In a brief setback, Switzerland has suspended India’s Most Favoured Nation (MFN) status under the Double Taxation Avoidance Agreement (DTAA). It will be effective from January 1, 2025. Previously, the status allowed lower withholding tax rates on dividends paid between the two countries, reducing the rate from 10% to 5% for qualifying dividends. The Swiss decision follows the Indian Supreme Court’s 2023 ruling in a case involving Nestlé, which clarified that the MFN clause isn’t automatically enforceable without a formal notification by the Indian government under the Income Tax Act.
Why Did Switzerland Take This Step?
The suspension of the MFN clause happened due to its Double Taxation Avoidance Agreement (DTAA) with India, rather a lack of reciprocity in the application of DTAA. According to Swiss authorities, the Indian Supreme Court’s 2023 decision fundamentally changed the understanding of the MFN clause. The ruling stated that MFN benefits are not automatically applicable and require explicit notification under Indian law, reversing a 2021 Delhi High Court decision.
Previously, the lower court had upheld that tax rates on dividends could be reduced under the MFN clause without additional notifications, enabling Swiss companies to benefit from lower withholding taxes. However, the decision of the Apex Court clarified that India has to explicitly notify them of such benefits. Otherwise, they would not be allowed to apply, which created a legal divergence.
The fact that India’s tax treaties with non-OECD nations, such as Lithuania and Colombia, offered lower dividend tax rates than those accessible to OECD nations further complicated matters. When Colombia and Lithuania later joined the OECD, Switzerland interpreted the MFN clause to mean that the reduced tax rates applicable to these nations should also apply to its treaty with India. However, India disagreed, citing the absence of notification requirements under its Income Tax Act. Switzerland viewed this divergence as an indication of India’s reluctance to apply for MFN benefits equitably, prompting the Swiss government to suspend the clause for dividends accruing on or after January 1, 2025.
Areas of Impact
The suspension of the MFN clause will have wide-ranging implications on several fronts, particularly for businesses and investments between the two nations. These include changes in withholding tax rates, impacts on bilateral trade relations, and challenges for Indian and Swiss companies alike.
Increased Withholding Tax on Dividends
One of the most immediate effects of Switzerland’s decision is the increase in withholding tax on dividends. From January 1, 2025, dividends paid by Swiss entities to Indian tax residents and vice versa will be taxed at a rate of 10% under the original DTAA instead of the reduced 5% rate that was applied earlier under the MFN clause. Indian companies with investments or operations in Switzerland, such as subsidiaries, will have to pay higher tax liabilities. The increase in withholding tax reduces the net income that Indian businesses can derive from their Swiss investments, potentially reducing their profitability and changing financial planning strategies.
Impact on Swiss Investments in India
Switzerland has invested significantly in India; over 330 Swiss companies are operating in India in various sectors such as pharmaceuticals, machinery, electrical goods, and financial services. Many of these Swiss companies include the names Nestlé, ABB, and Roche, among others. This higher withholding tax may reduce India’s attractiveness as an investment destination. Swiss investors may reassess their business strategies or even consider alternative markets with more favourable tax conditions. This shift could also impact India’s broader economic goals of attracting foreign direct investment (FDI) and fostering international business ties.
Indian Companies Operating in Switzerland
This decision will also affect Indian businesses operating in Switzerland. Nearly 140 Indian companies, such as Infosys, TCS, Dr Reddy’s Laboratories, and HCL Technologies, have invested in about 180 companies in Switzerland. The major sectors of these companies are technology (32%) and life sciences (21%), two areas with high dependence on international operations. The suspension of the MFN clause may increase tax burdens for these companies, thereby affecting their financial strategies and potentially leading them to reassess their operational setups. Additionally, Indian companies with ODI structures in Switzerland will face more challenges as the dividend taxes on Swiss subsidiaries will be increased from 5% to 10%.
Greater Bilateral Trade Relationship
The decision further complicates an already sensitive relationship between trade and tax matters between India and Switzerland. The two have strong economic relationships, and Switzerland has invested over $10 billion in India between the year 2000 and 2023. However, this suspension of the MFN clause would deter other business ventures or expansions from taking place. Moreover, it will require greater clarity and mutual understanding about the terms of the tax treaty provisions in order to have stability and predictability in bilateral agreements.
What Lies Ahead for Indian Investors or Businessmen?
Suspending the MFN clause means several challenges and requires a tactical shift for Indian investors and businesses. Here is what awaits them:
Higher Tax Liabilities
Indian businesses operating in Switzerland will have to include the increased withholding tax rates in their financial planning. A higher 10% tax rate on dividends is going to reduce the net income from Indian investors, which will directly affect profitability. Companies will have to adjust the budget, review the tax implications that the earnings will face, and look for possible ways to absorb these additional costs.
Strategic Adjustments
To lessen the effects of the higher tax burden, Indian businesses may search for alternate investment alternatives. This may be accomplished by renegotiating contractual terms with Swiss business partners. Moving investments to other countries with more advantageous tax treaties or restructuring their activities may be the other option. Businesses hoping to successfully navigate these changes will need to use professional consulting services and engage in strategic tax planning.
The Swiss decision may well have implications for other countries to reexamine their MFN clauses with India. More disputes and renegotiations of tax treaties are in the offing, thereby making the international tax landscape more complicated. The Indian companies with global operations would be costlier in terms of legal and compliance expenses.
Focus on Domestic Tax Policy
Indian authorities may have to reconsider their approach towards international tax treaties to achieve greater clarity and reciprocity. It will be important to maintain the strength of diplomatic and economic ties with treaty partners to preserve India’s appeal as an investment destination. Proactive resolution of ambiguities in treaty provisions can help prevent similar disputes in the future and ensure a stable environment for foreign investors.
However, the suspension is possibly going to be renegotiated, understanding its importance. The MEA spokesperson Randhir Jaiswal said in a statement, “My understanding is that with Switzerland, because of EFTA, the double taxation treaty that we have, it’s going to be renegotiated. That is one aspect of it,” MEA spokesperson Randhir Jaiswal said.
