Switzerland Withdraws ‘Most Favoured Nation’ Status for India

Context: Switzerland has announced the suspension of the Most Favoured Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India, effective January 1, 2025.

What is the Most Favoured Nation (MFN) Clause?

• MFN Principle: The MFN clause is a principle in international treaties, including tax agreements, ensuring equal treatment for all parties involved.
• Equal Treatment: If a country offers favorable tax rates or conditions to one partner, it must extend those same benefits to all other treaty partners.
• No Favoritism: The clause ensures no country is treated less favorably than others in matters of trade or taxation.
• WTO MFN Application: MFN is a core principle under:
  • WTO’s General Agreement on Tariffs and Trade (GATT),
  • General Agreement on Trade in Services (GATS, Article 2), and
  • Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).

Exceptions to MFN:

1. Free Trade Agreements (FTA): Countries can form FTAs that apply preferential treatment to member nations, excluding others.
2. Special Access for Developing Countries: Developed nations may allow special market access for developing countries.
3. Unfair Trade Measures: Barriers can be raised against products perceived to be traded unfairly.
4. Limited Discrimination in Services: Under strict conditions, discrimination in services is permitted.

India-Switzerland MFN Clause

• Switzerland granted MFN status to India under its DTAA, signed in 1995 and amended in 2011.

What is Withholding Tax (WHT)?

• Definition: WHT (also called retention tax) is the tax deducted at the source by a payer (resident or non-resident) when making specified payments, such as rent, commission, or salary.
• Income Tax Act, 1961: The applicable WHT rate is determined under the Income Tax Act or the DTAA, whichever is lower.
• Non-Resident Taxation: Non-residents are taxed on Indian-sourced income, including:
  • Interest, royalties, and fees for technical services paid by residents,
  • Salaries for services rendered in India, and
  • Income arising from a business connection or property in India.
• WHT Rate: Tax is withheld at 10% of the value of benefits or perquisites arising from business or professional activities.

Why has Switzerland Suspended the MFN Clause?

1. 2023 Nestlé Case:

   • Swiss company Nestlé sought a refund on withholding tax paid on dividends, citing the MFN clause under the India-Switzerland DTAA.
   • The issue arose due to lower tax rates granted to countries like Colombia and Lithuania after they joined the OECD.

2. OECD Provisions:

   • Switzerland argued that the lower rates applied to India automatically under the MFN principle.

3. Supreme Court Judgment:

   • The Indian Supreme Court ruled that such adjustments require formal notification under Indian law and cannot be applied automatically.

4. Switzerland’s Response:

   • Following the ruling, Switzerland decided to suspend the MFN clause in its tax treaty with India.

Impacts of MFN Suspension

1. Higher Tax Liabilities for Indian Companies:

   • Indian companies receiving dividends from Switzerland will face increased tax rates, rising from 5% to 10%.

2. Impact on Swiss Investments in India:

   • Swiss companies receiving dividends from Indian subsidiaries will continue to face a 10% withholding tax, which aligns with the existing India-Switzerland DTAA.

3. No Impact on EFTA Investments:

   • Investments from the European Free Trade Association (EFTA) remain unaffected, as the 10% withholding tax rate already applies.

4. Other DTAA Benefits Remain:

   • Indian companies operating in Switzerland can continue to claim benefits such as tax relief on royalties and technical service fees.

5. Potential Re-Evaluation of MFN Clauses:

   • Other countries may reconsider the MFN clause in their tax treaties with India, particularly if similar legal rulings occur elsewhere.

What Lies Ahead?

• Aligning Treaty Partners: Ensuring clarity, predictability, and stability in the interpretation and application of tax treaties is critical.
• Proactive Negotiations: India must engage in discussions with treaty partners to harmonize interpretations and safeguard Indian firms’ interests abroad.