In a surprising turn of events, Switzerland has decided to suspend the application of the Most Favoured Nation (MFN) clause in its tax treaty with India. The decision follows an Indian Supreme Court ruling in a case involving the Swiss multinational Nestlé, which significantly altered the interpretation of the MFN clause. This move is set to have widespread implications for Indian entities operating in Switzerland, with higher withholding taxes on dividends coming into effect from January 1, 2025.
Credits: The Tribune
The Nestlé Case: Trigger for the Suspension
The controversy stems from a case initially decided by the Delhi High Court in 2021. At that time, the court ruled in favor of applying residual tax rates under the double taxation avoidance treaty between India and Switzerland, taking into account the MFN clause. The clause allowed for reduced withholding tax rates on dividends, lowering the tax rate to 5% for Indian entities earning income in Switzerland.
However, in 2023, the Indian Supreme Court reversed the Delhi High Court’s decision. It ruled that the MFN clause could not be directly applied unless there was a specific notification under Section 90 of the Income Tax Act. This reversal prompted Switzerland to reassess its position, ultimately leading to the suspension of the MFN clause’s application.
What the Suspension Means
From January 1, 2025, Indian entities earning dividends in Switzerland will face a withholding tax rate of 10%, doubling the current 5% rate. This decision disrupts the bilateral tax dynamics and increases tax liabilities for Indian businesses operating in Switzerland. It may also impact investment flows between the two nations, as higher taxes could dissuade Swiss firms from engaging in Indian markets and vice versa.
Expert Perspectives: Tax and Treaty Dynamics
Tax experts view Switzerland’s move as a significant shift in international tax relations. Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen, called the decision a “marked shift” that highlights the complexities of navigating evolving global tax treaties. He emphasized the importance of ensuring clarity and alignment in interpreting treaty clauses to maintain stability and equity.
Similarly, Amit Maheshwari, Tax Partner at AKM Global, pointed out that Switzerland’s decision revolves around the principle of reciprocity. In 2021, the Swiss authorities announced the retroactive reduction of the withholding tax rate to 5%, effective from July 5, 2018, under the MFN clause. However, the 2023 Supreme Court ruling contradicted this interpretation, leading Switzerland to withdraw the reduced rate.
Maheshwari further noted that the increased tax burden could deter Swiss investments in India, complicating economic ties between the two countries.
Broader Implications for Businesses
The suspension of the MFN clause underscores a broader challenge in international tax frameworks: the lack of uniformity in interpreting treaty provisions. For Indian businesses operating in Switzerland, the higher tax rate will impact their profitability and operational costs. Conversely, Indian tax authorities may face pushback from Swiss firms affected by this shift.
The move also raises concerns about bilateral economic cooperation. Switzerland has traditionally been a significant partner for Indian businesses, offering investment opportunities and a stable financial environment. With higher taxes on dividends, Indian companies might reconsider their presence in Switzerland or explore other markets with more favorable tax conditions.
What Lies Ahead: Aligning on Treaty Interpretations
The suspension serves as a reminder of the need for greater alignment between treaty partners on tax provisions. Discrepancies in interpretation can lead to disruptions in business operations and investments. As global tax policies evolve, countries must prioritize predictability and equity in their agreements to foster long-term partnerships.
Credits: Hindustan Times
Conclusion: A Wake-Up Call for International Tax Cooperation
An important turning point in the economic relationship between India and Switzerland has been reached with Switzerland’s suspension of the MFN provision. Although the ruling immediately affects Indian companies operating in Switzerland, it may also have repercussions for bilateral investment and trade. In an increasingly integrated global economy, the episode emphasizes the significance of mutually agreed upon, unambiguous, and consistent interpretations of tax treaties.
