Switzerland to Suspend MFN Clause for India under DTAA from January 1, 2025

December 17, 2024 Posted by India Briefing Written by Archana Rao Reading Time: 5 minutes

Starting January 1, 2025, Switzerland will suspend the Most Favored Nation (MFN) treatment for India under their 30-year-old Double Taxation Avoidance Agreement (DTAA), a decision that may complicate international taxation strategies for multinational firms.

On December 11, 2024, Switzerland suspended the Most Favored Nation (MFN) clause under the Double Taxation Avoidance Agreement (DTAA) with India. The MFN treatment will cease to apply from next year. Starting January 1, 2025, dividend payments from Swiss entities to Indian investors will be taxed at 10 percent, up from the current 5 percent.

Why Switzerland has suspended India’s MFN status

Switzerland cites a 2023 Indian Supreme Court ruling, involving Nestle SA and others, as the basis for this change. The Court had clarified in its judgment that the benefits under the MFN clause require explicit notification by the Indian government under the Income Tax Act, introducing procedural complexities to treaty implementation.

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Given the Swiss government’s differing interpretation of the DTAA’s Protocol between the two nations, it announced it would suspend unilateral implementation of the MFN clause in the absence of reciprocal acknowledgment.

With this decision, Indian entities operating in Switzerland will pay higher taxes from January 1, 2025, onwards. The MFN clause between India and Switzerland was introduced as part of the Protocol to the DTAA signed between the two countries in 1994.

What’s under contention

The MFN clause in the India-Switzerland DTAA is a provision that ensures equal treatment for both countries in the context of tax benefits. Under this clause, if India or Switzerland enters a DTAA with a third country and grants that country a more favorable tax rate or benefit, the same advantage must automatically be extended to the other partner (in this case, India or Switzerland).

For instance, if Switzerland agreed to a reduced withholding tax rate on dividends, interest, or royalties with another country (say 5 percent), India would automatically be entitled to the same lower rate under the MFN clause.

Concerns about higher tax burden for Indian firms in Switzerland

Tax experts have characterized this as a significant change in bilateral treaty dynamics, warning that it will increase tax liabilities for Indian companies operating in Switzerland and complicate compliance with international tax treaties. According to Ajay Srivastava, Director of the Global Trade Research Initiative (GTRI), Indian businesses previously benefited from a reduced 5 percent tax rate on dividends and other incomes under the MFN clause. However, with the suspension of the MFN provision, the tax rate will revert to 10 percent starting January 2025, adding financial pressure and reducing the competitiveness of Indian firms compared to businesses from countries that still enjoy MFN benefits.

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Analysts highlight that this development aligns with a larger global trend where nations are increasingly adopting stricter interpretations of treaty provisions to safeguard their domestic tax revenues. They also stress the importance of clear and consistent understanding between treaty partners to ensure predictability and stability in international taxation.

Meanwhile, the GRTI director has expressed concerns about the broader repercussions of this suspension, particularly for key sectors like IT, pharmaceuticals, and financial services, where Indian firms have notable operations in Switzerland. He cautioned that unresolved issues around MFN clause interpretations could trigger similar challenges with other trade and investment treaty partners, potentially disrupting both inbound and outbound investment flows.

To protect the interests of Indian businesses, trade analysts emphasize the urgency of proactive negotiations to harmonize treaty interpretations. They also advocate for modernizing India’s tax treaty frameworks to address contemporary business realities, particularly in digital and service sectors, thereby reducing tax-related uncertainties and enhancing global competitiveness.

MFN suspension unlikely to impact US$100 billion EFTA investment commitment

Switzerland’s decision to suspend the unilateral application of the MFN clause with India under the DTAA is not expected to jeopardize the US$100 billion investment commitment outlined in the trade agreement between India and the European Free Trade Association (EFTA) countries, signed earlier in March 2024.

In March 2024, India signed the Trade and Economic Partnership Agreement (TEPA) with the four EFTA member nations—Switzerland, Iceland, Norway, and Liechtenstein. This agreement is expected to facilitate foreign direct investment (FDI) inflows of up to US$100 billion over the next 15 years, which could result in the creation of approximately one million jobs across various sectors in India.

The India-EFTA TEPA also focuses on improving market access, facilitating technology exchange, and promoting investment in sectors like manufacturing, services, and infrastructure, aligning with India’s economic growth ambitions.

Despite concerns surrounding the MFN suspension, India’s Commerce Secretary, Sunil Barthwal, clarified on December 16, 2024, that Switzerland’s move is unlikely to impact the investment targets set under the TEPA. He emphasized that from the EFTA countries’ perspective, including Switzerland, the MFN clause suspension is viewed as a separate issue and does not alter their overall commitment to long-term economic cooperation and investments in India.

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The trade agreement with EFTA is regarded as a milestone in fostering trade relations and boosting India’s economic growth by providing a conducive environment for FDI. While the MFN suspension raises short-term tax considerations, it does not undermine the broader investment goals of the agreement, which are expected to enhance India’s manufacturing capabilities, technology exchange, and job opportunities.

Indian Supreme Court’s stance on the MFN clause in the India-Switzerland DTAA

The Indian Supreme Court’s position on the MFN clause in the India-Switzerland DTAA is centered around its interpretation and application. In October 2023, India’s apex court ruled that the MFN clause does not automatically apply; instead, it requires a formal notification under the Income Tax Act to trigger its implementation.

Key aspects of the Supreme Court’s ruling:

Automatic trigger rejected: The Court clarified that the MFN clause in India’s DTAAs, including the one with Switzerland, does not take effect automatically when India or Switzerland enters into a more favorable tax agreement with a third country. The benefits can only apply after proper notification by the Indian government.
Protocol interpretation: The Indian Supreme Court emphasized that the interpretation of the MFN clause must align with India’s domestic legal framework, which requires formal notification to enforce treaty provisions. This position contrasts with Switzerland’s prior unilateral application of the clause.
Impact on treaty benefits: Prior to the ruling, Indian businesses operating in Switzerland benefited from reduced withholding tax rates (e.g., 5 percent on dividends) under the MFN clause. With the Court’s stance, these benefits cannot be extended unless India issues an official notification. Without this, higher residual tax rates (e.g., 10 percent) will apply.
Treaty implementation dynamics: The ruling highlighted the importance of reciprocity and mutual acknowledgment of treaty interpretations. It underscored that India would not allow automatic implementation of tax benefits granted to other nations without due process.

Background

The MFN clause dispute, which began with the 2014 Steria India Pvt. Ltd. case, gained further attention with Nestle SA’s challenge in 2021 regarding a 10% withholding tax under the India-Switzerland DTAA. The Delhi High Court ruled in favor of Nestle, reducing the tax rate to 5%. However, the Supreme Court overturned this decision in October 2023, ruling that MFN benefits require explicit notification under Indian law. The court also clarified that MFN benefits only apply if the third country was an OECD member when the treaty was signed, excluding countries like Lithuania and Colombia.

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