Supreme court judgement in the Nestle Income tax case sets bad precedent

Supreme court judgement in the Nestle Income tax case sets bad precedent

Subject: Economy

Section: External Sector

In News:  Supreme Court’s (SC) recent ruling states that no automatic international treaty benefit, including a lower withholding tax, is available to foreign companies operating in India.

Key Points:

• The issue involves Nestle and some other EU companies claiming lower withholding tax of 5% instead of the 10% based on the Double Taxation Avoidance Agreements (DTAAs) that India had signed with Switzerland and other EU countries.
• This was done on the basis of invoking the most favoured nation (MFN) clause in the tax treaties.

What do the DTAAs mean for taxation?

• 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).
•  This provision allows India to sign tax treaties with other countries to avoid an income being taxed twice.
• These DTAAs also contain an MFN provision.

What does the MFN clause say?

• 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.
• Now India’s DTAAs with Slovenia, Colombia, and Lithuania have a lower withholding tax requirement of 5%. Hence the other countries are claiming the 5% rate as per the terms of MFN clause.

What was the issue before the courts?

• 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.

What does the Supreme Court ruling say?

• The Supreme Court overruled the HC order and held 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.
• Further SC noted that for MFN clause to come in effect, a separate notification for the same under Section 90 of the Income-Tax Act needs to be issued.
• This ruling will impose a tax burden estimated to be ₹11,000 crore on foreign investors. It may also lead to opening past cases.

Why is the judgement problematic?

• 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 critical question here is why the MFN clause could not be given effect in India without notification for the same under Section 90 of the Income-Tax Act.
• The SC judgement freezes the provisions of a treaty in time when there is nothing in the DTAA treaties that says that it applies only to countries that were members on the day the treaty was signed. 
• SC has 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.