Challenging CBDT’s MFN Clause Circular No. 3 of 2022 dated 03.02.2022

1. CHALLENGINGCBDT’SMFNCLAUSECIRCULARNO.3OF 2022DATED 03.02.2022 AUTHOR:AMANGUPTA https://taxguru.in/income-tax/challenging-cbdts-mfn-clause-circular-no-3-2022-dated-03-02-2022.html Recently,HighCourtofDelhihasacceptedWritPetitioninthecaseofSocieteDeParticipationsFinancieres ETIndustriellesSpafi(FrenchShareholder)vs.AssistantCommissionerofIncomeTax&ANR.(W.P. (C)9316/2022&CMAPPLs.27903-27904/2022)andhasissuednoticechallengingCBDT’sMFNCircular No.3of2022whereinithasbeensubmittedbytheassesseethatCBDThasexceededitsjurisdictionbylaying downconditions for invocation of theMFN clause. UnderstandingMFNClause India has entered into DTAA’s having an MFN clause with various countries. The Protocol to the DTAA’s with said countries (‘relevant DTAA’) provide that if under any DTAA between India and a third State (‘subsequent DTAA’), India limits its taxation to a lower rate or a more restricted scope than the rate or scope provided in the relevant DTAA, the same rate or scope as is applicable in the subsequent DTAA shall also apply under the relevantDTAA. MFNclauseisusuallyfoundinProtocolsandExchangeofNotestoDTAAs.Oncethisclauseispartofatreaty, theresidentsof contractingstatesget equaltreatment asisbeing giventoresident ofother (third)states. TheintentionofMFNclauseintaxtreatiesis: grantingoflowerrateonspecifiedincomeand/or; restrictingthescopeofincomeand/or; otherbenefitintermsofallowanceofexpensesincaseofbusinessincome MFN clause, as forming part of protocol, is an integral part of the tax treaty. Dr. Klaus Vogel in his Commentary onDouble Tax Conventions mentions- “……Aspreviouslymentioned,(final)protocolsandinsomecasesothercompletingdocumentsare frequentlyattachedtotreaties.Suchdocumentselaborateandcompletethetextofatreaty,sometimes even altering the text. Legally they are a part of the treaty, and their binding force is equal to that of the principal treaty text. When applying a tax treaty, therefore, it is necessary carefully to examine these additionaldocuments” AtypicalMFNclauseinanyIndianDTAAreadsasunder(reproducedfromProtocolIV(2)oftheIndia- Netherlandstreaty– “IfafterthesignatureofthisconventionunderanyConventionorAgreementbetweenIndiaanda third State which is a member of the OECD India should limit its taxation at source on dividends, interests,royalties,feesfortechnicalservicesorpaymentsfortheuseofequipmenttoaratelowerora

2. scopemorerestrictedthantherateorscopeprovidedforinthisConventiononthesaiditemsofincome, then as from the date on which the relevant Indian Convention or Agreement enters into force the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also applyunder this Convention.” Thus, in view of the above, while examining the tax liability of Royalty / FTS under the relevant provisions of theDTAA, itwould alsobe critical toexamine whetherthe DTAA hasan MFNclause ornot. ConditionsStipulatedinCircularNo.3/2022andourcomments In the circular it has been clarified that the applicability of the MFN clause and benefit of the lower rate or restricted scope of source taxation rights in relation to certain items of income (such as dividends, interest income, royalties, Fees for Technical Services, etc.) provided in India’s DTAA with the third states (OECD Member) will be available to the treaty with an MFN clause (treaty with the first state) only when all the four conditions are met. The conditions are being discussed here with respect to the act, DTAAs and the prior judgmentsof the High Courts: S.No. Condition Ourcomments The treaty with the third stateThetextoftheaboveIndia-Netherlandstreaty,explicitlymentionsthatthe theMFNclauseshallbeextendedonlyifIndiaentersintoanagreementwith is entered into after signature/EntryintoForceof(memberofOECD)aftersignatureoftheIndia-Netherlandstreaty. 1. the treaty with an MFNHence,itseemsthat theCBDTclarificationin thisregardislikely toholdgood clause(treatybetweenIndiabeforethecourts. andtheFirstState); Aplainreadingoftheaboveprotocoldoesn’tseemtosuggestthatthethirdstat memberoftheOECDatthetimethatthetreatybetweenitandIndiaissigned thetime of applicabilityof the MFNclause. Further,theHighCourtofDelhiinConcentrixServicesNetherlandsB.V.v Officer(TDS)P.(C)NOS.9051OF2020AND882OF2021ANDCMAPP Thesecondtreatyisentered OF2021APRIL22,2021hadheldthattheprincipleofcommoninterpretati aappliedintheinterpretationofDTAAs.Further,reliancewasplacedbyth intobetweenIndiaand StatewhichisamemberofinterpretationoftheothercontractingState,i.e.,theNetherlandswhichha 2. ofclauseIV(2)toholdthat“thelowerrateoftaxsetforthinthe theOECDatthetime signingthetreatywithit; Convention/DTAAwillbeapplicableonthedatewhenSloveniabecamea OECD,i.e.,from21-8-2010,although,theConvention/DTAAbetweenIndia cameinto forceon 17-2-2005.”(emphasis supplied) The plain reading of the protocol and more so, the judgment of the Delhi HC s the issue squarely and in view of the same, the clarification from CBDT is withstand,if challenged.

3. Indialimitsitstaxingrights in the second treaty inThisconditionwill,inanycase,beapre-requisitefortheimportofMFNclaus 3. relationtorateorscopeofandavailingthebenefitofthesame.Hence,itisunlikelytobecontesteda taxationinrespectof thedoesn’trequirein-depthinterpretation/analysis. relevantitemsofincome; and Thetextoftheprotocolandtheprovisionsofsection90(1)oftheIncome-t containnoexplicitmentionoftherequirementofaseparatenotificationfor benefitsof the MFN clause. InSteria(India)Ltd.vs.CIT,[2016]386ITR390(Del)theHighCourtofD “protocolsandinsomecasesothercompletingdocumentsarefrequently Aseparatenotification hastreaties…Legallytheyarepartofthetreaty,andtheirbindingforceisequal been issued by India,principaltreatytext.Whenapplyingataxtreaty,therefore,itisnecessary 4. importingthebenefitsoftheexaminetheseadditionaldocuments.Therefore,theconclusionoftheAARth treaty with thethird state into theProtocol,whichformspartoftheDTAAbetweenIndiaandFran thetreatywithMFNclause. automaticallybecomeapplicableandthattherehastobeaseparate incorporatingthebeneficialprovisionsoftheDTAAbetweenIndiaandU partoftheIndia-FranceDTAAisnotagreeable.”(emphasissupplied) Inviewoftheprovisionsofsection90andtheabovejudgementoftheDelhi thatthisconditionmightnotbeacceptablebeforetheadjudicatingauthorities.

4. IssuesregardingapplicabilityofMFNarebeinglitigatedatvariousjudiciallevels.AsaCircularisbindingon tax authorities and not necessarily on taxpayers and therefore it has been clarified in circular that in the case of a taxpayer there is any decision by any court on this issue favourable to such taxpayer, then the circular will not affectthe implementation of the courtorder in such case. Disclaimer: This document has been prepared for academic use only and to share the same with the fellow professionals and all concerned. Though every effort has been made to avoid errors or omissions in this document yet they may creep in inadvertently. The author shall not be responsible for any damage or loss to any one, of any kind, in any manner due to this article. The author shall also not be liable or responsible for any loss or damage to any one in any matter due to difference of opinion or interpretation in respect of the text. It is suggestedthatto avoidany doubt(s),theuser shouldverify thecontents ofthisarticle independently.