Switzerland’s decision to suspend India’s Most Favoured Nation status under the Double Taxation Avoidance Agreement (DTAA) marks a significant development in the financial and trade dynamics between the two countries.
This move, effective from January 1, 2025, stems from legal interpretations and rulings that have reshaped the understanding of tax treaties and international agreements. The shift has implications for dividends, bilateral trade relations, and future negotiations under the broader economic framework.
The Supreme Court Ruling and Its Implications
The origin of Switzerland’s decision can be traced back to a ruling by the Supreme Court of India involving Nestlé, the Swiss multinational conglomerate. The case centered on the applicability of the MFN clause in India’s tax treaties.
Switzerland, along with several OECD nations, has an MFN clause embedded in its DTAA with India. This clause ensures that if India provides a lower tax rate on specific incomes to another country, the same rate would apply to other MFN partners.
The complexity arose when India signed tax treaties with Colombia and Lithuania, both of which later joined the OECD. The treaties with these countries featured a 5% tax rate on dividends, compared to the 10% rate outlined in India’s treaty with Switzerland. Switzerland interpreted that the MFN clause automatically triggered a 5% rate for dividends.
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However, the Supreme Court of India ruled otherwise in October 2023. It concluded that the MFN clause was not directly applicable unless a formal “notification” under Section 90 of the Income Tax Act was issued.
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This decision reversed a lower court’s interpretation and clarified that the benefits of the MFN clause could not be automatically extended without explicit procedural compliance.
Trade and Tax Impacts
As a result of the Supreme Court ruling, Switzerland suspended the MFN clause, leading to the imposition of a 10% tax rate on dividends originating from Indian entities. This marks a departure from the previously assumed 5% rate and introduces higher tax liabilities for Indian businesses with Swiss investments.
The financial implications are significant for corporations operating across the two nations. Indian entities, which often seek foreign investments to fuel growth, may face reduced attractiveness for Swiss investors.
The higher dividend tax rate could lead to a reevaluation of existing and future investment strategies, potentially impacting capital flow between the two nations.
Beyond the immediate tax implications, the suspension signals a recalibration of trade and economic relations. While India’s robust economy remains an attractive destination for foreign investments, the suspension of MFN benefits could lead to renegotiations of existing agreements to align with the evolving global economic landscape.
Prospects for Renegotiation
India has responded to Switzerland’s suspension of MFN benefits by indicating the need for renegotiations of the DTAA. The Ministry of External Affairs (MEA) highlighted the potential alignment of the tax treaty with the broader Free Trade Agreement (FTA) signed in March 2024 between India and the European Free Trade Association (EFTA).
This FTA, encompassing Switzerland, Norway, Iceland, and Liechtenstein, is a cornerstone of India’s expanding trade relationships with Europe.
Under the agreement, EFTA nations are expected to invest $100 billion in India over the next 15 years, focusing on sectors such as technology, infrastructure, and renewable energy. Renegotiating the DTAA with Switzerland could provide an opportunity to address the MFN clause and foster a more balanced approach to taxation.
The renegotiation may also present India with a chance to assert its stance on equitable tax policies. As the global economic order shifts, India’s growing influence as a major trade partner and investment hub underscores the need for reciprocal agreements that reflect its economic aspirations.
Broader Implications for International Tax Treaties
The suspension of MFN status by Switzerland is not merely a bilateral issue; it highlights broader questions regarding the interpretation and implementation of international tax treaties.
The Supreme Court ruling establishes a precedent for the procedural rigor required to apply MFN clauses, emphasizing the importance of explicit notifications and compliance with domestic legal frameworks.
This development is likely to influence other OECD nations in their interactions with India. Countries seeking clarity on the application of MFN clauses may now be compelled to revisit their own agreements with India and evaluate the need for renegotiations.
Furthermore, the case underscores the dynamic nature of global tax treaties in an era of shifting economic alliances and trade priorities.
As nations pursue their economic interests, the balance between fostering foreign investments and protecting domestic tax revenues will remain a central theme in international negotiations.
While the suspension of MFN benefits introduces short-term challenges, it also sets the stage for India and Switzerland to redefine their economic partnership.
The renegotiation of the DTAA, if approached strategically, could address not only the immediate tax concerns but also pave the way for enhanced cooperation in other areas.
For businesses and policymakers, the developments serve as a reminder of the need for adaptability in an evolving global economic landscape. As trade relations continue to evolve, aligning national priorities with international agreements will be key to sustaining economic growth and fostering long-term partnerships.