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Switzerland suspends MFN clause with India
Context:
Starting January 1, 2025, Switzerland’s suspension of the Most-Favoured-Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India, originally signed in 1994 and amended in 2010, could lead to higher taxes on Indian companies operating in Switzerland and impact Swiss investments in India.
Most Favoured Nation (MFN)
It is a principle in international trade that ensures equal treatment among trading partners. Under this principle, if one country grants favorable trade terms (such as lower tariffs) to another country, it must extend the same terms to all other countries with MFN status. This non-discriminatory approach aims to promote fair competition and prevent preferential treatment among nations.
Key aspects of MFN include:
- Equal Trade Advantages: Countries must treat all MFN partners equally, ensuring that no single nation receives preferential treatment over others.
- WTO Framework: The World Trade Organisation (WTO) incorporates MFN as a foundational principle, requiring member countries to adhere to it in their trade agreements.
- Exceptions: There are exceptions for regional trade agreements and preferential treatment for developing countries, allowing certain flexibility within the MFN framework.
More in News
- This decision was announced in a Swiss government statement dated December 11, 2024.
- The move follows a 2023 ruling by the Indian Supreme Court, which held that the DTAA cannot be enforced unless explicitly notified under the Income Tax Act.
- This judgment overturned an earlier Delhi High Court ruling that had prevented double taxation for companies and individuals working with foreign entities.
- Consequently, Swiss companies like Nestlé may now face increased taxes on dividends.
Potential Implications
- Tax experts warn that this suspension could hinder investments in India, as dividends will now attract higher withholding taxes.
- This poses risks to the $100 billion investment commitment under the European Free Trade Association (EFTA) trade pact, signed in March 2024 by Iceland, Liechtenstein, Norway, and Switzerland.
- The Swiss government justified its decision, citing a lack of reciprocity in the DTAA implementation by India.
- From January 1, 2025, the source state’s residual tax rate on dividends will be capped at 10%.
Background and Rationale
- The Swiss competent authority acknowledged that its interpretation of paragraph 5 of the DTAA protocol differs from India’s stance.
- As a result, the unilateral application of the MFN clause will be suspended, and taxes will be imposed based on the original treaty rates, irrespective of the MFN provision.
- Amit Maheshwari, tax partner at AKM Global, explained that the suspension stems from the Supreme Court’s Nestlé ruling, which clarified that the MFN clause’s benefits are not automatic and require explicit notification from India.
- Switzerland’s stance reflects concerns about unequal treatment compared to countries with more favorable treaties with India.
- Switzerland had earlier reduced its tax rate on dividends from 10% to 5% under the MFN clause, effective retroactively from July 5, 2018.
- However, the 2023 ruling invalidated this adjustment, leading Switzerland to reassess its application of the clause.
Broader Impact on International Taxation
- Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen, noted that the suspension underscores the increasing emphasis on reciprocity and mutual agreement in treaty interpretations.
- It could raise tax liabilities for Indian companies operating in Switzerland, illustrating the complexities of navigating international tax treaties.
- This move also aligns with a global trend of countries asserting stricter interpretations of tax provisions to safeguard domestic revenues.
- The Supreme Court ruling clarified that treaty benefits could be claimed only from the treaty’s effective date, not retroactively.
- It also addressed the applicability of the MFN clause when a third country was not an OECD member at the time of signing.
