Analysis of India’s Tax Treaty Implications on Foreign Investors
Context:
Foreign investors in India often face challenges related to the uncertainty in taxation measures, which impact their ability to conduct business in the country mostly due to judicial actions.
Supreme Court of India in its recent judgement stated that in Assessing Officer Circle (International Taxation) New Delhi vs M/s Nestle SA case sheds light on this issue.
Background:
The case revolves around whether the most favored nation (MFN) clause in India’s tax treaties, such as Double Taxation Avoidance Agreements (DTAAs), can be enforced without formal notification under Section 90 of the Income Tax Act.
Relevance:
GS – 3 (Indian Economy)
Prelims:
FDI, Double Taxation Avoidance Agreements (DTAAs)
Mains Question:
Discuss the implications of the recent Supreme Court judgment on the Assessing Officer Circle (International Taxation) New Delhi vs M/s Nestle SA case for foreign investors in India and its impact on the application of the most favored nation (MFN) clause in tax treaties. (150 words)
Dimensions of the Article:
- The MFN Clause
- The Legal Interpretation
- Dualism vs. Monism
- Implications
The MFN Clause:
- India’s bilateral DTAAs with the Netherlands, France, and Switzerland include an MFN provision, imposing a 10% withholding tax on dividends paid by Indian entities to residents of these countries.
- The MFN clause states that if India extends preferential tax treatment to any third country that is an OECD member, the same treatment should apply to the Netherlands, France, and Switzerland under their respective DTAAs.
- In contrast, India’s DTAAs with Slovenia, Colombia, and Lithuania require a lower withholding tax of 5%.
The Legal Interpretation:
- When the matter initially came before the Delhi High Court, it held that the MFN provision should extend preferential tax treatment from one DTAA to another. However, the Supreme Court overruled this decision, arguing that when the India-Netherlands DTAA was signed, Slovenia was not an OECD member. Therefore, the benefits given to Slovenia, which later joined the OECD, do not apply to the India-Netherlands DTAA. This ruling imposes a significant tax burden of approximately ₹11,000 crore on foreign investors and may reopen past cases.
- The Supreme Court’s reasoning is questionable as it restricts the interpretation of treaty provisions to the time of signing. There is no textual evidence in the India-Netherlands DTAA that the phrase “is a member of the OECD” only applies to countries that were OECD members when the treaty was signed. This decision raises concerns as it employs domestic interpretative techniques to understand an international treaty, undermining the purpose of non-discrimination standards like the MFN clause.
Dualism vs. Monism:
- The Supreme Court held that to give effect to the MFN provision, notification under Section 90(1) of the Income Tax Act is necessary. This approach aligns with the doctrine of dualism, where international law is not enforceable domestically until transformed into municipal law through enabling legislation.
- While India’s Constitution supports dualism, the Supreme Court has gradually moved towards the monist tradition, incorporating international law into the domestic legal regime, even when not explicitly mentioned, as long as it does not contradict domestic law.
- Cases such as PUCL vs India, Vishakha vs State of Rajasthan, and Puttaswamy vs Union of India established the presumption of compatibility between domestic and international law, which can only be rebutted if domestic law explicitly contradicts international law. This approach ensures that international law protects the rights of citizens even if the legislature and executive have not transformed it into domestic law.
- The Supreme Court’s decision does not reference these cases, marking a setback in taking international law seriously. Without a notification under Section 90(1), the Court could have harmoniously interpreted India’s international law obligations in the DTAAs with those in the Income Tax Act, reading the DTAA provisions as part of Indian law. The issuance of a notification under Section 90(1) is an executive act, not a legislative one. Even following the principle of dualism, the Court’s reasoning remains questionable.
Implications:
- The Court’s interpretation allows the executive to evade international law obligations by not issuing required notifications domestically. This not only rationalizes international law violations but also exposes India to international claims under other international instruments, such as bilateral investment treaties.
- India should also strengthen its commitment to international legal norms to maintain its credibility on the global stage and provide a stable and favorable environment for foreign investments.
Conclusion:
The Supreme Court’s decision highlights the need for a nuanced and well-considered approach to international tax treaties, fostering a conducive environment for foreign investments in India while adhering to international obligations. India’s economic growth and global standing depend on its ability to strike this balance effectively.
