Switzerland has recently announced that it will suspend the Most Favoured Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India, effective from January 1, 2025. The decision will see a doubling of the withholding tax rate on dividends paid to Indian tax residents, raising it from 5 per cent to 10 per cent. This move follows a significant ruling by the Indian Supreme Court in 2023, which clarified that the MFN clause does not automatically apply when a country joins the Organisation for Economic Co-operation and Development (OECD), especially if a previous tax treaty is already in place.
But what exactly is the MFN clause, and what does Switzerland’s suspension mean for India?
What is the MFN clause?
The MFN clause is a principle typically embedded in international treaties, including tax agreements. It ensures that a country offering favourable terms to one party must extend those same terms to all other parties covered by the treaty. In the context of taxation, this clause is designed to guarantee equal treatment for all countries involved. If a country enters into a tax treaty that provides more beneficial conditions, the MFN clause mandates that these conditions must be extended to other countries within the scope of the agreement.
The 2023 nestlé case: A turning point
In 2023, Swiss company Nestlé sought a refund for the withholding tax it had paid on dividends, arguing that it should benefit from the lower tax rate under the MFN clause in the India-Switzerland tax treaty. Nestlé believed that the favourable tax terms offered to other countries, such as Lithuania and Colombia, should also apply to Switzerland due to the MFN clause.
However, the Indian Supreme Court ruled that the MFN clause cannot be applied automatically. It clarified that such tax benefits require formal notification under Section 90 of the Indian Income Tax Act, and they cannot be assumed to apply by default. The ruling overturned a decision by the Delhi High Court that had favoured Nestlé, creating a precedent that Swiss authorities could no longer unilaterally apply the lower withholding tax rate to India.
Why has Switzerland suspended the MFN clause?
Following the Supreme Court’s 2023 ruling, Switzerland reconsidered its stance on the MFN clause. The court had clarified that tax rate reductions from countries like Colombia and Lithuania, which had joined the OECD, would only apply to India if formally notified. Without such notification, the tax rates could not be automatically adjusted.
As a result, Switzerland decided to suspend the MFN clause in its treaty with India, effective from 2025. This suspension will lead to an increase in the withholding tax on dividends paid to Indian residents, from the current 5 per cent to 10 per cent, which could significantly impact investors.
What will the impact be on india?
The suspension of the MFN clause will have several significant consequences for both businesses and investors in India:
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- Higher tax liabilities for indian companies: Indian companies receiving dividends from Switzerland will face a higher tax burden, as the withholding tax on those dividends will rise to 10 per cent from 5 per cent. This increase could reduce the profitability of Indian firms reliant on Swiss investments.
- Impact on swiss investments in india: Swiss companies that receive dividends from their Indian subsidiaries will continue to face a 10 per cent withholding tax, as this tax rate has always applied under the India-Switzerland DTAA.
- Limited impact on EFTA investments: Investments from the European Free Trade Association (EFTA), which includes Switzerland, are already subject to the 10 per cent withholding tax rate, so they will not be affected by this change.
- No change to other DTAA benefits: Indian companies operating in Switzerland will still benefit from other provisions of the India-Switzerland DTAA, including tax relief on royalties and fees for technical services.
- Reevaluation of MFN clauses by other countries: This move by Switzerland could prompt other countries to reconsider how they apply the MFN clause in their tax treaties with India. If similar legal challenges arise in other jurisdictions, it could lead to more countries scrutinising and possibly suspending their MFN clauses.
The importance of mutual agreement
This decision underscores the significance of mutual understanding in interpreting international tax agreements. While the MFN clause is intended to ensure fairness and equal treatment, it requires clarity and consent from both parties. The suspension of the MFN clause by Switzerland reflects a more cautious approach to interpreting tax treaties, emphasising that changes to tax rates or conditions should not be applied automatically but must be mutually agreed upon and clearly defined.
In conclusion, while Switzerland’s suspension of the MFN clause will undoubtedly impact the taxation landscape between the two countries, it also highlights the importance of precise and agreed-upon terms in international agreements. Businesses and investors will need to carefully navigate these changes as they come into effect in 2025.
