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Role of Protocol and MFN Clause in interpreting Tax Treaties (DTAAs)

Q. 1: What is Most Favored Nation (MFN) Clause in Tax Treaty?

MFN clause refers to a situation wherein two non-resident taxpayers are given impartial treatment by the source country. In DTAAs, MFN clauses find place when countries are reluctant to forgo their right to tax some elements of income. Generally, MFN clause form part of Protocol in Indian Tax Treaties.

Q. 2: Effect of MFN Clause in Tax Treaty?

Resident of other Contracting state can get beneficial treatment without having this clause into its original treaty which the contracting state providing to third state. It primarily has the following effects:

  1. To guarantee that no discriminatory treatment when compared with a third country;
  2. To offer a better treatment because of favorable change in policy; and
  3. It essentially substitutes the need for entering negotiations to modify tax treaty, but it automatically modifies tax treaty if certain conditions stated therein are met.

Example: MFN clause binds a contracting State (India) to offer to a resident of the other contracting State (France), the same benefits which A may offer to a resident of a third State (UK) regarding restrictive definition of FTS.

Q. 3: Is the MFN clause applicable automatically?

Its applicability depends upon the wordings of protocol e.g. India-Finland DTA require each party to notify each other to execute such change; while India-Philippines & India-Switzerland DTAs requires in protocol to re-negotiate without delay and if no specific requirement in protocol, it is self-operational and no further action is required.

Q. 4: Countries with which India is already having MFN?

Belgium, France, Finland, Hungary, Israel, Kazakhstan, Netherlands, Norway, Philippines, Saudi Arabia, Spain, Sri-Lanka, Sweden, Swiss confederation & United-kingdom.

Q. 5: What is treaty Protocol? What is its importance in Tax Treaties?

A protocol completes the tax treaty and the provisions of the protocol conferring, expanding or reducing a particular benefit, which is absent in the tax treaty, are to be applied to that extent. The protocol should not be viewed as a document independent of the tax treaty and must be considered as its addendum.

Conclusion, it is thus necessary to evaluate whether the DTA have MFN clause & protocol and if so, beneficial treatment is considered to drive correct tax treatment.

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