Switzerland revokes India’s MFN status

Switzerland will suspend the Most Favoured Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India from January 1, 2025.This will increase the tax rate on dividends paid to Indian taxpayers from 5% to 10%.

Key Facts Regarding MFN Clause in DTAA

• DTAA between India and Switzerland: DTC IN-CH (India-Switzerland Direct Tax Convention) was signed on 2nd November 1994, to avoid double taxation on income between India and Switzerland. It was revised in 2000 and 2010.Article 11 of the 2010 protocol contains the MFN clause, which forms the basis for withdrawal of the MFN status by Switzerland under DTAA.
• MFN Clause in Protocol: The MFN clause ensures that lower tax rates offered by India to any third-country Organisation for Economic Cooperation and Development (OECD) member automatically apply to Switzerland as agreed upon after the 2010 protocol.The MFN clause aimed to maintain parity in taxation rates.
• Reason for Switzerland’s MFN Withdrawal: After the 2010 protocol, India signed DTAA with two OECD members i.e., Lithuania (5% tax rate on dividends) and Colombia (5% general tax rate on dividends).However, the same concessional tax rate was not extended to Switzerland.Following the Indian Supreme Court’s ruling in 2023, Switzerland acknowledged the lack of reciprocity in its MFN clause interpretation and decided to revert to the earlier 10% withholding tax rate starting 1st January 2025.
• India’s Response: India claimed that the MFN clause does not apply automatically unless officially notified under Section 90 of the Income Tax Act, 1961.It further argued that the clause applies only to countries that were OECD members at the time of signing the 2010 protocol.In October 2023, India’s Supreme Court ruled that Lithuania and Colombia joining the OECD after 2010 does not trigger the MFN clause, so India need not lower its dividend tax rates to 5%.Lithuania and Colombia joined the OECD in 2018 and 2020 respectively.
• Future Taxation under DTAA: From 1st January 2025, the withholding tax rate will be 10% as the MFN clause no longer applies. 5% tax rate valid for the period 2018-2024.
• Impact on Investments and Trade: Switzerland clarified that this decision will not affect the free trade agreement between India and Switzerland or Swiss investments in India.India and EFTA have signed the Trade and Economic Partnership Agreement (TEPA) in 2024 under which India will receive USD 100 billion as foreign direct investment (FDI) in 15 years.EFTA (European Free Trade Association) consists of Iceland, Switzerland, Norway, and Liechtenstein.

What can be the Impact of Suspension of MFN Status with India

• Increased Tax Liabilities: Indian businesses operating in Switzerland may face higher tax liabilities as withholding tax on dividends from Switzerland will rise to 10% from 5%.Withholding Tax (retention tax) is an obligation on the individual (either resident or non-resident) to withhold or deduct tax when making payments e.g., in the form of dividends, interest, and royalties.
• Cross-Border Tax Disputes: The suspension could lead to disputes between India and Switzerland regarding the interpretation of the treaty provisions.
• Protectionism in Taxation: Switzerland’s move reflects a broader trend of countries, including India, adopting stricter tax treaty interpretations to protect domestic revenues. This decision could be seen as part of a global shift where countries are adopting more protectionist policies to safeguard their tax bases.
• Evolving International Tax Norms: The decision may push other countries to follow uniformity in tax treaty negotiations, ensuring that all parties align on essential clauses like MFN.

Double Tax Avoidance Agreement

• DTAA is a bilateral or multilateral agreement between two or more countries aimed at avoiding double taxation of the same income.
• It ensures that income is not taxed by both the country of residence and the country of source.

Objectives of DTAA

• Double Taxation Avoidance: Prevents paying taxes twice on the same income.
• Fiscal Evasion Prevention: Enables information sharing to combat tax evasion.
• International Trade Encouragement: Promotes cross-border business with clear tax rules and reduced liabilities.

Mechanisms of DTAA

• Residency and Source-based Taxation: DTAA defines tax rights for both residence and source countries.
• Credit Method: Tax paid in the source country is credited in the residence country.
• Exemption Method: Income is taxed in one country and may be exempt in the other.
• India’s DTAA: India has one of the largest networks of DTAAs consisting of over 94 comprehensive DTAAs and eight limited DTAAs.