INTRODUCTION AND CONTEXT
Switzerland has announced its decision to suspend the Most Favoured Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India, effective January 1, 2025. This decision, rooted in recent Supreme Court of India, ruling in Swiss Company Nestle Case marks a significant development in international taxation and bilateral relations between the two countries. The ruling redefined the interpretation and application of the MFN clause, requiring procedural formalities for enforcement, thereby increasing tax liabilities for Indian companies and potentially impacting investments between the two nations.
BACKGROUND OF INDIA-SWITZERLAND DTAA
The India-Switzerland Double Taxation Avoidance Agreement (DTAA), signed in 1994 and amended in 2010, aims to prevent double taxation of income between the two nations. The MFN clause introduced in the 2010 protocol allowed for the extension of lower tax rates offered to other OECD countries. However, disputes arose regarding its automatic applicability after India signed treaties with Lithuania and Colombia, offering lower dividend tax rates of 5%.
SUPREME COURT RULING AND ITS IMPLICATIONS
The Indian Supreme Court ruled that the MFN clause in the DTAA requires formal notification for enforcement. It also stated that the OECD membership of third-party countries must be assessed at the time the treaty was signed. Consequently, the reduced tax rates granted to Lithuania and Colombia do not apply to Switzerland, leading the latter to revert to the original 10% withholding tax rate on dividends starting in 2025.
KEY CHANGES IN TAXATION RATES
- From January 1, 2025, dividend payments from Swiss entities to Indian investors will be taxed at a 10% rate, up from 5%.
- For the tax years 2018 to 2024, the lower 5% rate remains applicable.
- Dividends paid by Indian entities to Swiss investors will continue to attract a 10% tax rate, consistent with India’s interpretation of the treaty.
IMPACT ON CROSS-BORDER INVESTMENTS
The suspension of the MFN clause is likely to affect bilateral investments negatively:
- Higher Tax Liabilities: Indian companies operating in Switzerland and receiving dividends will face increased tax burdens.
- Investment Uncertainty: Swiss companies may reconsider investments in India due to the higher procedural and financial costs.
- EFTA Investments: Investments under the European Free Trade Association (EFTA) framework remain unaffected, with the 10% tax rate continuing to apply.
IMPLICATIONS FOR INTERNATIONAL TAXATION
Switzerland’s decision reflects a global trend towards stricter interpretations of tax treaties to safeguard domestic revenues. This development underscores the need for clarity and mutual agreement in international tax frameworks to prevent disputes and foster stable investment environments.
INDIA-SWITZERLAND INVESTMENT RELATIONSHIP
Switzerland has been a significant investor in India, with inflows amounting to nearly USD 10 billion between 2000 and 2023. Over 330 Swiss companies operate in India, spanning sectors like pharmaceuticals, machinery, and ICT services. Conversely, Indian firms, including TCS and Infosys, have substantial investments in Switzerland, primarily in technology and life sciences.
CONCLUSION
The suspension of the MFN clause may reduce Swiss companies’ investment in India and marks a pivotal moment in India-Switzerland tax treaty relations, emphasizing evolving global tax norms. While it may increase tax liabilities and deter cross-border investments, it highlights the critical need for alignment and clarity in treaty provisions to ensure equitable and predictable tax outcomes for all stakeholders. A liberal solution by both the countries is needed to overcome the situation.
