The Most Favoured Nation (MFN) clause, how it works, why it stopped working, and how to assess any MFN claim in five questions

In 2021, a French company receiving dividends from its Indian subsidiary withheld tax at 5 percent instead of the 10 percent its treaty prescribed. It was not being reckless. It was relying on a clause in the India-France treaty called Most Favoured Nation, and on a Delhi High Court ruling that said the clause worked on its own. For two years, the position looked settled.

Then, in October 2023, the Supreme Court decided the Nestle SA batch of appeals. In a single judgment it held that the clause did not work on its own at all. Overnight, companies that had withheld at the lower rate were exposed to being treated as an assessee-in-default, facing the differential tax, interest, and an argument about penalty.

That is the Most Favoured Nation clause: one of the most valuable and most misunderstood provisions in India’s tax treaties. This article explains what it promises, why India ever agreed to it, how it actually operates, and the exact sequence you should run before you rely on it for a single rupee of saving. By the end you will be able to assess any MFN claim, in any Indian treaty, in five questions.

What MFN actually promises

A Most Favoured Nation clause is a promise India makes to a treaty partner: if India later gives a more generous deal to some other comparable country, the first partner gets the same deal. The idea is that your treaty partner should never be left worse off than India’s newest friend.

The generosity can take two forms, and the distinction matters. The first is a lower rate of source tax, for example dividends taxed at 5 percent instead of 10. The second is a narrower scope of what is taxable, for example a tighter definition of fees for technical services that excludes plain managerial services or requires that the service make available technical knowledge. A rate concession saves money on the same income. A scope concession can take the income out of tax altogether. Read every MFN claim to see which of the two is really being asserted, because they are argued and proven differently.

Why India ever agreed to this

MFN clauses did not appear by accident. India negotiated most of its treaties with developed countries in the 1980s and 1990s, as a capital importer, from the weaker side of the table. India follows a source-based approach drawn from the UN Model, which lets it tax payments like royalties and fees for technical services even without a permanent establishment. To reassure OECD partners that they would not be undercut if India later offered a competitor better terms, India conceded MFN in a number of treaties, including those with France, the Netherlands, Switzerland, Sweden, Spain, and Hungary.

The result is a web of cross-references. A rate India agreed with one country can, in principle, ripple across to several others through their MFN clauses. That is exactly what made the clause so valuable to taxpayers, and so contentious for the revenue.

The anatomy of an MFN clause

The first thing to know is where it lives. The MFN clause sits in the Protocol to the treaty, not in the main articles. A Protocol is signed and ratified alongside the treaty and has the same binding force, so a clause in the Protocol is as much a part of the treaty as any numbered article. Practitioners who read only the main text and skip the Protocol miss the clause entirely.

The clause names the income types it covers, commonly dividends, interest, royalties, and fees for technical services. It then sets a trigger. In plain terms: if, after a stated date, India signs a treaty with a third state that is a member of the OECD, and in that treaty India limits its source taxation to a lower rate or a more restricted scope, then that same lower rate or restricted scope applies to the first partner too. The India-France Protocol, for instance, carries this promise across its dividend, interest, and royalty-and-technical-services articles.

So there are two countries in play beyond India. The first state is your treaty partner claiming the benefit, France in our example. The third state is the OECD country whose better deal is being borrowed, whichever later treaty offers the lower rate or tighter scope. Keeping these two straight is half the analysis.

The fork that decided everything: does it work on its own?

Every rupee of dispute came down to a single question. When the trigger is met, does the benefit apply automatically, or does it only become claimable once India issues a formal notification importing it?

One reading is self-operational: the moment India signs a qualifying treaty with a third state, the better treatment flows to the first partner by force of the clause itself, with no further step. The taxpayer simply withholds at the lower rate. The other reading is non-self-operational: the clause creates only a promise between the two governments, and the benefit becomes enforceable in Indian law only when the government issues a notification under Section 159 of the Income-tax Act 2025 (earlier Section 90(1) of the 1961 Act) giving it effect. For roughly two decades, taxpayers argued the first reading and the revenue argued the second. The Delhi High Court repeatedly sided with taxpayers.

The litigation saga and the Supreme Court’s answer

Three fact patterns reached the top. In Steria India, an Indian entity paying fees for technical services to a French resident argued that the narrower make-available definition from the India-UK treaty should be read into the India-France treaty through MFN, taking pure management fees out of tax. In Concentrix and Optum, Dutch companies claimed a 5 percent dividend rate through the India-Netherlands MFN clause, borrowing from India’s treaty with Slovenia. In Nestle SA, a Swiss resident claimed a lower dividend rate through the India-Switzerland MFN clause, borrowing from India’s treaty with Lithuania. In each case the High Court favoured the taxpayer and treated the clause as self-operational.

The department appealed, and the Supreme Court decided the batch together in Assessing Officer (International Taxation) v. Nestle SA, reported at 458 ITR 756, on 19 October 2023. It reversed the High Court and answered the fork decisively.

What the Supreme Court actually held

Two holdings from the judgment govern every MFN claim today.

First, a notification is mandatory. A treaty, or a protocol that changes the terms of a treaty in a way that alters the existing provisions of Indian law, has no effect in India until the government issues a notification under Section 159 of the Income-tax Act 2025 (earlier Section 90(1)). The MFN clause is therefore non-self-operational. Until the notification appears, the lower rate or narrower scope is a promise between governments, not a right a taxpayer can enforce. This settled twenty years of argument in one stroke.

Second, the third state must have been an OECD member when it signed with India. The Court read the requirement that the third state “is a member” of the OECD as fixed at the date that state entered into its treaty with India, not a later date when it happened to join the OECD. That single point defeated the Slovenia, Lithuania, and Colombia routes, because those countries acceded to the OECD only after signing their treaties with India. So even where a notification exists, the borrowed treaty has to clear this membership timing test.

So how do you assess an MFN claim now? Five questions

The skill is not knowing that a lower rate exists somewhere in India’s treaty network. It usually does. The skill is running these five checks in order before you promise anything.

One. Does the first treaty even contain an MFN clause, and for which income types? Check the Protocol, not just the articles. Many treaties have no MFN clause at all, and those that do may cover only some income types.

Two. Is there a later Indian treaty with a third state that gives a lower rate or narrower scope on that income type? Identify the specific borrowed treaty and the exact benefit being claimed, rate or scope.

Three. Was that third state an OECD member on the date it signed its treaty with India? Not the date of your claim, and not a later accession date. If the membership came afterwards, the claim fails on Nestle.

Four. Has the government issued a notification importing that benefit into the first treaty, under Section 159 of the Income-tax Act 2025 (earlier Section 90(1))? This is the step that Nestle made decisive. No notification, no enforceable benefit.

Five. If yes to all four, read the notification’s exact terms before you apply it. A notification may import only part of the benefit. Only then can you withhold at the lower rate or treat the income as outside scope.

The aftermath, and the quiet end of the MFN era

The Supreme Court did not invent the notification requirement. The Central Board of Direct Taxes had already set out these conditions, including the need for a separate notification, in Circular No. 3/2022 dated 3 February 2022. Nestle effectively endorsed that circular and gave it the force of a binding precedent.

The mechanism the Court described has since been used exactly as intended. By Notification No. 33/2024 dated 19 March 2024, the government formally imported a 10 percent rate for royalties and fees for technical services into the India-Spain treaty, borrowing from the India-Germany treaty, applicable from the financial year 2023-24. Note the detail that catches people: the notification imported only the lower rate, not the narrower scope that some other treaties carry. The benefit is exactly as wide as the notification says, and no wider.

The larger trend is that India is now removing MFN clauses altogether. The India-France Amending Protocol signed on 23 February 2026 deletes the MFN clause outright and instead negotiates the FTS scope, dividend rates, and permanent establishment rules directly into the treaty. That protocol is not yet in force, but the direction is clear. The era of importing benefits through MFN is closing, and future disputes will turn on the negotiated text itself rather than on cross-references to third-country treaties.

Practical gaps that still catch people

A few errors recur, and they are expensive.

Assuming MFN is automatic. After Nestle it is not. Without a notification, the benefit cannot be claimed, however clearly the clause seems to grant it.

Relying on High Court rulings decided before October 2023. Steria, Concentrix, and the line of decisions that treated the clause as self-operational no longer represent the law. Advice built on them is unsafe.

Forgetting the OECD timing condition. The third state must have been an OECD member when it signed with India. A country that joined the OECD later cannot be used as the source of the benefit, even if a notification exists.

Assuming a notification imports everything. As the Spain notification shows, India may import the rate and leave the narrower scope behind. Read the operative words of the notification, not the marketing summary of it.

Overlooking the deductor’s exposure for past years. A payer who under-withheld in earlier years relying on MFN can be treated as an assessee-in-default, with interest running under Section 398 of the Income-tax Act 2025 (earlier Section 201(1A)). Penalty under Section 271C of the 1961 Act, and its successor provision under the 2025 Act, is arguable given the reasonable-cause defence and the prior High Court rulings, and interest relief may be available under CBDT Circular No. 11/2017 where the non-deduction was backed by a jurisdictional High Court ruling that the Supreme Court later reversed. This is a live cleanup issue, not just a forward-looking one.

Ignoring timing on the treaty itself. Where a protocol is deleting the MFN clause, as with France, a benefit available today may disappear once that protocol enters force. Confirm the current status of the treaty before you rely on the clause.

Conclusion

The Most Favoured Nation clause was a generous idea undone by a question of mechanics. For years the debate was about fairness and good faith between governments. The Supreme Court reframed it as a question of Indian constitutional and statutory law: a promise in a protocol does not change what an Indian taxpayer owes until the government formally says so through a notification.

For a practitioner, that reframing is a gift, because it turns a contested area into a checklist. Find the clause, find the borrowed treaty, test the OECD timing, and above all look for the notification. A lower rate that lives only in an unnotified promise is not money in the bank. Treat it as a possibility to be verified, never as a benefit to be assumed, and you will keep both your clients and yourself out of the assessee-in-default column.

About the Author

Mukesh Thakur is a Fellow Chartered Accountant (FCA) with ACCA credentials and IFRS specialisation, and the Founder and Managing Partner of Exactitude International Private Limited (EXI), a multidisciplinary professional advisory firm headquartered in New Delhi. EXI advises on international tax, India entry, transaction advisory, IFRS and Ind AS, ESG reporting, and virtual CFO engagements.

www.exi.co.in  |  Where Excellence Meets ImpactThis article is for educational purposes and does not constitute legal or tax advice. Treaty positions change through amendment, court rulings, and notifications. Seek specific professional advice for your situation.