[Opinion] The Rise and Fall of Most Favored Nation Clause in Indian Tax Treaties

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Last Updated on 9 July, 2024

Priyanka Jain – [2024] 164 taxmann.com 130 (Article)

What is Most Favored Nation (MFN) clause

The underlying principle of a MFN clause is that the contracting states agree to extend equal tax benefit to one country as extended by it to another country. By virtue of a MFN clause in a tax treaty, one state obligates itself to its treaty partner for providing a favorable tax treatment if it offers such favorable tax treatment in its tax treaty with another state. This helps in elimination of tax planning strategies by companies leading to complications in structuring by setting up its presence in tax heavens or tax favorable jurisdictions.

A MFN clause in Indian tax treaties obligates India with its treaty partner for beneficial treatment to be extended to its treaty partner, if India enters into a tax treaty with a third state, wherein India limits its source taxation rights in relation to certain items of income (usually being in the nature of dividends, interest income, royalties, fees for technical services, etc.) to a rate lower or a scope more restricted than the scope provided for those items of income in the tax treaty with its treaty partner.

Indian Tax Treaties with MFN clause

India has entered into bilateral tax treaty with more than 80 countries. However, only some of the Indian tax treaties contain MFN clause. We have set out below extracts of MFN clause in verbatim from tax treaties between India and OECD members countries.

Tax Treaty	Protocol language
India-The Netherlands	If after the signature of this convention, under any Convention or Agreement between India and a third State which is a member of the OECD, India should limit its taxation at source on dividends, interests, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, then as from the date on which the relevant Indian Convention or Agreement enters into force the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also apply under this Convention.
India-France	In respect of articles 11 (Dividends), 12 (Interest) and 13 (Royalties, fees for technical services and payments for the use of equipment), if under any Convention, Agreement or Protocol signed after 1-9-1989, between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate of scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items income shall also apply under this Convention, with effect from the date on which the present Convention or the relevant Indian Convention, Agreement or Protocol enters into force, whichever enters into force later.
India- The Swiss Confederation	In respect of Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical services), if under any Convention, Agreement or Protocol between India and a third State which is a member of the OECD signed after the signature of this Amending Protocol, India limits its taxation at source on dividends, interest, royalties or fees for technical services to a rate lower than the rate provided for in this Agreement on the said items of income, the same rate as provided for in that Convention, Agreement or Protocol on the said items of income shall also apply between both Contracting States under this Agreement as from the date on which such Convention, Agreement or Protocol enters into force. If after the date of signature this Amending Protocol, India under any Convention, Agreement or Protocol with a third State which is a member of the OECD, restricts the scope in respect of royalties or fees for technical services than the scope for these items of income provided for in Article 12 of this Agreement, then Switzerland and India shall enter into negotiations without undue delay in order to provide the same treatment to Switzerland as that provided to the third State.
India-Sweden	In respect of Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical services) if under any Convention, Agreement or Protocol between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, or fees for technical services to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items of income shall also apply under this Convention.
India-Spain	The competent authorities shall initiate the appropriate procedures to review the provisions of Article 13 (Royalties and fees for technical services) after a period of five years from the date of its entry into force. However, if under any Convention or Agreement between India and a third State which is a Member of the OECD, which enters into force after 1-1-1990, India limits its taxation at source on royalties or fees for technical services to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of incomes, the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also apply under this Convention with effect from the date on which the present Convention comes into force or the relevant Indian Convention or Agreement, whichever enters into force later.
India-Hungary	In respect of Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical services), if under any Convention, Agreement or Protocol between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties or fees for technical services to a rate lower or a scope more restricted than the rate or scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention. Agreement or Protocol on the said items of income shall also apply under this Convention.
India-Belgium	If under any Convention or Agreement between India and a third State being a member of the OECD which enters into force after 1st January, 1990, India limits its taxation on royalties or fees for technical services to a rate lower or a scope more restricted than the rate or scope provided for in the present Agreement on the said items of income, the same rate or scope as provided for in that Convention or Agreement on the said items of income shall also apply under the present Agreement with effect from the date from which the present Agreement or the said Convention or Agreement is effective, whichever date is later.

All of the above MFN clauses require the third state to be an OECD member. To illustrate, for operation of MFN clause between India-France tax treaty, if India has signed any Convention, Agreement or Protocol after 1-9-1989 with a third state, which is a member of the OECD whereby a benefit by way of lower tax rate or restrictive scope is provided to the such third state on specified incomes than what is available to France, India shall be required to limit its taxation at source on such incomes to a lower rate or a restricted scope in India-France tax treaty, with effect from the date on which the India-France tax treaty or the relevant Indian Convention, Agreement or Protocol enters into force, whichever enters into force later.

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