April 29, 2021
Indian Court rules on applicability of Most Favored Nation clause for determining withholding tax rate on dividend payments
On 22 April 2021, India’s Delhi High Court (the Court) ruled in favor of non-Indian taxpayers on the issue of the rate of withholding tax applicable to dividend income received from Indian subsidiaries under the India-Netherlands tax treaty.1 The Court applied the principle of parity and granted a 5% withholding tax rate under the Most Favored Nation (MFN) clause of the treaty. The Court also noted that as the MFN clause is part of the protocol to the India-Netherlands tax treaty, no separate notification is required to apply the MFN provisions.
This Alert summarizes the decision of the Court and implications for taxpayers.
Pursuant to the India-Netherlands tax treaty, dividends paid by Indian entities to residents of the Netherlands, who are beneficial owners of such dividends, are liable to withholding tax at a rate not to exceed 10%. Further, the protocol of the tax treaty has an MFN clause which states that if India enters into a tax treaty on a later date with a third country, which is an OECD2 member, providing a beneficial rate of tax or restrictive scope for taxation of dividends, interest and royalties, a similar benefit should be accorded to the India-Netherlands tax treaty.
Some Indian tax treaties with OECD member countries such as Slovenia, Lithuania and Colombia provide for a lower withholding tax rate of 5% for dividend taxation (subject to conditions). However, these countries were not OECD members when the respective tax treaties were entered into by India but became OECD members only at a later date.
There has been a lack of judicial guidance on whether the beneficial tax rate under the tax treaties with Slovenia, Lithuania and Colombia could be applied to other tax treaties with the MFN clause, and this ruling provides the much-needed guidance.
The Court’s ruling
The Court’s considerations from its ruling are summarized as follows:
This decision provides timely guidance on the potential for lower withholding tax rates pursuant to the MFN clause amid the recent adoption of the classical system of dividend taxation in India from the tax year 2020-21 onwards. The Court reiterated that the MFN clause has automatic application and there is no requirement for any notification to trigger the MFN clause. Further, by applying the principle of parity, the Court has granted the benefit of the lower tax treaty rate pursuant to the MFN clause as agreed by India in other relevant tax treaties entered into after the India-Netherlands tax treaty was executed.
This is a significant ruling as many tax treaties entered into by India with countries such as France, Spain, Switzerland and Hungary have comparable MFN clauses. Furthermore, as the MFN clauses also apply to income in the nature of interest, royalties and fees for technical services, it is recommended that multinational companies with Indian investments through these countries or operations in these countries evaluate the impact of this favorable ruling on dividends and other streams of income.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India)
Ernst & Young LLP (United States), Indian Tax Desk, New York
Ernst & Young LLP (United States), Indian Tax Desk, San Jose
Ernst & Young Solutions, Indian Tax Desk, Singapore
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
Ernst & Young LLP (United States), Asia Pacific Business Group, New York