Switzerland has decided to withdraw the Most Favoured Nation (MFN) status granted to India, a move that will have significant tax implications for Indian companies operating in the European nation. This decision comes after an adverse ruling from the Indian Supreme Court regarding a tax dispute involving Nestlé, the Swiss food giant headquartered in Vevey. From January 1, 2025, Indian businesses in Switzerland will face higher withholding tax rates, particularly on dividend income, signalling a shift in the tax landscape for bilateral trade and investments.
The Withdrawal of MFN Status
Switzerland’s federal department of finance (DFF) announced that it would suspend the application of the MFN clause in the tax treaty between Switzerland and India, specifically within the context of the Double Taxation Avoidance Agreement (DTAA). The decision follows the Supreme Court’s October 2023 ruling, which effectively reversed a previous interpretation that allowed Indian entities to benefit from lower tax rates based on subsequent tax treaties between Switzerland and other nations.
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This ruling has led Switzerland to withdraw its unilateral application of the MFN clause. As a result, from January 2025, income generated by Indian entities in Switzerland will be subject to a higher withholding tax rate, specifically a 10% tax on dividends. Previously, the MFN clause allowed India to benefit from lower tax rates applied to dividends by Switzerland, particularly as a result of changes to tax treaties with countries like Colombia and Lithuania.
The Legal Backdrop
The controversy dates back to a case involving Nestlé, where Indian courts were asked to interpret the provisions of the double taxation agreement between the two countries. Initially, the Delhi High Court ruled in favour of extending the benefits of Switzerland’s subsequent treaties with other countries to India through the MFN clause. However, the Supreme Court overruled this decision in October 2023, stating that the benefit of lower tax rates in the Swiss-India treaty could not be automatically extended without a separate notification by India under the Indian Income Tax Act, specifically Section 90.
This legal interpretation has significant implications for the application of tax treaties. The Supreme Court emphasized that any changes to tax rates stemming from international agreements could not be retroactively applied unless explicitly stated by the Indian authorities. Switzerland, acknowledging this interpretation, decided to withdraw the MFN status, thus ending the preferential tax treatment Indian companies had previously enjoyed.
Impact on Indian Businesses
From January 2025, Indian companies with operations in Switzerland will face higher taxes on income generated in the European country, especially in relation to dividends. The 10% withholding tax on dividends is a direct consequence of the withdrawal of the MFN clause. This change is expected to affect a wide range of Indian businesses that have significant dealings in Switzerland, including those in the financial, manufacturing, and technology sectors.
In the context of the India-Switzerland Double Taxation Avoidance Agreement, the MFN clause was a key provision that allowed India to benefit from more favourable tax terms, particularly when Switzerland updated its treaties with other countries. The Swiss decision to withdraw this provision, while legally justified, will result in higher tax liabilities for Indian entities and could affect their investment strategies in the region.
Broader Economic and Trade Relations
This tax change comes amid growing economic ties between India and European nations. In 2023, India and the European Free Trade Association (EFTA) – which includes Switzerland, Norway, Iceland, and Liechtenstein – concluded a new Trade and Economic Partnership Agreement (TEPA). This agreement aims to promote trade and investment between India and EFTA nations, focusing on goods, services, intellectual property, and investment cooperation.
While the MFN withdrawal may create short-term challenges for Indian businesses, it should not overshadow the broader potential of the TEPA. Under this agreement, India stands to gain enhanced market access and foreign investments, which could offset the higher taxes imposed by Switzerland. Furthermore, India is also negotiating a separate free trade agreement with the European Union, which could provide additional avenues for economic growth.
The Path Forward
As Switzerland moves forward with the implementation of its new tax stance, it will be important for Indian companies to reassess their tax planning strategies. The removal of the MFN clause may encourage businesses to explore other investment routes or revise existing agreements with Swiss counterparts to mitigate the impact of the higher withholding tax.
For the Swiss authorities, the decision to withdraw the MFN status is a necessary adjustment to align their tax treaties with the latest interpretations of international law. While the change may be unpopular with some Indian businesses, it underscores the complexities involved in international tax agreements and the importance of clear communication between treaty partners.