The Supreme Court (SC), as the ultimate judicial authority, has stated the law of land concerning application of Most-Favored-Nation (MFN) clause as contained in the Protocol of India’s Double Taxation Avoidance Agreements (DTAAs) with some of the OECD member countries (Netherland, France and Switzerland). It is now settled by the court that the benefit of MFN provision in protocol to DTAA for reduction of rate of tax at source on dividend, interest, royalties or fee for technical services (FTS), or restrictive scope of FTS based on concession (“make available clause”) given under DTAA with other OECD member country does not have an automatic application. The benefit must be extended through appropriate notification by the government. The road ahead is now clear and for all to follow. However, the decision has far-reaching implications for numerous taxpayers who have over the years benefited by taking a non-taxable position basis restrictive scope of FTS by importing the “make available” clause or lower WHT rate from other DTAAs.
The development thus requires course correction and proactive remedial evaluation by the taxpayers to mitigate continuing exposure arising from past positions.
Implication for payer of income – Payers who may have taken a non-taxable position with regard to FTS payments to non-resident (in light of MFN “make available” import) or applied lower WHT rate on the strength of a withholding tax order issued by the revenue authorities would arguably have adequate grounds to defend against any penal consequence of incorrect/non withholding of taxes. However, the exposure may potentially arise if the revenue authorities pursue the payer in the capacity of a representative assessee/agent should the recovery from the recipient not be possible.
On the other hand, payers who may have claimed the benefit suo-motu will have reason to be concerned and could potentially face consequences of failure to deduct/short deduction which may include recovery of tax, interest and penalty. While one may argue against levy of penalty considering the issue was settled only by the SC by reversing the favorable decisions of lower courts, this may entail a prolonged legal battle. The payers may need to consider a look back period of at least 7 years from the end of relevant financial year, taking cue from the limitation period prescribed for passing order holding an assessee in default for withholding tax non-compliance in relation to domestic payment.
Concern may also arise regarding potential disallowance of expense, specifically where no WHT has been deducted, in ongoing proceedings or a potential risk of reopening of assessment on account of wrongful claim of deduction.
Implication for recipient of income – The law is well established that the primary obligation to pay taxes is that of the recipient of income. The failure of the payer to withhold taxes as appropriate does not absolve the recipient to declare and pay appropriate taxes. Under reporting of income or short payment of tax consequent to application of lower WHT rate, on the strength of MFN provisions pre-SC decision, will thus very likely attract departmental scrutiny. The potential action could be rectification of past order as a consequence of SC judgment or reopening of past years due to escapement of income, subject to period of limitation. The revenue authorities can rectify past orders suo-motu or on application of the taxpayer up to a period of 4 years from the end of financial year in which the order, subject of rectification is passed. On the other hand, reassessment notices can be issued up to a period of 6 years from the end of relevant assessment years in case of AY 2021-22 and prior years, and 10 years for subsequent years (3 years where income escaped is less than 50 lacs).
Given the risk, taxpayers must evaluate the exposure and strategies a remediation plan proactively rather than adopt a reactive mode. For instance, a taxpayer may be better off filing a suo-motu application for rectification where possible, explore declaration through an updated return for tax years not picked for scrutiny assessment or voluntarily compute and discharge tax liability, etc. rather than wait for adversarial departmental action such as reassessment notices for detailed scrutiny or notice deeming assessee in default. A proactive approach will enable ring-fence the exposure toward tax, interest and penalty. There are other nuances that may need to be considered ie. for instance, whether any reassessment notices merely on account of wrong application of WHT rate would at all pass the primary test of “escapement of income” for any action of reassessment.
The CBDT had issued Circular No. 3/2022, dated 3rd February 2022 clarifying its position that beneficial provision of certain OECD treaty member countries cannot be automatically imported in other treaties such as with The Netherlands, France, the Swiss Confederation, Sweden, Spain and Hungary by reason of MFN clause in Protocol without specific notification. The position was aggressively defended by the revenue authorities before the SC with success. Having thus reached so far, it is unlikely that the revenue authorities will let this success pass only as an academic win without milking the opportunity to garner additional tax resource. In this light, taxpayers impacted by the ruling, whether as a person responsible for deducting tax or recipient of income, must evaluate the options and formulate a sound strategy of remediation rather than react to uncertainties.
Yatin Sharma and Abhishek Dutta.