Switzerland has decided to suspend the Most-Favoured-Nation (MFN) clause in the Double Taxation Avoidance Agreement (DTAA) with India, originally signed in 1994 and amended in 2010. This move, announced in a statement by the Swiss government on December 11, could lead to higher taxes on Indian companies operating in Switzerland and potentially affect Swiss investments in India starting January 1, 2025.

The decision follows a ruling by the Indian Supreme Court last year, which stated that the DTAA cannot be applied unless it is formally notified under the Income-Tax Act. As a consequence, Swiss companies like Nestlé now face increased taxes on dividends. This Supreme Court verdict overturned a previous Delhi High Court order that had ensured individuals and companies were protected from double taxation while working for or with foreign entities.

Tax experts have warned that Switzerland's decision could "affect investments" in India, as dividends will now be subject to a "higher withholding tax." This move presents a potential risk to the $100 billion investment pledge made by the four-nation European Free Trade Association (EFTA)-comprising Iceland, Liechtenstein, Norway, and Switzerland-under a trade agreement signed in March this year, which aims to span over a 15-year period.

Understanding the Most-Favoured-Nation (MFN) Clause in International Tax Agreements

The Most-Favoured-Nation (MFN) clause is a principle in international agreements, including tax treaties, that ensures all parties are treated equally. If one country provides favorable tax rates or terms to another, it is obligated to extend the same benefits to all other countries included in the treaty. The purpose of this clause is to ensure that no country is given less favorable treatment than any other in matters of trade or taxation.

2023 Nestlé Case: What happened?

The 2023 Nestlé case involved a legal challenge by Nestlé and other Swiss companies against the Indian tax authorities. The Indian Supreme Court ruled that the Double Taxation Avoidance Agreement (DTAA) between India and Switzerland could not be enforced unless it was notified under the Indian Income-Tax Act. This decision overturned a previous Delhi High Court ruling that had prevented double taxation for companies operating in both countries. As a result, Swiss firms like Nestlé now face higher taxes on dividends in India, leading to the suspension of the Most-Favoured-Nation (MFN) clause in the tax pact between the two nations.

Expert Insights

Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen, stated that Switzerland's decision to suspend the unilateral application of the MFN clause under its tax treaty with India marks a significant change in bilateral treaty dynamics. He explained that this shift, based on the Indian Supreme Court's Nestlé ruling which rejected the automatic application of the MFN clause, reflects a growing focus on reciprocity and mutual agreement in interpreting treaty provisions.

"Effective 1 January 2025, the beginning of the tax year in Switzerland, this suspension may lead to increased tax liabilities for Indian entities operating in Switzerland, highlighting the complexities of navigating international tax treaties in an evolving global landscape. Beyond its immediate fiscal impact, this development reflects broader trends in international taxation, with countries like India increasingly asserting stricter interpretations of treaty provisions to protect domestic tax revenues. It further underscores the necessity of aligning treaty partners on the interpretation and application of tax treaty clauses to ensure predictability, equity, and stability in the international tax framework," Jhunjhunwala added.

How will this impact India?

Higher Tax Burden: The suspension of the MFN clause could lead to higher withholding taxes on dividends for Indian companies operating in Switzerland, impacting their profitability.

Investment Flow: The move may deter Swiss investors, potentially reducing foreign direct investment (FDI) in India, especially in sectors relying on Swiss capital.

Trade Relations: Strained tax agreements may affect India's trade relations with Switzerland and the European Free Trade Association (EFTA) countries.

Investment Commitment Risk: The $100 billion investment commitment by EFTA could be jeopardized, as higher tax rates might make India less attractive for future investments.

DTAA Benefits: Indian companies operating in Switzerland will continue to enjoy other advantages under the India-Switzerland DTAA, including tax relief on royalties and fees for technical services.

Economic Growth: Reduced investments may slow down India's economic growth prospects.