By Pradeep S. Mehta & Anushka Kewlani,
Summary
India’s inconsistent stand on bilateral investment treaties risks deterring foreign investors due to a lack of robust legal protections.
India’s firm and sometimes inconsistent approach to international agreements, especially concerning tax treaties and bilateral investment treaties (BITs), is beginning to create uncertainty that could harm its economic interests. The latest example is the Supreme Court (SC) ruling in the Nestlé case, which involved the interpretation of the most favoured nation (MFN) clause in India’s tax treaties, specifically with Switzerland. The ruling, along with other recent decisions, reveals the government’s rigid legal framework that could complicate foreign investments and deter economic growth.
The legal debate surrounding the MFN clause in India’s tax treaties, particularly the India-Switzerland Double Taxation Avoidance Agreement (DTAA), has gained much attention after Nestlé sought a preferential dividend tax rate of 5%, instead of the standard 10%, by invoking the provision, arguing that India had granted lower rates to other members of the Organisation for Economic Co-operation and Development (OECD) like Colombia and Lithuania. The MFN provision in the India-Switzerland DTAA provides that the benefits given to a country “which is a member of the OECD” should be extended to the signatory state.
In Nestlé, the SC ruled that India was not obligated to extend preferential tax rates to Switzerland based on treaties with Colombia and Lithuania, as these countries were not OECD members at the time India signed DTAAs with them. It also emphasised the need for a specific notification under Section 90(1) of the Income Tax Act, 1961 to implement the MFN provision, rejecting automatic application. In response, Switzerland has suspended the MFN clause in its tax treaty with India, effective January 1. This move will increase the withholding tax rate on dividends paid to Indian residents from 5% to 10%.
However, Nestlé’s argument was in line with established legal precedents such as Steria (2016), Concentrix (2021), and Nestlé (2021), all concerning the MFN clause in India’s tax treaties. In Steria, the case centred on whether the restrictive definition pertaining to fee for technical services as contained in India-UK DTAA can be read into India-France DTAA by virtue of MFN clause in the latter. The Delhi High Court (HC) ruled that the protocol is integral to the treaty and no separate notification is needed to invoke the MFN clause. Similarly, in the Concentrix case, the court allowed a reduced withholding tax rate under the India-Netherlands treaty by referencing more favourable rates in other treaties, requiring no separate notification for the protocol’s applicability.
In Nestlé (2021), the Delhi HC upheld the application of the MFN clause, granting a reduced 5% dividend tax rate under the India-Switzerland DTAA, without the need for a separate notification, reinforcing the automatic applicability of MFN benefits. However, in Nestlé (2023), the SC overturned the 2021 judgment and analysed the relevant precedents. The SC emphasised that the interpretation and integration of treaties into domestic law are influenced by each country’s unique constitutional and legal framework. While treaties are binding, implementation varies.
India requires a notification to avail benefits under the MFN clause, reflecting its domestic legal procedures. The court acknowledged that while treaties are binding, their implementation and benefits derived from them depend on the specific terms of each treaty and the domestic legal requirements of the signatory countries.
The uncertainty stemming from recent rulings could prompt other countries to reassess their treaties with India, potentially impacting investments. India has established DTAAs with key nations like Singapore, Mauritius, the UAE, and the UK, aiming to reduce withholding taxes and encourage outbound investments.
Take Singapore. It plays a pivotal role in India’s investment landscape. In the July-September quarter of 2024-25, foreign portfolio investment inflows surged by an impressive 43%, reaching $13.6 billion, with over $7.5 billion (or 50% of the total foreign investment) originating from Singapore. This underscores Singapore’s critical role in driving India’s economic growth and the importance of maintaining clarity in tax agreements.
This trend extends beyond tax treaties and is evident in India’s approach to BITs, which also exhibits inconsistencies and rigidity. For example, the new India-UAE BIT includes a clause prohibiting third-party funding. The restriction means that in investor-state disputes, financial support provided by an external entity to a party in exchange for a share of the potential monetary award or settlement is disallowed. This marks a departure from both earlier Indian BITs and the Indian Model BIT. This approach could create an uneven playing field for Indian investors in countries with more permissive stances on third-party funding, potentially putting them at a disadvantage.
Concerns have also been raised the likes of Saudi Arabia, the UK, and the European Union over India’s firm stance in these negotiations, particularly regarding its Model BIT and the finance ministry’s refusal to amend it. While the Model BITS’ stringent provisions aim to protect India from liability, they often deter foreign investors who seek robust legal protections.
The Nestlé (2023) ruling and inconsistent decisions vis-à-vis the MFN clause in India’s DTAAs have created uncertainty around tax benefits. This could impact foreign investments and India’s attractiveness as an investment destination. Similarly, India’s rigid and inconsistent stance on BITs, as seen in the Model BIT and the India-UAE BIT, risks deterring foreign investors due to a lack of robust legal protections. While India aims to protect its interests, it must balance this by creating a predictable, investor-friendly environment to sustain growth and attract global capital.
The authors work for CUTS International, a global public policy research and advocacy group. Amol Kulkarni, director (research), CUTS contributed to this article..
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