Companies such as Nestle SA (the parent company of Nestle India) may have to face demand for higher taxes on dividend after the Supreme Court on Thursday held that a Double Taxation Avoidance Agreement (DTAA) cannot be given effect unless notified under the Income Tax Act.

“A notification under Section 90(1) is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a DTAA, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law,” a Division Bench of Justices S Ravindra Bhat and Dipankar Datta said while disposing of a bunch of 11 petitions clubbed with Nestle SA as the respondent in main petition and ruled in favour of the Income Tax Department.

With this, the Apex Court set aside order by Delhi High Court. Section 90 of the Income Tax Act prescribes tax relief under the Double Taxation Avoidance Agreement (DTAA). It ensures that no company or individual pays income tax twice while working in a foreign country or for a foreign company. 

Also read: All you wanted to know about...DTAA

Wider implications

Amit Maheshwari, Tax Partner with AKM Global, feels this decision will have wider repercussions for the industry and could result in millions of dollars of additional tax revenue for the government. “The decision would also entail revival of pending matters in the form of fresh action by tax authorities by initiating proceedings, raising demands or denying lower withholding in respect of these remittances made in the past. This may not go well with our tax treaty partners,” he said.

The core of the matter arose from decisions of the Delhi High Court involving interpretation of the MFN clause contained in various Indian treaties with countries that are members of the Organisation for Economic Cooperation and Development (OECD). This clause provides for lowering of rate of taxation at source on dividends, interest, royalties or fees for technical services (FTS) or restriction of scope of royalty/FTS in the treaty, similar to concession given to another OECD country subsequently.

The bilateral treaties in question were between India and Netherlands, France, and Switzerland, respectively. Broadly, the issues arose whether there is any right to invoke the MFN clause when the third country with which India has entered into a DTAA was not an OECD member yet (at the time of entering into such DTAA); and secondly whether the MFN clause is to be given effect automatically or it only comes into effect after a notification is issued.

The government argued that India follows the “dualist” practice which means that international treaties and conventions are not, upon their ratification, automatically assimilated into municipal law (the national legal system) but require enabling legislation.

The Apex Court concluded: “The fact that a stipulation in a DTAA or a Protocol with one nation, requires same treatment in respect to a matter covered by its terms, subsequent to its being entered into when another nation (which is member of a multilateral organisation such as OECD), is given better treatment, does not automatically lead to integration of such term extending the same benefit in regard to a matter covered in the DTAA of the first nation, which entered into DTAA with India. In such event, the terms of the earlier DTAA require to be amended through a separate notification under Section 90.”

Commenting on the ruling, Mihir Gandhi, Partner with BDO India, said that this denies the benefit of the favourable tax rates and restricted scope for DTAA with some countries (like the Netherlands, France and Switzerland) which was accessed through the MFN clause. “The foreign companies that have claimed the benefit and were relying of the favourable rulings of the High Court will have to now evaluate the impact of this ruling of the SC,” he said.