Context: Switzerland will suspend the Most Favoured Nation (MFN) clause in its double taxation avoidance agreement (DTAA) with India starting January 1, 2025.

• This will double the withholding tax rate on dividends paid to Indian tax residents from 5% to 10%.

Background

• The decision is followed by Supreme Court ruling in 2023, determining that MFN clause isn't automatically triggered when a country joins OECD if Indian government signed a tax treaty with that country before it joined the organisation. 

• SC said that DTAA cannot be enforced unless it is notified under Income-Tax Act, 1961.

• India-Switzerland DTAA was entered into force in 1994 for the avoidance of double taxation with respect to taxes on income. 

About DTAA

• A Double Taxation Avoidance Agreement (DTAA) is a treaty signed between two or more countries to prevent income earned in one country from being taxed twice. 

• It aims to provide relief to taxpayers, ensure tax fairness, and foster international trade and investment.

Most Favoured Nation (MFN)

• Definition: MFN principle requires that any favourable trading terms granted by one WTO member to another must be extended to all other WTO members.

• Purpose: Promote equality in international trade by preventing discrimination and ensuring that all members are treated equally.

• MFN is a priority in General Agreement on Trade in Services (GATS) (Article 2) and Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) (Article 4).

What is the MFN Clause?

• The MFN clause ensures equal treatment in international treaties, requiring countries to extend favorable tax rates or conditions to all other parties under the treaty.

• It guarantees that no country is treated less favorably than any other in trade or taxation matters.

The 2023 Nestlé Case:

• Swiss company Nestlé sought a refund on withholding tax, claiming the benefit of the MFN clause under the India-Switzerland tax treaty.

• The Supreme Court ruled in 2023 that the MFN clause does not automatically apply without formal notification, which led to Switzerland re-evaluating its tax treaty with India.

Why Switzerland Suspended the MFN Clause

• The Supreme Court ruling clarified that automatic adjustments in tax rates under the MFN clause require formal notification under Section 90 of the Indian Income Tax Act.

• Switzerland suspended the MFN clause after this clarification, impacting the withholding tax rate.

Impact of the Suspension

• Higher Tax Liabilities for Indian Companies: Indian companies receiving dividends from Switzerland will face a higher withholding tax of 10% instead of 5%.

• Swiss Investments in India: Swiss companies will continue to face the 10% withholding tax on dividends received from Indian subsidiaries.

• EFTA Investments Unaffected: Investments from the European Free Trade Association (EFTA) will not be impacted, as they are already subject to the 10% tax rate.

• No Change for Other DTAA Benefits: Indian companies operating in Switzerland can still benefit from other provisions in the DTAA, such as tax relief on royalties and technical service fees.

• Reevaluation of MFN Clauses by Other Countries: Switzerland’s decision may prompt other countries to reconsider how the MFN clause is applied in their tax treaties with India, especially after similar legal rulings.

Road Ahead

• The decision highlights the need for clear mutual agreement in interpreting international tax agreements.

• The suspension reflects a shift towards careful and clearly defined interpretations of tax treaty provisions.

• India’s double taxation treaty with Switzerland may need renegotiation due to its trade pact with the European Free Trade Association (EFTA) member states.