In a landmark judgment, the Delhi High Court (High Court) has ruled that the dividend income earned by a resident of the Netherlands from an Indian company would be taxable at 5%, as opposed to the otherwise provided rate of 10%, under the India–Netherlands tax treaty, by invoking the most favoured nation (MFN) clause of said treaty.
Under current Indian tax law, dividend received by a non-resident from an Indian company is generally taxable at 20% (plus applicable surcharge and cess), subject to any lower rate applicable under a tax treaty.
The taxpayers, in this case, were two Netherlands-based entities (Concentrix Services Netherlands BV and Optum Global Solutions International BV), and each had a subsidiary in India, from which they received dividend income during the year under consideration.
Under the India–Netherlands tax treaty, read with the corresponding protocol, a benefit of the MFN clause allows the originally negotiated withholding tax rate (i.e. 10%) to be reduced if, subsequently, India agrees to lower withholding tax rates in tax treaties negotiated with other OECD member countries. Such lower rates of tax shall be applicable from the date of entry into force of the subsequent relevant tax treaty.
After the India–Netherlands tax treaty, India, in its tax treaties with Slovenia, Lithuania, and Columbia, has agreed to a tax rate of 5% on dividend income. However, such tax treaties involving a 5% withholding rate for dividend were negotiated by India when such countries were not members of the OECD at the time of signing the tax treaty.
Given the language of the MFN clause in the India–Netherlands tax treaty, the essential dispute before the High Court was whether or not the benefit of the MFN clause under the India–Netherlands tax treaty can be taken in cases where such countries are not OECD member countries at the time of the signing of the tax treaty, but where said countries become OECD member countries at a later point in time.
While dealing with this matter, the High Court ruled in favour of the taxpayer, and provided its detailed analysis and observations. A summary is provided below:
- The MFN clause incorporates the principle of parity, and once the following conditions are fulfilled, the lower rate agreed to by India in its subsequent tax treaties will apply to the India–Netherlands tax treaty as well:
- The third country with whom India entered into a tax treaty should be a member of the OECD; and
- India should have, in its tax treaty, limited its rate of withholding tax to a rate lower than the one mentioned in the subject tax treaty (i.e. the India–Netherlands tax treaty in the present case).
- On the contention that the third country should be an OECD member ‘at the time of execution’ of the India–Netherlands tax treaty, the High Court held that the term used in the India–Netherlands tax treaty describes the state of affairs “at the time of claiming the tax treaty benefits and not necessarily at the time of execution of the India-Netherlands tax treaty”; and
- The High Court also referred to the interpretation of the MFN clause adopted by the Netherlands with respect to taxability of dividend income pursuant to Slovenia’s OECD membership. The decree issued by the Kingdom of the Netherlands clearly recorded that the tax rate of 5% for the dividend income shall be effective from the date of Slovenia becoming an OECD member. To maintain consistency in the interpretation of the provisions by the tax authority and courts of the concerned contracting state (principles of ‘common interpretation’), the High Court took cognisance of and followed the interpretation adopted by the Netherlands in the decree issued by it.
Accordingly, the High Court held that dividend income should be taxed at 5% under the India–Netherlands tax treaty, because Slovenia, Lithuania and Columbia were OECD members at the time when the benefit was being claimed.
Given that India has reintroduced the classical system of dividend taxation in the hands of the shareholder from tax year 2020–21 onwards, this decision is a welcome one and would assume great significance, since the issue of lower withholding pursuant to the MFN clause has been a topic of much debate.
The ruling is of significance as many tax treaties entered into by India with countries such as France, Spain, Switzerland, Sweden and Hungary have comparable MFN clauses.
Furthermore, MFN clauses also extend to other streams of income, namely interest, royalties and fees for technical services, and hence multinational companies from such countries may wish to evaluate the impact of this favourable ruling in respect of taxability of dividend and other streams of income, with a lower rate and a restricted scope, as may have been provided.
The High Court has also taken cognisance of the interpretation taken by the Netherlands through the issuance of a decree on the applicability of the MFN clause.
A similar decree has also been issued by France (vide notification dated November 4 2016 in the context of the India–Slovenia tax treaty), which states that the rate of tax withholding on dividend from Indian payers shall be reduced to 5% post-conclusion of the tax treaty between India and Slovenia (and Slovenia becoming an OECD member country).
It will, however, be important to see how the Indian tax authorities reflect specifically on this aspect, given that they have not confirmed the position adopted in these decrees.
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