Switzerland’s decision to revoke India’s Most-Favoured Nation (MFN) status, effective January 1, 2025, marks a significant shift in the bilateral relations between the two nations.
The move, linked to taxation disagreements stemming from a Supreme Court ruling in India, is expected to impact Indian businesses operating in Switzerland and vice versa.
Understanding the MFN Status Between India and Switzerland
The concept of Most-Favoured Nation (MFN) status is central to international trade and tax treaties. It ensures that a country extends the best possible tariff rates or treatment to a partner nation under similar circumstances.
In the context of tax treaties, such as the Double Taxation Avoidance Agreement (DTAA) between India and Switzerland, the MFN clause ensures that benefits extended to residents of other Organisation for Economic Co-operation and Development (OECD) countries are also applicable to the treaty partner.
India and Switzerland signed their DTAA in 1994, with amendments introduced in 2010. Under this agreement, the MFN clause had previously ensured lower tax rates for Indian and Swiss businesses in line with other OECD member nations.
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For example, a 5% tax rate on dividends was applicable due to the MFN clause, instead of the standard 10% rate outlined in the treaty. However, disputes arose when new members, such as Colombia and Lithuania, joined the OECD.
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Switzerland interpreted that the accession of these nations to the OECD automatically activated the MFN clause, allowing the 5% tax rate on dividends to apply.
However, a subsequent ruling by India’s Supreme Court challenged this interpretation, setting the stage for Switzerland’s drastic decision to revoke MFN status.
The Supreme Court Ruling and Switzerland’s Response
The crux of the issue lies in a 2023 ruling by the Indian Supreme Court in a case involving Nestlé. Initially, a lower court had upheld Switzerland’s interpretation of the MFN clause, ensuring that the lower tax rate applied.
However, the Supreme Court reversed this decision, stating that the MFN clause in the DTAA does not automatically apply when a country joins the OECD. According to the ruling, specific notification under Section 90 of the Income Tax Act is required for such changes to take effect.
Switzerland expressed its disapproval of the ruling, viewing it as a breach of mutual understanding under the DTAA. In response, the Swiss government announced the suspension of India’s MFN status.
This decision will result in higher withholding tax rates on dividends for Indian entities operating in Switzerland and Swiss businesses in India, effective January 1, 2025. Dividends will now be taxed at 10%, the rate specified in the original DTAA, instead of the reduced 5% rate under the MFN clause.
Swiss authorities justified their decision by emphasizing the importance of predictability and reciprocity in international tax agreements. They argued that India’s stance undermines the principles of fairness and stability in bilateral treaties, necessitating Switzerland’s move to protect its interests.
Implications of the MFN Status Revocation
The suspension of India’s MFN status by country carries significant implications for businesses and investments between the two nations. Key impacts include:
- Increased Tax Liabilities: Indian companies operating in Switzerland will face higher withholding tax rates on dividends, increasing from 5% to 10%. This change will also affect Swiss companies earning income in India, as they will be subjected to higher tax rates on their dividends.
- Impact on Overseas Direct Investment (ODI): Indian companies with ODI structures involving subsidiaries in Switzerland will bear the brunt of the increased tax burden. This could lead to reduced profitability and a reevaluation of ODI strategies.
- Potential Decline in Investments: The decision may deter Swiss investments in India, as higher tax rates make Indian operations less attractive. Similarly, Indian businesses may reconsider expanding their presence in Switzerland due to the increased costs.
- Complexity in Tax Treaty Negotiations: The suspension highlights the challenges of aligning interpretations of international tax agreements. It underscores the need for clear and consistent guidelines to avoid disputes and ensure stability in bilateral relations.
- Strained Bilateral Relations: While the decision is primarily economic, it could strain diplomatic ties between India and Switzerland. The suspension of MFN status signals a shift in Switzerland’s approach to bilateral relations, potentially influencing other areas of cooperation.
Tax experts have emphasized the importance of aligning treaty interpretations to maintain predictability and equity in international taxation. They view Switzerland’s decision as a retaliatory step following the Supreme Court ruling, aimed at ensuring reciprocity in bilateral agreements.
Switzerland’s suspension of India’s MFN status is a watershed moment in the economic relations between the two nations. Triggered by disagreements over the interpretation of the MFN clause under the DTAA, the decision underscores the complexities of international tax treaties and their impact on businesses.
With higher tax rates on dividends set to take effect from January 2025, Indian and Swiss companies will need to navigate the evolving tax landscape carefully.
As both nations work to address these challenges, the incident serves as a reminder of the importance of clarity, fairness, and mutual understanding in international agreements. The revocation of MFN status not only affects businesses but also sets a precedent for how similar disputes may be handled in the future.