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A verdict that hampers international law obligations

Relevance

• GS Paper 2 Effect of policies and politics of developed and developing countries on India’s interests.
• Tags: #InternationalLaw #Taxation #GS2 #UPSC

Why is the News?

• Foreign investors in India face taxation uncertainties due to legislative, executive, and judicial factors, complicating the business environment.
• Recent Supreme Court Judgment in the Assessing Officer Circle (International Taxation) New Delhi vs M/s Nestle SA Case:
  • The case involved 11 petitions from corporations like Nestle (a Swiss multinational company) and Steria (a European company) and revolved around the interpretation of the most favored nation (MFN) clause in tax treaties, particularly the Double Taxation Avoidance Agreements (DTAAs) signed by India.
  • The critical question in the case was whether the MFN clause in tax treaties could be applied in India without the need for a formal notification under Section 90 of the Income-Tax Act.
    • This section enables India to enter into tax treaties with other countries to prevent double taxation of income.
  • The Supreme Court’s judgment in this case has broader implications for foreign investors, as it clarifies the applicability of the MFN clause and provides guidance on how tax treaties should be enforced in India, potentially reducing uncertainty in taxation measures.

On Most Favored Nation status

• Withholding Tax Requirement: DTAAs between India and OECD member countries like the Netherlands, France, and Switzerland impose a 10% withholding tax on dividends paid by Indian entities to residents of these countries.
• Most Favored Nation (MFN) Provision: These DTAAs include an MFN provision, allowing for preferential tax treatment in India to be extended to these countries if India extends similar benefits to any other third country that is an OECD member.
• Lower Withholding Tax: India’s DTAAs with countries like Slovenia, Colombia, and Lithuania, which were not OECD members at the time of signing, require a lower withholding tax rate of 5%.

Supreme Court Ruling and Its Implications

• The Supreme Court ruled that the benefits extended to a later OECD member, like Slovenia, do not automatically apply to DTAAs with countries like the Netherlands, as they were not OECD members when these DTAAs were signed.
• This ruling is expected to result in a tax burden of approximately ₹11,000 crore on foreign investors and may lead to the review of past cases.
• The court’s reasoning, which restricts the MFN clause to countries that were OECD members at the time of signing, is criticized for freezing the provisions of the treaty in time.
• The court’s use of domestic interpretative techniques for an international treaty term is viewed as puzzling and not aligned with the spirit of economic treaties, which include non-discrimination standards such as MFN.
• This interpretation can be seen as defeating the purpose of the MFN clause, which is meant to ensure that benefits extended to a third country are automatically made available to treaty partners without considering the timing of their OECD membership.

Dualism strikes back

• The Supreme Court ruled that to apply the Most Favored Nation (MFN) provision in the Double Taxation Avoidance Agreements (DTAA), a notification under Section 90(1) of the Income Tax Act is necessary.
  • This upholds the doctrine of dualism, where international law isn’t enforceable domestically until it’s incorporated into municipal law through enabling legislation.
  • Traditionally, Indian courts had moved towards monism, where international law could be incorporated into domestic law without explicit enabling legislation, as long as it didn’t conflict with domestic law.
• Presumption in Favor of International Law:
  • In cases like PUCL vs India, Vishakha vs State of Rajasthan, and Puttaswamy vs Union of India, the courts presumed compatibility between domestic and international law.
    • Domestic law should be interpreted to align with India’s international law obligations, unless there is an explicit conflict.
  • This approach ensures that progressive international law is upheld by the courts to protect citizens’ and persons’ rights, even if the legislative and executive branches haven’t incorporated it into domestic law.
• Missed Reference to Previous Cases: Surprisingly, the recent Supreme Court ruling didn’t refer to this line of cases, which have established the ‘presumption of compatibility’ principle.

Impact of the Decision

• The ruling is seen as a setback to the progressive judicial journey initiated by cases like Vishakha, which recognized the importance of international law.
• The ruling doesn’t give due consideration to the harmonious interpretation of India’s international law obligations within the DTAA and the Income Tax Act.
• Executive’s Role: The Supreme Court’s interpretation allows the executive to avoid international law obligations by not issuing the necessary domestic notifications.
  • This can lead to violations of international law and potential international claims, such as under bilateral investment treaties.
• Questioning the Rationale: This decision raises concerns about the court’s adherence to dualism and its implications for India’s commitment to international agreements.
  • The judgment underscores the notion that the Supreme Court is supreme because it is the final authority, but it is not infallible.

Source: The Hindu

Mains Question

Discuss the implications and consequences of a country revoking Most-Favored-Nation status for a specific trading partner. Examine its impact on global trade relations.