NEW DELHI: The Supreme Court (SC) might have revived the ghost of retrospective tax with its Thursday order that the most favoured nation (MFN) clause will not automatically come into force with the signing of a tax treaty with a country.
Experts say Indian businesses may have to cough up past taxes and interest if they had withheld lower taxes from clients and investors based in treaty countries. With the MFN status, taxpayers in treaty countries can pay lower taxes on dividends, royalties and other fees.
“Indian companies, which may have made remittances outside India, applying the MFN clause (which was not specifically notified) without deducting taxes or after deducting taxes at a lower tax rate, will face the brunt of this ruling which is certain to open up a fresh set of litigation,” says Shruti KP, Partner, Induslaw said, The ruling could potentially make the MFN clause in tax treaties itself redundant and inoperative as the benefit would only be granted where the government specifically issues such a notification, explains Shruti.
“Interestingly, foreign tax authorities such as those of Switzerland, France and the Netherlands had previously formally indicated their intention to impose a lower withholding tax rate of 5% on dividends by invoking the MFN clause under the respective tax treaties with India relying on the tax treaties between India and Slovenia/Lithuania/Columbia,” she added.
The Indian tax authorities had, by way of a circular (which is not binding on taxpayers) disagreed with the position adopted by those countries. Unfortunately, with this ruling, the SC also endorses India’s unilateral contrary view, which is completely at loggerheads with its treaty partners. Dinesh Kanabar, CEO, of Dhruva Advisors, says that the judgment will result in payment of back taxes and interest for the past, but it would be incorrect to characterize the judgment as being retrospective.
Penalties may not be asserted because there were favourable High Court judgments, which upheld the application of the MFN Clause under different interpretations. Divakar Vijayasarathy, founder and CEO, of DVS Advisors, says the SC’s judgement on MFN will lead to challenges on various fronts.