Interpretation of tax treaties is often a vexed topic and various Indian courts have over time laid down golden rules to interpret treaties and their terms. In a recent interesting development, the Delhi High Court had occasion to interpret the Most Favored Nation (MFN) clause of the India–Netherlands tax treaty (the tax treaty).
The MFN clause of the tax treaty provides that post signing of the tax treaty, if India signs a treaty with an Organization for Economic Co-operation and Development (OECD) member country which provides for a scope more restricted or rate lower than that provided under the tax treaty in respect of certain items of income (e.g. dividends, interest etc.), then such beneficial provisions would also apply to the tax treaty.
The Delhi High Court was confronted with a question whether the benefits of the said MFN clause of the tax treaty would also apply in case of a treaty entered into by India with a third country which was not an OECD member on the date of signing of such treaty, but subsequently became one.
The High Court ruled in favor of the taxpayer while placing reliance on the “common interpretation” approach as well as concluding that the effect of the MFN clause has to be seen at the time of application of the tax treaty and not when it was entered into with the third country.
Before we delve into the detail of this interesting case (Concentrix Services Netherlands B.V v. ITO (TDS), (TS-286-HC-2021)), the authors would like to briefly touch upon some relevant aspects of treaty interpretation, particularly in the Indian context.
Legal Framework of Tax Treaties in India
It is an acknowledged fact that tax treaty negotiations are largely based on dynamics of various trade and commercial factors between respective countries and are negotiated by diplomats at higher levels of government, and hence the language of tax treaties cannot be compared with the wording of a domestic statute drafted by legal craftsmen. Thus, tax treaties have to be interpreted liberally with a view to implementing the true intention of the parties (Union of India v. Azadi Bachao Andolan, 10 SCC 1).
In India, the power of entering into a treaty is an inherent part of the sovereign power of the state and once India has entered into a treaty with another country and such treaty has also been notified under Section 90 of the Income-tax Act, 1961, the treaty becomes a law under Article 253 read with Article 73 of the Indian Constitution.
Although India does not officially have a model version of its own tax treaty, a de facto Indian version of its model convention often acts as a base during treaty negotiations, though it also depends upon the other country, as the other contracting state often relies heavily also on OECD or UN model conventions.
Technical Explanations and Model Commentaries as Aids in Treaty Interpretation
Once the tax treaty is negotiated and enters into force, a few countries (e.g. the U.S.) as a practice release their official versions of explanations to the tax treaty, which give an insight into the negotiations and context of signing the treaty.
India, however, does not release any such versions giving insight into the negotiation of the tax treaty, and hence there is no direct official version available to determine the context of the terms of the treaty negotiated. Recourse thus needs to be made to different aids to interpreting the treaty.
Although India is not a signatory to the Vienna Convention of Law of Treaties, 1969 (Vienna Convention), it is well accepted that it contains many principles of customary international law, and the principle of interpretation as enshrined in Article 31 of the Vienna Convention provides a broad guideline as to what could be an appropriate manner of interpreting a treaty also in the Indian context (Ram Jethmalani vs. Union of India, 8 SCC 1).
Similarly, OECD model commentaries have been accepted and referred to in multiple forums (Union of India v. Azadi Bachao Andolan, 10 SCC 1, Formula One World Championship Ltd. v. CIT, 15 SCC 602, CIT v. E-Funds IT Solution Inc.13 SCC 294, Engineering Analysis Center of Excellence v. CIT, Civil Appeal nos 8735-8736 of 2018) as an aid to interpretation of a tax treaty, even in the Indian context.
Reference to the OECD model commentary is also blessed by Article 32 of the Vienna Convention, which allows recourse to be had to supplementary means of interpretation in order to confirm the meaning resulting from the application of Article 31, or to determine the meaning when the interpretation according to Article 31 leaves the meaning ambiguous or leads to an absurd or unreasonable result (Thiel v. Federal Commissioner of Taxation, High Court of Australia, 94 ALR 647).
Principle of Common Interpretation
The principle of common interpretation of tax treaties is another vital concept propounded under various commentaries, and plays a fundamental role in tax treaty interpretation.
Tax treaties, being instruments born out of trade negotiations between two countries, act chiefly to reduce a double taxation burden for a country’s residents and are meant to allocate tax claims equally between the contracting states. This goal can only be achieved if the treaty is applied consistently by the authorities and courts of both the contracting states.
In interpreting tax treaties, therefore, an interpretation should be sought which is most likely to be accepted in both the contracting states. This precept of “common interpretation” is also recognized in private international law with regard to the interpretation of conflict rules.
Private international law determines, in cases of conflicts related to private transactions, the possibility of making a choice of court, forum selection, choice of applicable law, as well as of recognizing or enforcement of a foreign judgment. There have been cases in India in which various judicial forums have applied this principle to rely on foreign court judgments or for determination of residential status under domestic tax law (e.g. Aberdeen Asia Pacific v DCIT, Bombay HC).
Historically, in most cases, such reliance on foreign court rulings is made in determining treaty interpretation based on similar facts of the case—for example, how a court in a foreign jurisdiction (not necessarily in the other contracting state) has interpreted a particular provision; or even where concepts have been borrowed in Indian domestic laws (e.g. anti-abuse provisions).
However, it has not frequently happened that courts have relied on any unilateral decree or unilateral official position on a particular concept of tax treaties while interpreting treaties in the Indian context. In fact, reliance on U.S. technical explanations (which are also an official but unilateral version of the tax treaty between India and U.S.) has been rejected as not being binding upon India, as they have been issued unilaterally by the U.S. and are not an official protocol or clarification which has been mutually agreed upon by the two countries (NGC Network Asia LLC v. DDIT, Mumbai Tribunal).
It is accepted that a uniform understanding of both contracting states has persuasive value, and not unilateral decrees or official positions which can at best be used for orientation purposes.
This leads us to another intriguing aspect—if a contracting state releases any official position or decree on a unilateral basis and India has reservations with such unilateral state actions, would it be bound to issue its official reservation or position on that particular issue? Would no action from India be regarded as deemed acceptance of such positions?
In the authors’ view, unilateral declarations on a specific treaty might not have impact on the content of the treaty itself. This is, from an international public law point of view, also true for so-called technical explanations. Therefore, generally, India would not be bound to object officially to a certain position if the government of the other contracting state does not share the view expressed in the unilateral declaration. Subsequent practice might have some (but limited) impact on the treaty interpretation, but only if it is uniform.
The principle of common interpretation would thus mean (and perhaps be restricted to) that courts of one contracting state should look at decisions made by courts of the other contracting state when confronted with problems of interpretation, and that they test whether their interpretation can be transferred.
If the decisions are plausible and if their application may lead to the avoidance of double taxation, they should at least be considered and any deviation from them should be explained explicitly. Common interpretation does not mean that the case law of the other state must be accepted without review (Klaus Vogel and Prokisch, General Report on “Interpretation of Double Taxation Conventions” for the International Fiscal Association).
Decision of the Delhi High Court
The Delhi High Court has also referred to the concept of common interpretation while delivering its judgment on the crucial aspect of applicability of MFN clause benefits to the tax treaty in respect of treaties signed by India with non-OECD countries which subsequently became OECD members.
Briefly stated, the facts before the High Court were that India signed its tax treaty with the Netherlands in 1989, and subsequently signed tax treaties with Slovenia (2005), Colombia (2011) and Lithuania (2011), when all these countries were not OECD members: they were subsequently accorded OECD memberships in 2010 (Slovenia), 2020 (Colombia) and 2018 (Lithuania).
A question thus arose as to whether, post acceding to their membership to OECD, the benefits of the tax treaties entered into by India with these respective countries would be accorded to the tax treaty with the Netherlands as well. The question was crucial, as these tax treaties were negotiated to allow India to withhold tax on dividend income at 5%, whereas the tax treaty with the Netherlands permitted such withholding at 10%.
It was brought to the notice of the Court that the treaty partner in question, i.e. the Netherlands, in 2012 also published a unilateral decree in which it explained its position that the benefits of the India–Slovenia tax treaty would be available to the India–Netherlands tax treaty (from the date of accession of Slovenia to OECD membership) in view of the MFN clause; and hence dividends would suffer only 5% withholding tax. The High Court relied upon the said decree, and in view of the principle of common interpretation allowed the taxpayer to remit the dividend income after withholding tax at 5% by adopting the restricted rate under the India–Slovenia tax treaty.
In the authors’ view, with due respect the conclusion of the High Court seems particularly intriguing given its reliance on a unilateral instrument to ascribe a meaning given by one treaty partner as “common interpretation” of the two contracting states. As stated above, India is not duty bound to express reservations on a unilateral decree. It would be interesting to see if the court ruling would have been different if India had released an official reservation against the Netherlands decree, or even if India now publishes an official position contrary to the Dutch position.
Treaty negotiations with Slovenia at a time when it was a non-OECD member could have been influenced by different conditions, as a result of which a lower rate would have been agreed upon. As a matter of fact, discussions of Slovenia’s accession into the OECD began in 2007 (i.e. subsequent to the conclusion of its tax treaty with India in 2005). India would have been well aware of its obligations to the Netherlands had it been entering into a treaty with an OECD country; and the lower tax rate agreed with Slovenia seems also to be in consideration of its status as a non-OECD country.
In fact, subsequent to the Dutch tax treaty, India did enter into tax treaties with some other OECD countries, none of which restricted the tax treaty rate below 10%.
As unfortunately neither Slovenia nor India publishes official explanations to the treaties, it is difficult to gauge whether the fact of its plans for OECD accession were conveyed to India.
Another crucial aspect which warrants a mention is the date from which applicability of the treaty entered into with the OECD country would be recognised. The MFN clause reads as below (as relevant):
“If after the signature of this convention under any Convention or Agreement between India and a third State which is a member of the OECD India should limit its taxation at …. to a rate lower or a scope more restricted than the rate or scope provided for in this Convention …, 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 … shall also apply under this Convention.” (emphasis added)
The highlighted portion of the text gives a clear indication that from the date the treaty signed by India with the OECD member country enters into force, the MFN clause would apply to the tax treaty. The Delhi High Court (following a decree issued by the Netherlands) held that the India–Slovenia treaty (entered into force in 2005) would be applied once it became an OECD member country (in 2010). This argument might however be contrary to the wording of the clause, as a tax treaty can only enter into force once, i.e. in 2005 in the case of Slovenia, which also seems to be the intention of parties to give benefits to a country which is an OECD member country at the time of entering into a treaty.
It is fairly well known in common law jurisdictions like India that legal instruments and statutes are interpreted in a manner whereby redundancy of expressions and phrases is sought to be avoided (Ram Jethmalani vs. Union of India, 8 SCC 1). The aspect of entry into force was not considered in the High Court judgment and thus the crucial wording could be said to have been rendered redundant.
The ruling of the High Court in favor of the taxpayer has brought cheer to a large set of taxpayers. In view of the authors, however, this may not be the final word on this aspect, given some controversial elements in the ruling. Taxpayers should exercise caution in extending this principle also to other tax treaties having similar MFN clauses.
Views are personal.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Sudin Sabnis and Suraj Nangia are Partners with Nangia Andersen LLP.
The authors may be contacted at: [email protected]; [email protected]