Recalibrating Sovereignty: India’s Crossroads in International Tax Arbitration

The author is Utkarsh Shukla, a Second Year Student from Rajiv Gandhi National University of Law.

Abstract:

The article examines the tensions within India’s sovereignty-driven approach to International tax arbitration under the Multilateral Instrument (MLI). It argues that India’s non-alignment with mandatory binding arbitration, in addition to the judicial stance in the Nestlé SA ruling, creates significant layers of uncertainty for taxpayers and foreign investors. By closely scrutinising the shortcomings of the Mutual Agreement Procedure (MAP) and constitutional challenges posed by the dualist legal system, the article proposes a legislative, administrative and judicial reform pathway to modernise India’s dispute resolution framework primarily aiming to position itself as not a mere participant but an architect of the future global tax governance.

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I. Introduction: India at the Crossroads of Tax Sovereignty and Global Reform 

In the modern interconnected global economy, cross-border tax disputes are the foremost challenge for nations attempting to balance sovereignty and efficiency. The OECD’s Multilateral Instrument (MLI), introduced under the Base Erosion and Profit Shifting (BEPS) framework, provides a transformative framework that modernises tax treaties by standardising anti-avoidance provisions, curbing treaty abuse, and incorporating streamlined dispute resolution mechanisms across jurisdictions. It expedites dispute resolution mechanisms by automatic amendment of existing treaties without the need for bilateral renegotiation, thereby fostering greater certainty and uniformity. However, India’s sovereignty-centric approach to implementing MLI reveals a structural tension between international harmonisation and domestic legal autonomy. 

India’s firm refusal to adopt the “mandatory binding arbitration” clause under Part VI, Article 19 of the MLI,− along with procedural requirements such as mandatory parliamentary notifications under Section 90(1) of the Income Tax Act, 1961, presents considerable obstacles to the prompt and efficient resolution of tax disputes. The position came under judicial scrutiny in the Hon’ble Supreme Court’s ruling in  Assessing Officer v. Nestlé SA, [1]  which addressed the applicability of the Most Favoured Nation (MFN) clause in tax treaties. The case arose when Nestlé SA, while claiming a lower tax rate under the MFN clause of the India-Netherlands DTAA, argued for the automatic application of benefits following India’s treaties with third countries like Lithuania. The main issue dealt with was whether the MFN benefits have automatic application when a country joins the OECD, or there is a need for separate parliamentary notification. The Court, while adhering to the dualist approach of India towards treaty implementation, laid down that:

“80. In the light of the above discussion, it is held and declared that:

(a) A notification under Section 90(1) is necessary and a mandatory condition for a court, authority, or tribunal to give effect to a DTAA, or any protocol changing its terms or conditions, which has the effect of altering the existing provisions of law.

(b)The fact that a stipulation in a DTAA or a Protocol with one nation, requires same treatment in respect to a matter covered by its terms, subsequent to its being entered into when another nation (which is member of a multilateral organization such as OECD), is given better treatment, does not automatically lead to integration of such term extending the same benefit in regard to a matter covered in the DTAA of the first nation, which entered into DTAA with India. In such event, the terms of the earlier DTAA require to be amended through a separate notification under Section 90.”

This ruling creates an additional level of complexity by requiring explicit domestic notification under Section 90(1), especially in cases when the third country became an OECD member after the original treaty was signed. This reasoning underscores India’s dualist approach and procedural rigidity, while also reflecting its broader discomfort with binding international arbitration mechanisms as a means of resolving disputes.

Below, I examine three interrelated challenges in India’s tax treaty framework. First, the implications of India’s rejection of mandatory arbitration, particularly in light of the Nestlé SA ruling. Second, the systematic inefficiencies embedded in dispute-resolution processes, notably the Mutual Agreement Procedures (MAP). Third,  how the MLI framework addresses the criticisms of arbitration, towards the end, I propose actionable reforms to align India’s legislative approach with the evolving global tax standards. Through this structured analysis, the article sets the stage and proposes a pathway for India to reconcile and effectively navigate its sovereign-efficiency conundrum in the modern integrated global tax order.

II. Sovereignty, Procedural Rigidity, and India’s Rejection of Arbitration

India’s decision to exclude mandatory binding arbitration provisions under Part VI (Articles 18-26) of the OECD’s MLI demonstrates a cautious sovereignty-driven approach to international tax dispute resolution. Despite adopting the MLI in 2019 to combat BEPS, India consciously opted out of the arbitration mechanism, citing sovereignty concerns. This position was clearly articulated by Finance Minister Nirmala Sitaraman, who states, 

“Taxation is an integral function of the state’s sovereignty, and hence, such matters need not be escalated under treaty dispute settlement mechanisms.” 

This stance underscores (1) India’s reluctance to cede tax adjudication authority to an international arbitral body, thereby aligning with the less predictable and inefficient Mutual Agreement Procedure (MAP) as the primary dispute resolution tool. This contention relies on the OECD’s MAP Peer Review Report-India, which clearly points out that dispute resolution through MAP often exceeds the benchmark timeframe of 24 months, with an average resolution time rising to 34.31 to 35.66 months, signalling systemic procedural delays further compounded by India’s dualistic legal structure. (e.g. Nestlé SA case mandates explicit parliamentary notifications for MFN clause application in tax treaties, reinforcing procedural rigidity and limiting its adaptability); (2) the friction between India’s dualist legal approach and the global tax regime’s multilateral ambitions.

Beyond the procedural rigidity and sovereignty concerns, India’s resistance to arbitration is also rooted in broader structural critiques of the mechanism, which may also explain the reluctance of most developing economies. First, the paramount concern is sovereignty: countries fear that binding arbitration would amount to transferring sensitive policy decisions to external bodies which lack domestic accountability. Second, the issue of opacity poses substantial risks of perceived bias, forum shopping, diminished stakeholder trust and a challenge to the legitimacy of arbitration proceedings, which are often confidential, with ad-hoc appointments of arbitrators and different procedural and jurisdictional norms across the globe. Third, arbitration may not necessarily resolve the issue of timeliness, as the cases often stretch over 18-24 months, which further burdens the taxpayers and stakeholders, thereby defeating the core objective of arbitration, i.e. to offer a faster, fairer, and more predictable alternative to judicial resolution. 

The cumulative effect of India’s arbitration exclusion, the procedural bottlenecks exemplified by the Nestlé SA ruling, and the structural limitations of the arbitration procedure not only pose a serious challenge to effective dispute resolution but also risk misalignment with global tax governance standards. This friction, resulting from India’s continued reliance on MAP and domestic legal procedures and lack of predictability, disproportionately affects the taxpayers and foreign investors, who rely on clear legal positions for business certainty, the resulting uncertainty undermines their confidence and highlights the pressing need for domestic legislative and administrative reforms to reconcile with evolving international tax standards. 

III. The Nestlé SA Ruling and the MFN Clause Impasse 

The Nestlé SA ruling by the Hon’ble Supreme Court highlights the complexities arising from India’s dualist approach to international tax treaties, particularly concerning the application of MFN clauses.  In October 2023, the Court adjudicated in Assessing Officer v. Nestlé SA, holding that MFN benefits cannot be automatically enforced and instead require a separate parliamentary notification under Section 90(1) of the Income Tax Act, 1961. While the judgement aligns with the constitutional practice of incorporating treaties into domestic law, it also complicates the practical implementation of commitments and undermines the objective of efficiency and uniformity envisioned by multilateral instruments like MLI. By upholding procedural formalism, the ruling reinforces the reliance on slower and less predictable mechanisms like MAP, thereby illustrating an underlying tension between India’s adherence to domestic legal sovereignty and the global trend towards arbitration as a more standardised and efficient mode of global tax dispute resolution. 

Additionally, the Hon’ble Apex Court’s retrogressive interpretation of Section 90 has drawn considerable critique. This provision, as held in Azadi Bachao Andolan, [2] which upheld the Central Government’s power to enter tax treaties without separate parliamentary legislation, provides for the specific exception to the constitutional mandate under Article 253 by empowering the Central Government to give effect to tax treaties without separate legislative intervention. Prescribing a requirement for separate notification for the application of MFN clauses not only contradicts the legislative intent but also encourages the unilateral, selective and arbitrary implementation by tax authorities. This approach weakens the principle of good faith in treaty interpretation as affirmed in KS Puttaswamy’s case [3] (where the court endorsed the primacy of constitutional morality and good faith in interpreting state obligations), i.e. the principle of good faith takes precedence over the conflicting requirements of domestic law. The court justified its stance with the “subsequent practice” principle, i.e. the idea that consistent post-treaty conduct by parties which can guide the consistent and shared interpretation of treaty terms, overlooks the two critical nuances: first, earlier notifications were issued voluntarily and not as a legal necessity; second, the subsequent practice in a bilateral treaty framework must be reflective of mutual interests and not unilateral conduct. 

Additionally, this stance carries much wider ramifications for the effectiveness of tax treaties, resulting in partner nations (e.g. Switzerland) rescinding MFN benefits and imposing retroactive tax obligations. Further, the systematic shortcomings of the MAP-centric model thereby discourage foreign investors seeking transparent and predictable mechanisms for dispute resolution. Lastly, the judicial requirement of formal notifications not only delays the implementation of treaty provisions but also reflects India’s institutional inclination towards administrative oversight over efficient mechanisms like arbitration, thereby widening the disconnect between domestic tax governance and emerging global standards.  This highlights the tension between India’s dualist legal tradition and the interpretative framework under the Vienna Convention on the Law of Treaties,1969, which emphasises pacta sunt servanda and good faith implementation of the international treaty clauses. 

IV. Reforming the Architecture: Legislative, Administrative, and Judicial Pathways

Arbitration has emerged as a key component of global tax governance in a modern digital economy. It provides a neutral, consistent, and expedient substitute for bilateral dispute resolution procedures, which reduces transactional friction and legal uncertainty (core concerns for cross-border economic activity). While India’s current stance on international tax arbitration reflects significant apprehensions about sovereignty and procedural oversight, it nonetheless presents an opportunity for constructive reform. The global shift towards efficiency, transparency and greater standardisation of tax dispute settlement highlights an urgent need for India to recuperate its existing framework. Rather than viewing arbitration as a threat to domestic autonomy, the strategic reformative approach could capitalize on its potential to bolster investor confidence, reduce litigation burdens and bring India’s practices in closer alignment with evolving international norms. 

The redressal of systemic challenges discussed above requires a multi-pronged approach encompassing the legislative, administrative, judicial and policy dimensions. At the legislative level, amending Section 90(1) of the Income Tax Act to recognise the MFN and MLI clauses as self-executing upon treaty ratification eliminates the issue of procedural delays linked to parliamentary notifications, aligns with global norms by avoiding retroactive tax disputes through stricter compliance with BEPS 2.0 − Pillar Two, Global Minimum Tax. Simultaneously, a separate statutory framework for domestic and international arbitration, as proposed in the Draft Arbitration and Conciliation (Amendment) Bill, 2024, should be considered for enactment. This bifurcation enhances procedural clarity, reduces forum shopping and conforms to the global best practices, i.e. The UNCITRAL Model Law. Stricter timeline adherence, statutory recognition of forward-looking provisions like emergency arbitration, and the establishment of an appellate arbitral tribunal to reduce judicial burden would strengthen India’s position as a credible dispute resolution hub. 

On the Administrative front, CBDT could establish a real-time public treaty dashboard disclosing the applicability of MFN clauses, MLI implementation status and the treaty amendments in a time-bound manner. While Rule 21AB of the Income Tax Rules currently governs the furnishing of information by assesses to claim relief under DTAAs, the underlying principle of transparency could be administratively extended through an amendment or an internal circular to institutionalise such a disclosure mechanism. This approach would play a crucial role in the mitigation of the legal uncertainties created by delayed MFN notifications and serve as a proactive tool for dispute resolution. 

Furthermore, judicial clarity plays a crucial role in balancing domestic litigation with evolving global standards. Reinforcing the interpretative role of the Vienna Convention, particularly Articles 26 and 31, can guide courts in recognising treaty obligations as binding in both letter and spirit, thereby reducing the legal friction by aligning India’s dualist model with international norms. Additionally, establishing specialised benches or tribunals with cross-border expertise ensures consistency in treaty implementation while reducing litigation congestion and overload. These ameliorations would be critical in ensuring India’s credibility as a jurisdiction for cross-border tax governance.

Lastly, arbitration-focused reforms are essential. India’s blanket dissent to mandatory binding arbitration, as evident in the Switzerland-MFN impasse, has proven counterproductive. A balanced adoption of limited mandatory arbitration, specifically for the high-value transfer pricing disputes under Article 19, provides prompt and binding resolutions, balancing it with concerns over sovereignty through regulated arbitrator selection and termination powers. Further, the anonymised publication of arbitral awards would effectively aid the interpretative consistency and domestic acceptance of the arbitration process. 

V. Conclusion

In conclusion, I submit that (1) India’s firm emphasis on sovereignty, procedural formalism and the jurisprudence in Nestlé SA collectively entrench inefficiencies which undermine the predictability and credibility required for cross-border tax dispute resolution; (2) the rigid insistence on parliamentary notifications for treaty implementation (especially the MFN) reflects a formalistic approach which risks misalignment with the dynamic realities of international tax governance; and (3) the apprehension that the integration of structured arbitration mechanism would erode sovereign discretion, is as best, an exaggerated concern and, at worst, a mischaracterisation of the strategic opportunities embedded within a multilateral framework. 

To this end, the sovereignty–efficiency tussle necessitates a closer scrutiny. If the reforms, such as the legislative recognition of self-executing treaties, administrative institutionalisation of transparency, judicial reinforcement of good faith, treaty interpretation under the Vienna Convention, and the balanced adoption of Limited arbitration frameworks, merely give a structured effect to India’s constitutional and international commitments to fairness and efficiency, then such measures are not the dilution of sovereignty but rather its principled and strategic articulation. To argue alternatively would conflate the evolutionary institutional refinement while abandoning the core principles – a conceptual error which must be avoided by India’s international tax governance, as it primarily aims to help shape the future contours of the global tax order and not merely integrate with it.

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References

[1] Assessing Officer v. Nestle SA, 2023 SCC OnLine SC 1372

[2] Union of India v. Azadi Bachao Andolan, (2004) 10 SCC 1

[3] K.S. Puttaswamy (Aadhaar-5J.) v. Union of India, (2019) 1 SCC 1