Judicial Odyssey of MFN Clauses: Analysing AO v. Nestle SA

[Akarshi Narain and Harshitha Adari are third-year law students at NALSAR University of Law, Hyderabad]

In October 2023, the Supreme Court of India resolved a prolonged dispute in AO v. Nestle SA over the interpretation of the Most Favored Nation (MFN) clauses in Double Taxation Avoidance Agreements (DTAAs). A Delhi High Court case has further echoed its commitment to the verdict and dismissed contravening claims. The combined weight of these judicial affirmations underscores the importance of critically assessing the Supreme Court judgment and understanding its aftermath to determine whether the debate has been holistically clarified. Against this backdrop, this post first scrutinises the two issues decided by the Court, i.e., the date of OECD membership and the requirement of a separate notification. Second, it discusses the nuances of the judgment’s retrospective implications, specifically under the Income Tax Act 1956 (ITA), and explores the best way forward.

Issue 1: Date of Membership

India had entered into DTAAs with countries such as Slovenia, Colombia, and Lithuania that apply a lower rate of tax to dividends. These countries have since gained membership in the OECD. In light of this, prior OECD member states have enjoined India to grant them the same beneficial treatment as per the MFN clause. However, when the treaty was signed between India and the third states, the latter were not OECD members. This draws ambiguity as to whether the MFN clause, meant to operate solely among OECD countries, can be invoked.

The crux of this controversy revolves around the word, ‘is.’ In most MFN clauses, the language permits the clause’s invocation if the third state ‘is’ a member of the OECD. The key question is whether one considers membership to the OECD on the date of signing the treaty, or on the date when the MFN clause is invoked. The Supreme Court upheld the former reading, with the relevant date as the point of signing the treaty. The authors disagree with the reasoning adopted to arrive at the conclusion as well as with the ruling.

The Court undertook a rather technical analysis of the expression ‘is.’ As such, it attempted to find a domestic law meaning of the term by referring to criminal law cases. It might be argued that such an analysis is implicitly supported by Article 3(2) of the OECD Convention.  Article 3(2) applies to terms that are undefined in the Convention but have a meaning in the domestic legal context, such as “written-down value” and “royalty”. However, ‘is’ is a generic English word possessing no specific meaning in the domestic legal context. Moreover, a domestic law interpretation belies the principle of common interpretation, underscored by the Delhi High Court in the Concentrix case. The applicability of this principle in interpreting international treaties, including tax treaties, has also been upheld by the Supreme Court. According to the principle, there should be a harmonious construction of both countries’ interpretation of the disputed term. The Court’s conclusion that ‘the expression “is” has a present signification and derives meaning from the context’ thus forms a unilateral interpretation disregarding reciprocity and fairness.

A legally stronger approach would have been to engage with the rules of treaty interpretation of the Vienna Convention on the Law of Treaties (VCLT), which forms customary international law. In fact, their omission here, whilst being employed to resolve the notification issue, seems surprising. According to the general rule of treaty interpretation embodied in Article 31 of the VCLT, a treaty should be interpreted in good faith, respecting its object and purpose along with its context. This merits an examination into the reason and intention behind the insertion of MFN clauses, a crucial analysis missing in the judgment. Such clauses aim to establish parity between a group of countries. In the OECD context, the idea is that similar tax benefits are advanced to economically similar countries.

Now, the OECD is a largely static group, and membership in the OECD requires the fulfilment of several economic criteria. When the tax treaties were signed with third countries, the latter were economically well behind OECD members. It could not be reasonably predicted that such countries will become future OECD members. Likewise, there would be no intention of framing favourable tax provisions, keeping in mind the possible future invocation of the MFN clause. Hence, the context before and after becoming an OECD member is different and must be acknowledged. This context is at odds with understanding ‘is’ to refer to the time of signing the treaty. Thus, the Court’s technical analysis seems to be a red herring and calls for a deeper examination of the MFN clause via the treaty interpretation tools of VCLT.

Issue 2: Separate Notification Requirement

The second issue pertains to whether the MFN clause applies automatically or requires a separate notification by tax authorities upon the occurrence of the trigger event. The Court mandated the issuance of a separate notification, requiring legislative action by Parliament, which aligns with the established practice of incorporating treaties into domestic law. While this deferential approach to the Parliament heeding the balance of power doctrine is a welcome step, it overlooks the concomitant cascade of challenges.

Firstly, although the Constitution permits the executive to enter into treaties with other countries, the power of enforcement vests with the Parliament under Article 253 of the Constitution. However, section 90 of the ITA carves an exception, expressly allowing the Central Government to expedite the implementation of tax treaties, as noted in the Azadi Bachao case. Thus, the separate notification requirement contravenes the legislative intent behind section 90, presenting a misdirection in the Court’s approach that extends the need for notifying a Treaty and a Protocol to MFN benefits.

Secondly, this requirement may encourage cherry-picking by tax authorities, rejecting MFN benefits to certain parties unilaterally. This directly contravenes section 90 as well as the principle of good faith. The Court overlooked its own judgment in the Puttaswamy case, which noted that a domestic law requirement cannot override the good faith principle of treaty interpretation.

The Court justified this stance by superficially invoking India’s ‘subsequent practice’ as a treaty interpretation tool to show that it aligns with releasing a separate notification. However, while India previously issued separate notifications, it was voluntary and not mandatory. Consequently, non-issuance would not make infructuous the MFN clause, unlike in the current context of mandatory notification holding different implications. Furthermore, in a bilateral treaty, the subsequent practice must be reflective of both countries, not just India’s, rendering the justification a failure on the forefront.


This ruling comes as a compass needle, redirecting the course for the parties involved and also influencing past tax cases where taxpayers have applied the MFN clause, withholding lower taxes from investors in treaty countries. Certain reports hint that multinational companies might face up to ₹11,000 crores in retrospective tax. Such assertions of inevitable consequences of back taxes and past interests are met with strong opposition, as critics vehemently argue against characterising the judgment as strictly retrospective. Their opposition is further buttressed, given the broad scope of the MFN clause, encompassing favourable rates and extending the scope of the income to those such as dividends and fees for technical services. For instance, Indian taxpayers find themselves grappling with immediate concerns related to tax demands under the ITA.

Firstly, companies adhering to the MFN clauses might be summoned through the recovery mechanism under section 201(1) of the ITA. This stipulates that the non-deduction of tax by the concerned assessee-in-default is recoverable, along with the computed interest. While a limitation period under section 201(3) prescribes that an order under section 201(1) cannot be passed for the resident payees after the seven-year limit, it is still uncertain when it comes to non-resident taxpayers. Although certain decisions emphasise that the order must be made within a reasonable time and determined on a case-by-case basis for non-resident taxpayers, the need for explicit clarification becomes apparent given the lack of specific provisions.

Secondly, the CBDT Circular No. 11/2017 provides relief through a reduction or waiver of interest that the assessee needs to pay under section 201(1A). This relief could be granted where any sum was not liable for tax deduction at source on the basis of a High Court order, and, subsequently, taxes were held to be deductible as a consequence of any Supreme Court decision. This benefit should be available for the assessees in default when non-deductions were based on the High Court judgments overturned by the Supreme Court in the current case. Only then would the failure to deduct TDS not be penalised under section 271C of the ITA as the non-deduction stems from a ‘reasonable cause.’ The Court’s silence on both the interest levy and penalty imposition will open new litigation.  

The Road Ahead

While the Supreme Court has commendably ended a longstanding debate in AO v. Nestle SA, the rationale employed diverges from established legal principles in deciding the two pivotal issues, resulting in a less-than-comprehensive conclusion. The subsequent dismissal of writ petitions by the Delhi High Court highlights its binding authority over the lower courts, intensifying the frenzy of taxpayers, who anticipate clarifications on the flagged implications. Therefore, a circular clarifying the implications under the ITA, specifically the computation of interests and penalties, while assuring a prospective effect, would be a constructive step that effectively restores investor confidence and protects international investments.

Akarshi Narain & Harshitha Adari

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