Supreme Court on MFN

The supreme court of India had a mammoth task before itself to bring clarity on the much-debated MFN issue under India’s tax treaties and while we have got the court’s answer which has become the law of the land, in our view, it is not clear as to what is that central reasoning that made the court answer the way it did. We did not see much discussion on merits and it is unclear as to why the court does not agree with the arguments of the taxpayer. The Delhi High Court had held that the protocol forms integral part of the tax treaty and no separate notification was required to make its provisions into effect. The Delhi HC also placed reliance on its earlier decision, where the same was observed and views of Klaus Vogel were noted that protocol provisions completes the text of a treaty, sometimes even altering it and legally it is part of the treaty with binding force equal to that of the principal treaty text. However, the order of the Supreme Court makes no mention of these points and does not provide any reasoning on how the Delhi High Court’s order suffers from infirmities.

No doubt the implications of the order of the Supreme Court are huge. All those taxpayers who have taken benefit of the MFN clause, should now be subject to higher taxes on account of the beneficial provisions not being available as the order of the court would be applicable on a retrospective basis. This would also mean that they would be subject to interest and penalties.

From the order it also becomes clear that even protocols that India will enter into under its tax treaties with other countries will have no effect unless a separate notification under domestic law is issued. In this context, will the legislature ever notify the current protocols as notifying them may significantly impact the collection of the exchequer. One may question the reasoning and intent of the entering into these protocols so many years ago if it required a separate notification to be effective.

As the top court of the country, a well-reasoned speaking order was imperative for an issue that has been in debate for so long. A reasoned order, even if not favoring the taxpayer, can go a long way in affecting the jurisprudence on issues such as this in the long run which should have been considered by the court when pronouncing a judgment of this nature.

Below is a quick summary of the analysis of the order with some thoughts. Hope you enjoy reading it.

• Ratification of a treaty: The court states that while under the Constitution, treaty making power vests exclusively with the Union and it is in turn bound by them, Parliament can refuse to perform or give effect to such treaties. It states that if the treaty affects /restricts the right of the citizens, parliament needs to make law in respect of such treaties. Accordingly, it concludes that upon India entering into a treaty or protocol does not result in its automatic enforceability in courts and tribunals; the provisions of such treaties and protocols do not therefore, confer rights upon parties, till such time, as appropriate notifications are issued, in terms of Section 90(1). However, the court does not dwell into how the protocol is separate from the treaty itself and requires separate notification when the treaty has already been notified. In this context, what is interesting to note is that there is no discussion on the language of the protocol which under the India – Netherlands tax treaty states ‘…the undersigned have agreed that the following provisions shall form an integral part of the Convention’ . Further, the judgment does not provide any rebuttal or arguments or discussion against the contentions of the assessee wherein they had stated how once the convention has been notified, there is no requirement of separately notifying the protocol. The court has relied on some judicial precedents to come to its conclusion without providing any response to the assessee’s arguments.

  
  

• The interpretation of the term ‘is’: The court on this issue has held that when a third-party country enters into tax treaty with India, it should be a member of OECD, for the earlier treaty beneficiary to claim parity. This means that if the third-party country becomes a member of the OECD after entering into a tax treaty with India, the benefit under the tax treaty that India has with the third party will not be provided to the earlier treaty beneficiary. In reaching this conclusion, the order relies on a couple of judgments which have interpreted the term ‘is’ and essentially state that a contextual meaning has to be culled out to reveal the true intention of the term.  There is no discussion other than the above as to how the court has come to the conclusion that the treaty country has to be an OECD country at the time of entering into a tax treaty with India. What is disheartening is that there is yet again no discussion or rebuttal to the arguments of the assessee to state that they are flawed or incorrect. The Delhi High Court had discussed the use of this term at length in its order and provided interpretation as to how the term should be interpreted. However, there is no mention of how the Delhi High Court’s interpretation is incorrect or cannot be applied to the present facts.

  
  

• Treaty practice of India in relation to other countries: The judgment tries to argue how treaties are ratified in different ways  in different countries and provides how France, Netherlands, Switzerland have a process embodied in their domestic laws for ratification of their treaty. It then goes onto hold that in India, either the treaty concerned has to be legislatively embodied in law, through a separate statute, or get assimilated through a legislative device, i.e. notification in the gazette, based upon some enacted law and absent this step, treaties and protocols are per se unenforceable. Yet again, the court does not dwell into how the protocol is separate from the convention itself and requires separate notification when the convention has already been notified.

  
  

• The Court has also relied on Klaus Vogel, Vienna Convention on Law of Treaties and certain other international practices to come to the conclusion that the treaty practice in other countries is different than that of India and that a notification under Section 90 of the Income Tax Act, 1961 (Act) is an essential requirement when it comes to implementation of protocols under tax treaties.