One of the foremost challenges foreign investors face in India is the uncertainty in taxation measures. Taxation-related improbabilities arise not just due to the actions of the executive but also the judiciary. This makes doing business in India difficult for foreign players. The Supreme Court of India’s recent judgment in the Assessing Officer Circle (International Taxation) New Delhi vs M/s Nestle SA case, which disposed of 11 petitions involving corporations such as Nestle (a Swiss multinational company) and Steria (a European company) deserves to be seen in this light. The critical question in the case was whether the most favoured nation (MFN) clause in tax treaties such as the Double Taxation Avoidance Agreements (DTAAs) that India has signed, could be given effect in India without notification for the same under Section 90 of the Income-Tax Act. This provision allows India to sign tax treaties with other countries to avoid an income being taxed twice.
On Most Favoured Nation status
India’s bilateral DTAAs with the Netherlands, France, and Switzerland — all three countries are members of the Organization for Economic Co-operation and Development (OECD) — require imposing a 10% withholding tax (tax on dividends paid by Indian entities of foreign companies to the residents of Netherlands, France, and Switzerland). These DTAAs also contain an MFN provision. Thus, if India extends a preferential tax treatment to any third country “which is a member of the OECD”, the same treatment should be accorded to the Netherlands, France, and Switzerland under their respective DTAAs. India’s DTAAs with Slovenia, Colombia, and Lithuania have a lower withholding tax requirement of 5%.
When India signed DTAAs with these countries, they were not OECD members but joined the group later. When the matter initially came before the Delhi High Court, it held that under the MFN provision, the preferential tax in, say, the India-Slovenia DTAA should extend to the India-Netherlands DTAA. However, the Supreme Court overruled this, holding that when the India-Netherlands DTAA was signed, Slovenia was not an OECD member. Thus, the benefits given to Slovenia, which became an OECD member later, do not apply to the India-Netherlands DTAA. This ruling will impose a tax burden estimated to be ₹11,000 crore on foreign investors. It may also lead to opening past cases.
This reasoning is specious because it freezes the provisions of a treaty in time. There is nothing in the text of the India-Netherlands DTAA, for example, to prove that the words “is a member of the OECD” are restricted to countries that were members on the day the treaty was signed. It is puzzling that the top court used domestic interpretative techniques to interpret a term in an international treaty. Such an interpretation defeats the purpose of including non-discrimination standards such as MFN in economic treaties. MFN in a treaty ensures that future benefits given to a third country by one of the treaty-signing countries become automatically available to its treaty partners.
Dualism strikes back
The Supreme Court held that to give effect to the MFN provision in the DTAA, notification under Section 90(1) of the Income Tax Act is necessary and mandatory. Thus, the Court advocated the doctrine of dualism wherein international law is not enforceable domestically till it is transformed into municipal law through enabling legislation. While it is true that the Indian Constitution provides for such formal dualism, the Supreme Court has moved away from this principle toward the monist tradition of incorporating international law in the domestic legal regime, even if it is not explicitly incorporated, provided the international law is not inconsistent with domestic law.
This principle has been laid down in cases such as PUCL vs India, Vishakha vs State of Rajasthan, and Puttaswamy vs Union of India. The premise in these cases was the ‘presumption of compatibility’ or ‘presumption of consistency’ between domestic and international law. This presumption can be rebutted only if a domestic law explicitly contravenes international law. In other words, wherever possible, domestic law should be interpreted in a manner that does not contradict India’s obligations under international law. This approach ensures that progressive international law is given effect by the courts to protect the rights of citizens and persons even if the legislature and the executive have not acted to transform it into domestic law for whatever the reason.
Thus, international law is not just an interpretative tool. It has essential implications domestically. Surprisingly, the Court did not refer to this line of cases in its reasoning. This decision is a setback to the progressive judicial journey unleashed by cases such as Vishakha to take international law seriously. If India had issued a notification that expressly went against the MFN provision in some of the DTAAs, one could have plausibly argued that there is an inconsistency between domestic and international law. Thus, the former should be given effect, not the latter. However, without a notification under Section 90(1), the Court should have harmoniously interpreted India’s international law obligations contained in the DTAA with that of the Income Tax Act. It should have read the DTAA provision as part of Indian law. In any case, issuing a notification under Section 90(1) is an executive, not a legislative act. So, even from the principle of dualism, the Court’s reasoning is suspect.
The Court’s interpretation allows the executive to undo its international law obligations by not issuing the relevant notifications domestically. This not only rationalises violation of international law but also makes India susceptible to international claims under other instruments of international law such as bilateral investment treaties.
This judgment has once again proved the adage that the Supreme Court is supreme because it is final, not because it is infallible.
Prabhash Ranjan teaches at the Faculty of Legal Studies, South Asian University. The views expressed are personal