Application of the Most Favoured Nation clause to a double tax treaty

Most Favoured Nation (“MFN”) provisions generally exist to prevent countries from discriminating against other countries through the use of clauses in free trade agreements and double tax treaties.

Taxpayers need to be aware of these clauses, as they may change the amount of tax that must be withheld on payments of dividends, interest, royalties and services made overseas.

Although not a common feature of UK double tax treaties (“DTT”), examples include the UK-Chile DTT and the UK-India DTT. Such clauses tend to be complex and narrowly drawn but where present can impact the normal rates of withholding tax charged by the Contracting States under the terms of the DTT, often reducing the rate to zero.

Now the UK has left the EU and the directives relating to dividends, royalties and interest no longer apply, the relevance of tax treaties to transaction flows between the UK and overseas companies has increased considerably.

What should companies be doing now?

Where a UK company makes payments to, or receives payments from, any overseas entity, the relevant DTT should be checked to confirm the impact on withholding taxes, including the implication of MFN clauses. It is also important to note that caution is needed when using DTT, as the stated rates contained in them may be out of date (particularly in older treaties) or domestic legislation may have changed since the treaty was drawn up, such as the introduction of withholding tax on interest and royalties in the Netherlands from 1 January 2021. Failure to apply the correct withholding tax rate may lead to penalties and interest charges or, conversely, too much tax being paid over to the home tax authority.

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