The Supreme Court’s Judgment in the Nestle Case and Switzerland Revoking India’s MFN Status: A Comprehensive Analysis

Introduction

On December 16, 2024, Switzerland announced its decision to suspend the Most Favoured Nation (MFN) treatment for India under the India-Switzerland Double Taxation Avoidance Agreement (DTAA), effective January 1, 2025. The decision was heavily influenced by the Indian Supreme Court’s 2023 judgment in the Nestle case. This landmark ruling clarified the application of MFN clauses and the enforceability of international treaties under Indian law, impacting how treaty benefits are extended to contracting states. The interplay between judicial interpretation and international obligations in this case raises critical questions about the balance between domestic sovereignty and global reciprocity.

Background

1. The MFN Clause and Its Relevance in the India-Switzerland DTAA:

The MFN clause is a cornerstone of bilateral tax treaties, designed to ensure that neither party is disadvantaged compared to other treaty partners. Under the India-Switzerland DTAA, the MFN clause provided for:

• Lower taxation rates on dividends, interest, royalties, and fees for technical services.
• Automatic extension of benefits granted to third-party countries that are members of the Organisation for Economic Co-operation and Development (OECD).

Swiss entities, including Nestle, sought to invoke the MFN clause to claim tax benefits offered to other countries, such as Lithuania and Slovenia, that later joined the OECD.

2. Judicial Precedents and Section 90 of the Income Tax Act, 1961:

India’s legal framework requires treaties and protocols to be notified by the Central Government to be enforceable. Section 90 of the Income Tax Act empowers the government to enter into DTAAs but mandates statutory compliance for their applicability.

3. The Supreme Court’s 2023 Judgment in the Nestle Case:

The Supreme Court’s ruling arose from an appeal filed by the Income Tax Department, challenging the Delhi High Court’s decision to extend MFN benefits to Nestle and other foreign companies.

The Supreme Court’s Judgment

The bench, comprising Justice S. Ravindra Bhat and Justice Dipankar Datta, delivered a pivotal judgment addressing the interpretation and enforceability of the MFN clause.

Key Findings:

1. Procedural Requirement for Treaties:
   • Treaties must either be enacted through standalone legislation or notified under a statutory provision, such as Section 90 of the Income Tax Act.
   • Automatic extension of benefits from third-party treaties was ruled impermissible without explicit notification.
2. MFN Clause Interpretation:
   • For benefits to apply under an MFN clause, the third-party country must have been an OECD member when the original DTAA was signed.
   • Retroactive application of benefits based on subsequent OECD membership violates treaty principles.
3. Rejection of Automatic Parity:
   • The Court emphasized that international agreements do not override domestic law unless explicitly legislated or notified.
   • It rejected the argument that DTAA benefits extended to third-party OECD countries should automatically integrate into the India-Switzerland DTAA.
4. Consistent Practice in India:
   • India’s historical practice requires treaties and amendments to be formally notified in the official gazette for enforceability.

Switzerland’s Decision to Revoke India’s MFN Status

In response to the Supreme Court’s judgment, Switzerland cited the lack of reciprocity in India’s interpretation of the MFN clause as the basis for suspending India’s MFN status under the DTAA. A Swiss government communiqué stated that unilateral application of the MFN clause would cease from January 1, 2025. 

Implications

1. For India-Switzerland Relations: The revocation of MFN status by Switzerland reflects a divergence in treaty interpretations, potentially affecting economic and diplomatic ties.

2. For Tax Policy in India: The judgment reaffirms India’s stance on treaty compliance and procedural integrity. It sets a precedent that automatic benefits under MFN clauses cannot be claimed without adhering to statutory requirements.

3. Broader Impact on International Agreements: The ruling highlights the need for precise drafting of treaty clauses to avoid ambiguity. It may influence how other countries approach treaty negotiations and interpretations with India.

4. Sovereignty in Treaty Enforcement: The decision reasserts India’s sovereignty in determining treaty applicability, aligning with domestic legal principles.

Conclusion

The Supreme Court’s judgment in the Nestle case has had far-reaching implications, not just on India’s tax treaty enforcement but also on its bilateral relations with Switzerland. By upholding procedural rigor and statutory compliance, the Court has set a significant precedent in international taxation.

Moving forward, this case serves as a reminder of the need for clarity and reciprocity in treaty negotiations, ensuring that international obligations align seamlessly with domestic legal principles.

King Stubb & Kasiva,
Advocates & Attorneys

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