BACKGROUND

To grant relief from double taxation, avoid double taxation and ensure smooth exchange of information, the Government of India (GOI) has entered Double Tax Avoidance Agreements (DTAA or Tax Treaty or Treaty) with a number of countries. Some of its DTAAs contain the Most Favoured Nation (MFN) clause. As per this clause, if India enters a DTAA on a later date with a third country which is an Organisation for Economic Co-operation and Development (OECD) Member, providing a beneficial rate of tax or restrictive scope for taxation, a similar benefit will be available to the first country.
The CBDT vide had issued a clarificatory circular¹ laying down the conditions that should be satisfied to avail the benefit of the MFN clause. One of the prescribed conditions is the issuance of a separate notification by India importing the benefits of the favourable DTAA into the DTAA with the first country. Recently, the Hon’ble Supreme Court² of India has held that the MFN clause is not automatic, and that notification is required.
In the above backdrop, India’s Ministry of Finance has recently issued a notification³ invoking the MFN clause to notify a lower tax rate for Royalty and Fees for Technical Services (FTS) under the India-Spain DTAA. We, at BDO in India, have analysed and summarised the key provisions of the said notification and provided our comments on its impact hereunder:

• The DTAA between India and Spain came into force on 12 January 1995.

• The treaty between India and Germany came into force on 26 October 1996. Germany was a member of the OECD at the time of entering into the treaty with India. In accordance with section 90 of the IT Act, the GOI has hereby limited the taxation at source on royalties and FTS to a rate lower than that provided in the treaty between India and Spain on the said items of income.

• Through this notification and protocol to India-Spain DTAA⁴, the GOI has incorporated the beneficial tax rates applicable to Royalty and FTS in the India-Germany DTAA into the India-Spain DTAA.

• Article 13(2) of India-Spain DTAA before and after amendment reads as follows:

Before Amendment

After amendment

“However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the law of that State, but if the recipient is the beneficial owner of the royalties or fees for technical services the tax so charged shall not exceed: (i) in the case of royalties relating to the payments for the use of, or the right to use, industrial, commercial or scientific equipment, 10 per cent of the gross amount of the royalties; (ii) in the case of fees for technical services and other royalties, 20 per cent of the gross amount of fees for technical services or royalties”.

“However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the law of that State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed ten per cent of the gross amount of royalties or fees for technical services”.

The aforementioned amendment shall be applicable from the Fiscal Year (FY) 2023-24.

BDO IN INDIA’S COMMENTS

This notification is in line with the CBDT Circular No. 3/2022 dated 3 February 2022 and the recent decision by the Supreme Court in Nestle (supra) relating to the automatic application of MFN. It may be pertinent to note that the Supreme Court ruling in Nestle has specifically excluded interpretation of the matter involving India-Spain DTAA and the said matter has been de-tagged. While the decision of the Supreme Court on India-Spain DTAA is awaited, one needs to evaluate the impact of this notification for transactions carried out in and before FY 2023-24.

Further, it is imperative to note that only the lower tax rate is imported and not the restricted scope (which is there in India’s DTAA with OECD countries such as Sweden and the USA). While the notification has referred to India-Germany DTAA, no reference is made to India’s DTAA with other OECD Member countries, which has a restricted scope. Thus, one may evaluate whether such selective adoption of a DTAA, thereby keeping the restricted scope out of the purview of MFN, is legally tenable.
 
Furthermore, with the concessional rate notified for India-Germany DTAA under the MFN Clause, it would be interesting to see whether CBDT would notify separately for each country (where the MFN Clause exists).