Switzerland Pulls MFN Status: What Does It Mean?
New Delhi: The Swiss government suspended India’s “Most Favoured Nation” status earlier this week, which would have significant trade implications for both countries. The suspension of the MFN clause from the Double Taxation Avoidance Agreement (DTAA) will likely impact Swiss investment in India and increase the tax burden of Indian companies operating there.
When And Why This Tax Treaty Was Signed
This tax treaty was signed on November 2, 1994 to eliminate the risk of double taxation in trade between the two nations. A key component of the agreement included that if either India or Switzerland grants a lower tax to a country which is part of the Organisation for Economic Cooperation and Development (OECD), the same benefit will be made available to both India and Switzerland. To help it understand better, if India agrees to a 5%tax with another OECD nation, Switzerland would also benefit from the same rate.
Notably, the agreement was amended twice, first in 2000 and then in 2010, with the latter amendment including an MFN clause.
What Started The Disagreements?
The interpretation of the MFN clause is at the centre of the disagreements between India and Switzerland. The Swiss government is of the view that the MFN clause should be applicable to all countries that joined the OECD after 1994. However, India feels the MFN clause applies only to countries that were OECD members in 1994. India further argues that whenever there is an addition of a new country to the OECD, it requires an explicit notification under Section 90 of India’s Income Tax Act to make them eligible for the benefits of the MFN clause.
The matter took a sharp turn when the Swizz government unilaterally slashed the tax rate on dividends for Indian companies from 10% to 5%, citing India’s treaties with Lithuania and Colombia, which offered lower tax rates on specific income types compared to those provided to OECD countries. Notably, Lithuania and Colombia joined the OECD in 2018 and 2020, respectively.
India’s Supreme Court Ruling Limits MFN Clause, Hits Nestle and Swiss Firms
Nestle, the Swiss multinational headquartered in Vevey, became the focal point of a tax dispute when it contested India’s interpretation of the Most Favoured Nation (MFN) clause. In 2021, the Delhi High Court ruled in Nestle’s favour, granting a reduced 5% tax rate on dividends under the Double Taxation Avoidance Agreement (DTAA), referencing treaties India signed with Lithuania and Colombia.
India’s tax authorities appealed the ruling, leading to a landmark Supreme Court verdict on October 19, 2023. The apex court rejected the automatic application of the MFN clause to countries joining the OECD after 1994 without explicit notification.
By limiting the MFN clause to OECD members as of 1994, the Supreme Court excluded Lithuania and Colombia, reversing the earlier ruling. This decision marks a significant setback for Nestle and other Swiss firms operating in India.
Switzerland Cancels India’s MFN Status
The SC ruling came as a major blow to the Swiss firms operating in India, prompting their government to cancel India’s MFN status. The Swiss government cited a lack of reciprocity from India.
Starting January 1, 2025, Swiss and Indian companies will no longer enjoy the reduced 5% tax rate on dividends, the Swiss finance department announced on December 11. The tax rate will revert to the original 10%, increasing the tax burden on cross-border investments. This change could impact Swiss investments in India and result in higher taxes for Indian companies operating in Switzerland.
It would increase the tax burden on India’s IT, pharmaceuticals and financial services and could hamper their competitiveness.
Will It Impact The Trade Relations Between India And Switzerland Further?
The timing is a bit of a concern as the Swiss parliament is expected to ratify the Trade and Economic Partnership Agreement (TEPA) early next year. In March, India finalised the Trade and Economic Partnership Agreement (TEPA) with the European Free Trade Association (EFTA) member states, which include Norway, Switzerland, Iceland, and Liechtenstein.
Under the landmark trade agreement, the four European countries plan to invest $100 billion in India over the next 15 years, creating one million direct jobs in the country. While the Double Taxation Avoidance Agreement (DTAA) and the Trade and Economic Partnership Agreement (TEPA) are separate frameworks, the timing of Switzerland’s announcement raises concerns about its potential impact on foreign investor confidence regarding India’s adherence to DTAA commitments.