of the scheme could be the waiver of interest and penalties on the additional taxes to be paid. This would provide significant financial relief to taxpayers, making it more attractive for them to settle their disputes.

Legal Certainty: By participating in the scheme and settling their tax dues, taxpayers would gain legal certainty and avoid prolonged litigation. This could help businesses plan their finances better without the cloud of pending tax disputes.

Efficient Tax Collection: The scheme would lead to more efficient tax collection by encouraging taxpayers to come forward and pay their dues without the need for lengthy audits or legal proceedings. This would save administrative resources and reduce the backlog of disputes.

Conclusion

In conclusion, the implementation of a settlement scheme to resolve tax disputes arising from differential treaty interpretations, can be a proactive step towards reducing the litigation.

Such settlement schemes not only benefit taxpayers by providing clarity and certainty, but also strengthen tax administrations by promoting efficiency and consistency. As global economies become increasingly interconnected, the importance of clear and predictable tax regimes cannot be overstated.

Rajesh H. Gandhi is a partner with Deloitte Touche Tohmatsu India LLP.