The Questionable Favourability of the Most Favoured Nation Clause

“Most-Favoured-Nation” (“MFN”) treatment — requires Members to accord the most favourable tariff and regulatory treatment given to the product of any one Member at the time of import or export of “like products” to all other Members.  This is a bedrock principle of the WTO.  Under the MFN rule, if WTO Member A agrees in negotiations with country B, which need not be a WTO Member, to reduce the tariff on product X to five per cent, this same “tariff rate” must also apply to all other WTO Members as well.  In other words, if a country gives favourable treatment to one country regarding a particular issue, it must treat all Members equally concerning the same issue. 

Favourable treatment may include the utilization of trade advantages such as: 

• Low tariffs 

• High import quotas

• Free trade agreements

• Custom unions

This principle, while fundamental, has far-reaching implications, both positive and negative, that shape the landscape of global commerce.

Economic Implications

Increased Efficiency in the World Economy

MFN treatment promotes economic efficiency by allowing countries to import from the most cost-efficient supplier based on comparative advantage. It prevents trade distortion caused by differential tariffs and ultimately benefits both individual countries and the global economy.

Stabilization of the Multilateral Trading System

MFN ensures that favourable treatment and trade restrictions are applied equally to all members, reducing the likelihood of trade disputes turning into political issues. This stabilization of the multilateral trading system increases predictability, fostering trade and investment.

Simplifies Trade Laws

Enforcement of the MFN clause simplifies trade laws by eliminating the complexities of bilateral trade agreements. Standardizing trade terms among all nations streamlines international commerce.

Challenges and Drawbacks

Complexity in Trading

The specificity of MFN clauses adds complexity to trading, posing challenges for nations. Questions regarding whether the Least Developed Countries (LDCs) receive equitable treatment must be addressed, as they contribute minimally to global trade and face difficulties related to price volatility and inadequate infrastructure. It is interesting to note that the 48 LDCs contribute to only 1 % of global trade and even this trifling value fluctuates due to price volatility.

Sovereignty and Functionality 

The MFN clause may impinge on a nation's sovereignty and functioning by limiting its ability to tailor trade agreements to specific needs. Nations must strike a balance between adhering to MFN principles and protecting their individual interests. 

Now lets learn a bit about MFN clause and its impact in the Indian Economy-  

In the Indian context, the MFN clause has recently emerged as a contentious element in the country's economic landscape. It raises concerns about potential adverse impacts on India's financial stability and autonomy. As India strengthens its global trade relations, the detrimental effects of the MFN clause have become increasingly apparent, posing significant challenges for domestic industries and the overall economic well-being.

Recognizing the vulnerability that the MFN clause poses to the Indian economy, tax authorities have taken proactive measures to safeguard the nation's interests and curb potential exploitation by foreign developed countries. Specifically, authorities have toughened their stance to restrict foreign funds and strategic investors from MFN jurisdictions such as The Netherlands, France, and Switzerland. These investors had previously benefited from lower tax rates due to their MFN status with India, resulting in tax savings and advantages in areas like dividends and capital gains.

Despite a ruling in favour of these investors by the Delhi High Court, the recent directive from the Central Board of Direct Taxes (CBDT) has mandated that investors from specific countries, including The Netherlands and France, will continue to pay higher taxes on dividends. This decision is rooted in the belief that tax benefits granted to Slovenia, Lithuania, and Colombia cannot be extended to others as these countries were not members of the Organization for Economic Co-operation and Development (OECD) when their respective treaties with India were signed

The recent ruling by the Supreme Court has underscored the importance of a distinct notification under section 90(1) of the Income Tax Act, 1961, for the enforcement of amendments to the terms and conditions of tax treaties. This decision has significant implications, particularly for the most favoured nation clauses of the India-Netherlands, India-France, and India-Switzerland tax treaties, signalling a notable shift in existing legal provisions.

 Insights from the Supreme Court Case-

ASSESSING OFFICER CIRCLE (INTERNATIONAL TAXATION) 2(2)(2) NEW DELHI VS M/S NESTLE SA

The case revolves around the dispute concerning the application of the Most Favoured Nation (MFN) clause to dividend income. Taxpayers have been advocating for the inclusion of this clause to reduce the taxable amount for shareholders from France and the Netherlands from 10% to 5%. While the Delhi High Court ruled in favour of the taxpayers, the Revenue authorities contested the decision by filing a Special Leave Petition (SLP) in the Supreme Court, invoking the special provision that allows parties to present their case before the apex court.

The Supreme Court addressed two pivotal issues in its comprehensive judgment:  

1. Clear Application of the MFN Clause: The court emphasized the necessity for an OECD membership at the time of signing the Double Taxation Avoidance Agreement (DTAA) [a treaty between two countries to prevent double taxation of income and assets] for invoking the MFN clause and claiming parity, highlighting the importance of a consistent application of the MFN clause. 

2. Notification Requirements: The Supreme Court clarified that enforcing the protocol, including the MFN, requires a separate notification, as mandated under section 90(1) of the Income Tax Act, 1961, before implementing any treaty or protocol that modifies the terms or conditions of existing laws.

Implications and Future Outlook

The recent Supreme Court ruling has far-reaching implications for India's trade policies, particularly in terms of the MFN clause in bilateral tax treaties. It emphasizes the need for a balanced approach to international trade and a clear understanding of legal provisions. This case serves as a crucial precedent, underlining the significance of maintaining a transparent and equitable trade environment, and highlights India's evolving stance on global trade and business relations.

The MFN clause's application in the Indian tax treaties has faced intricate legal interpretations, with the recent Supreme Court ruling emphasizing the importance of clear policy guidelines and transparent application. This case serves as a critical milestone in the evolving landscape of India's trade policies, signifying the nation's commitment to fair and equitable trade practices and its dedication to creating a conducive environment for global business relations.