The Swiss government's withdrawal of the most favoured nation (MFN) clause in the Double Taxation Avoidance Agreement (DTAA) with India will raise costs for Indian firms operating in Switzerland, particularly for those in financial services, pharmaceuticals, and IT, according to a brief by the think-tank Global Trade Research Initiative.
These firms will have to pay a 10-percent tax on dividends and other incomes from January 1, 2025, higher than the earlier rate of 5-percent.
"With the reversion to a 10-percent residual rate starting January 1, 2025, these firms face higher tax liabilities, reducing their competitiveness compared to businesses from countries still benefiting from MFN provisions," said GTRI's founder Ajay Srivastava.
Switzerland's decision follows an Indian Supreme Court ruling in the Nestlé case back in October 2023, which clarified India’s interpretation around the MFN clause.
On October 19, 2023, the Indian Supreme Court ruled in the Nestlé case that MFN benefits could not be automatically applied to the India-Switzerland treaty unless explicitly notified under Section 90 of the Indian Income Tax Act.
The top court interpreted that the MFN clause applied only to OECD member countries as of 1994, the year the treaty was signed. This excluded subsequently added OECD members, such as Colombia and Lithuania, from the scope of the MFN clause.
According to GTRI, Switzerland disagreed with this interpretation for two key reasons.
"First, it viewed the MFN clause as automatically applicable, which allowed it to extend reduced tax rates to India based on benefits granted to newer OECD members like Colombia, which joined in 2020. Switzerland had unilaterally reduced the residual tax rate on dividends from 10 percent to 5 percent based on this understanding. Second, Switzerland believed that subsequent OECD members should also qualify for MFN benefits, contrary to India’s position," the GTRI brief added.
Given these differences, Switzerland announced the suspension of the MFN clause, reverting to higher tax rates on dividends and income.
GTRI says that Switzerland’s decision highlights broader issues in India’s approach to MFN clauses in bilateral treaties. The Indian Supreme Court’s judgment sets a precedent that could influence how India handles similar clauses in agreements with other trading partners.
"If disputes over MFN interpretations persist, Indian businesses could face similar challenges in other jurisdictions, potentially deterring outbound investments," the think-tank said.
This is not the first time, India is facing issues around DTAAs.
Indian software firms, faced disputes over the classification of income under the India-Australia Double Taxation Avoidance Agreement.
GTRI explains, Australia often categorises payments for software licenses and services as royalties, making them subject to source taxation, while Indian firms argue that such payments should be treated as business income, taxable only in India unless they maintain a permanent establishment (PE) in Australia.
This mismatch in interpretations leads to potential double taxation and compliance challenges, compounded by Australia's reliance on domestic laws that may override treaty provisions.
"The suspension of the MFN clause by Switzerland and earlier issues with Australia underscore the need for India to adopt a more consistent and strategic approach to international taxation treaties. India must ensure that its treaty frameworks reflect contemporary business realities, particularly in the digital and service sectors, to reduce tax uncertainties and promote global competitiveness," Srivastava added.
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