Switzerland has made a decisive move to revoke India’s Most Favoured Nation (MFN) status under the Double Taxation Avoidance Agreement (DTAA), citing the Supreme Court of India’s recent ruling in the Nestle case as the reason. The Swiss decision, announced on December 11, 2023, signals a significant change in the bilateral treaty relationship between the two countries and is expected to impact Indian businesses operating in Switzerland, as well as Swiss investments in India.
In its official statement, Switzerland’s finance department explicitly pointed to the Indian Supreme Court’s 2023 ruling, which stated that an MFN clause does not automatically apply when a country joins the Organisation for Economic Co-operation and Development (OECD). This landmark judgment set a precedent that existing tax treaties take precedence unless the MFN clause is explicitly triggered through a notification under Section 90 of India’s Income Tax Act.
The Role of the OECD and Its Framework
The OECD, established in 1961 and headquartered in Paris, is a global forum focused on promoting fair and sustainable economic policies. It works with policymakers, stakeholders, and citizens to develop evidence-based international standards to tackle global challenges, including economic, social, and environmental issues. For countries like India and Switzerland, OECD standards play a crucial role in shaping tax treaties and bilateral agreements.
Background of the Case
The dispute originated from India’s tax agreements with Lithuania and Colombia, which stipulated lower tax rates for certain income categories compared to those provided to OECD countries. Later, when Lithuania and Colombia joined the OECD, Switzerland interpreted the MFN clause to mean that the 5% tax rate for dividends applied to its tax treaty with India, instead of the 10% rate originally agreed upon.
However, the Indian Supreme Court clarified in its ruling that the MFN clause does not automatically apply to new OECD members. Instead, for the clause to take effect, it must be explicitly mentioned in a notification under Section 90 of the Income Tax Act. This interpretation invalidated Switzerland’s assumption that Lithuania and Colombia’s OECD membership would alter the India-Switzerland tax treaty’s terms.
The Nestle Case and Its Implications
Switzerland’s disappointment stems from the Supreme Court overturning a 2021 Delhi High Court judgment that had upheld Switzerland’s interpretation of the MFN clause. The High Court had ruled in favor of applying residual tax rates under the DTAA, which aligned with Switzerland’s perspective.
However, on October 19, 2023, the Supreme Court reversed this judgment, stating, “The MFN clause was not directly applicable in the absence of a ‘notification’ in accordance with Section 90 of the Income Tax Act.” This ruling directly impacted Nestle and indirectly undermined Switzerland’s stance, leading to its decision to revoke India’s MFN status.
Switzerland’s Response and Its Repercussions
As a response to the Supreme Court’s ruling, Switzerland has unilaterally withdrawn India’s MFN status under the DTAA. Starting January 1, 2025, dividends payable to Indian tax residents and entities will be subject to a 10% tax rate, doubling the current 5%. Swiss tax residents claiming foreign tax credits will also face similar implications.
In its official statement, the Swiss finance department announced, “Suspension of the application of the MFN clause of the protocol to the agreement between the Swiss Confederation and the Republic of India for the avoidance of double taxation with respect to taxes on income.” The statement specifically attributed the decision to the Indian Supreme Court’s 2023 ruling on the Nestle case.
Perspectives from Tax Experts
The decision has drawn mixed reactions from experts. While some view it as a retaliatory move, others see it as an assertion of reciprocity.
Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen, described Switzerland’s action as unilateral. He explained, “This suspension may lead to increased tax liabilities for Indian entities operating in Switzerland, highlighting the complexities of navigating international tax treaties in an evolving global landscape.” He emphasized the need for treaty partners to align their interpretations to ensure stability and predictability in international tax frameworks.
Amit Maheshwari, Tax Partner at AKM Global, interpreted Switzerland’s move as an effort to maintain reciprocity. He noted, “The main reason behind the decision to withdraw MFN is of reciprocity, which ensures that taxpayers in both countries are treated equally and fairly.”
Maheshwari elaborated that Switzerland had earlier announced a reduction in the tax rate on dividends from 10% to 5% under the MFN clause, effective retroactively from July 5, 2018. However, the Supreme Court’s 2023 ruling contradicted this approach. “This could impact Swiss investments in India as dividends would be subject to higher withholding now,” he added, pointing out that post-2025, income accruing on dividends will likely be taxed at the higher rates specified in the original DTAA.
Kumarmanglam Vijay, Partner at JSA Advocates & Solicitors, highlighted the potential impact on Indian companies with overseas direct investment (ODI) structures involving Swiss subsidiaries. He explained, “This would especially impact Indian companies having ODI structures with subsidiaries in Switzerland and will raise the Swiss withholding tax on dividends from 5% to 10% from January 1, 2025.”
Looking Ahead
The revocation of India’s MFN status by Switzerland is a significant development in international tax relations. It underscores the challenges of interpreting and applying MFN clauses in the context of global tax treaties. For Indian companies and Swiss investors, the decision introduces new tax liabilities and complicates financial planning.
While the move has drawn criticism for its unilateral nature, it also highlights the need for clearer and more harmonized interpretations of international agreements. For now, the Indian business community and Swiss investors must navigate these changes while governments on both sides explore potential resolutions to avoid further economic disruptions.