MFN clause affects the face and shape of taxability

By virtue of Most Favoured Nation (MFN) clause in some tax treaties, beneficial tax rates and / or restricted scope of tax available under tax treaties with some countries can be applied to other tax treaties

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The concept of Most Favoured Nation (MFN) clause is customary in international tax treaties.  The presence of the clause in a tax treaty helps establish parity in the competitive opportunities that are present to investors in different foreign countries. India has a huge network of tax treaties, entered over a period spanning several decades. A number of Indian tax treaties contain MFN clauses such as those with Spain, The Netherlands, France, Belgium, Sweden, etc. By virtue of the MFN clause in some tax treaties, beneficial tax rates and/or restricted scope of tax available under tax treaties with some countries can be applied to other tax treaties.

MFN - The Origin and concept The origin of the concept of MFN can be traced back to international trade agreements of the World Trade Organization (WTO). Under WTO agreements, countries cannot discriminate between their trading partners. Accordingly, international trade agreements between two countries generally contain an MFN clause under which each party agrees that any trade concession given to other trading partners will also be applied to the other party to the agreement, i.e. more favourable terms will not be granted to other countries without granting the same concessions to the treaty partner.  Such clauses liberalise trade and accordingly, MFN clauses are approved by the General Agreement on Tariffs and Trade (GATT).

MFN embodies the principle of non-discrimination. The MFN clause, meant to accord equitable treatment vis-à-vis a third country, links agreements by ensuring that parties to one treaty are accorded treatment no less favourable than the treatment provided under other treaties in areas covered by the clause. Plainly put, MFN implies favourable treatment accorded to one country by another.

MFN in Indian tax treaties
In the context of Indian tax treaties, the MFN clause is typically placed in the ‘protocols’ to tax treaties. Protocols are documents annexed to tax treaties, which elaborate and at times, alter the text of a tax treaty. Legally, they are a part of the treaty and carry binding force equal to that of the principal treaty text. The application of protocol to tax treaties (and therefore, consequent application of MFN clause) is generally automatic and is not dependent upon any further action by the respective governments. An exception to this appears in India’s tax treaties with Philippines and Switzerland where a specific enabling action is required from the respective governments to give effect to the MFN clause.

By virtue of the MFN clause in several Indian tax treaties, tax rate or the scope/coverage of tax is restricted to rates/scope present in other beneficial tax treaties. For instance, a tax treaty provides for 15 percent rate of tax on dividends and contains an MFN clause in the protocols which enables application of the lower tax rate with respect to dividends from other tax treaties. The tax rate on dividends therefore in the base tax treaty will be restricted to such lower rate (say 10 percent) as imported from other beneficial tax treaties. There can of course be limitations provided in the MFN that a beneficial treatment can only be applied, say for instance, from any tax treaty executed with an OECD country.

The application of MFN clause in Indian tax treaties has not been debated often. There are rulings by the Karnataka High Court in the case of De Beers India Minerals Private Limited and ISRO Satellite Centre, among others, where the benefit of the MFN clause to India’s tax treaties with The Netherlands and France respectively was granted.

In mid-2014, a pertinent debate on the application and interpretation of MFN clause was stirred in context of the India-France tax treaty. The Authority for Advance Rulings (AAR) in the case of Steria (India) Ltd interpreted the protocol to the India-France tax treaty in a rather restricted manner suggesting that protocol can be used for interpreting provisions of the tax treaty but not for importing from other tax treaties, words, phrases or clauses that are not already present in the base tax treaty. This ruling of the AAR was contrary to many past rulings on similar issue, and it has therefore unsettled the time-tested principles for interpretation of a tax treaty, read with protocol.  However, within 40 days of the pronouncement of the ruling by AAR, another ruling was pronounced by the Mumbai bench of the tribunal in case of IATA BSP India which upheld the applicability of MFN clause present in the protocol to India-France tax treaty, restoring some of the lost certainty.

Concluding thoughts
Originated from the international trade agreements, it is true that taxation laws have not remained untouched by the rules of trade. In today’s egalitarianism regime, MFN clause has been built as an integral part of tax treaties in consonance with global practices. It affects the face and shape of taxability and often times, MFN clause and benefits associated with it guide investment decisions. MFN and like clauses (eg: non-discrimination clause) in a tax treaty seem to be the most practicable solution for promoting equity and accord in international taxation.

(Views expressed are personal)

- By Sumeet Hemkar, Partner, BMR & Associates LLP with inputs from Anuj Agarwal, Manager, BMR & Associates LLP.

The thoughts and opinions shared here are of the author.