Vienna Convention for MFN cases? SC to decide

Ruling on a batch of five petitions, a landmark 19 October Supreme Court verdict had backed the tax department in the matter, effectively doubling the withholding tax outgo of these companies, and potentially opening up more companies to similar tax demands.

The aggrieved companies soon filed review petitions; among them, Steria India challenged a tax ruling pertaining to the India-France tax treaty. Concentrix Services BV and Optum Global Solutions challenged a tax ruling interpreting the India-Netherlands treaty; and Nestlé’s appeal was about India-Switzerland tax treaty. While each of the cases vastly differed from each other, the common question of law involved the MFN clause.

For example, dividends earned by Dutch companies in India are subject to a withholding tax of 10%, under the Double Tax Avoidance Agreement (DTAA) between the two countries. However, under the treaty’s MFN clause, if India has a lower withholding tax rate with any other country, dividends will be taxed at the lower rate, not the treaty rate of 10%. Since India has a lower withholding tax rate of 5% with some other countries, the Dutch companies calculated tax at that rate, which was rejected by the tax department on the grounds that the government had not specifically notified it. The Supreme Court backed the tax department in these cases.

The apex court is expected to allot a bench to hear the review petitions soon, the people cited above added. Vienna Convention acts as a guiding framework for various international treaties.

“The petition seeks the court to reconsider the judgment, drawing upon the principles of the Vienna Convention on the Law of Treaties," said Suresh Swamy, partner, Price Waterhouse & Co LLP. “As per the convention, treaties in force obligate the parties to comply in good faith. It’s noteworthy that while some Indian tax treaties necessitate a notification for the MFN clause to be operational, others may be inherently effective. This aspect merits careful consideration to ensure that treaty obligations are honoured appropriately," Swamy added.

However, the apex court held that MFN tax provisions don’t automatically apply, and that the Indian government would have to notify the lower tax rate and since India didn’t notify, Dutch entities will be subject to 10% tax rate. However, the appellants are of the view that Indian law may require notification, but the same practice may not be existent in the other country which has signed a DTAA with India.

In its verdict, the apex court cited the example of the Chicago Convention, which governs charter air services. The court observed that under this convention, a charter airline doesn’t need to obtain permission from the country it is landing in, if it doesn’t pick up or collect cargo/passengers. However, it is a matter of practice that in reality, all chartered flights obtain landing permission at every airport they land—irrespective of whether they are picking up passengers or not. The court similarly held even with the existence of MFN clause, subsequent practice of notifying rules must be taken into consideration.

“Currently, a group of petitioners have filed a review petition against the hon’ble SC ruling, citing various grounds, including the need for a reinterpretation of Article 31(3)(b) of the Vienna Convention and the interpretation of the term ‘is’ in the protocol," said Sandeep Jhunjhunwala, M&A tax partner at Nangia Andersen LLP. “While the honourable SC delved into the principles of international interpretation, it appears to have adhered primarily to an Indian law perspective, overlooking the treaty practices of both states."