The Swiss government’s decision to suspend the most favoured nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India is poised to have a significant impact on both Swiss investments in India and the tax obligations of Indian companies operating in Switzerland. This move, effective from January 1, 2025, follows a landmark decision by the Indian Supreme Court in October 2023, which clarified the interpretation and application of the MFN clause. The suspension of the MFN clause comes after the ruling that the clause should not automatically apply when a country joins the Organisation for Economic Co-operation and Development (OECD), particularly if India had signed a tax treaty with the country prior to its OECD membership.
The MFN clause in the tax treaty between India and Switzerland was initially designed to ensure that Indian entities would benefit from any more favorable tax terms that Switzerland might grant to other countries. However, after India signed tax treaties with Colombia and Lithuania that provided lower tax rates on certain types of income, Switzerland interpreted that the MFN clause would apply retroactively, lowering the dividend tax rate from 10% to 5% on Indian entities receiving dividends from Switzerland. This interpretation was based on the assumption that Switzerland’s tax treaty with India would mirror any favorable tax terms extended to other countries under the MFN clause.
But after the Indian Supreme Court ruling in 2023, which reversed the Delhi High Court’s decision and clarified that the MFN clause would not automatically apply to countries that later joined the OECD, Switzerland decided to suspend the MFN status, thus reinstating the original 10% tax rate on dividends paid to Indian tax residents. This change in the tax treatment could lead to higher tax liabilities for Indian companies with Swiss subsidiaries or operations, as they will no longer benefit from the reduced dividend tax rate.
The suspension of the MFN clause is seen as a significant shift in the bilateral tax treaty dynamics between India and Switzerland, as it highlights the complexities of interpreting and applying tax clauses in the context of changing international tax laws and court rulings. According to tax experts, the move could lead to increased tax burdens for Indian entities operating in Switzerland, especially for those engaged in activities involving the repatriation of dividends. Additionally, Swiss investors may now be discouraged from investing in India, as they would face higher withholding taxes on dividends.
Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen, commented that this unilateral suspension of the MFN clause underscores the need for clear alignment between treaty partners when it comes to the interpretation of tax treaty clauses. The suspension could also affect businesses operating in both countries, particularly those involved in cross-border transactions or those relying on tax incentives under the MFN clause to reduce tax costs. He further noted that navigating the evolving global tax landscape would require businesses to adjust their strategies to account for these changes.
Amit Maheshwari, Tax Partner at AKM Global, explained that the reason behind Switzerland’s decision to withdraw the MFN clause is grounded in reciprocity, ensuring that taxpayers in both countries are treated fairly and equitably. He pointed out that the 2021 decision by Switzerland to retroactively apply the MFN clause and reduce the dividend tax rate to 5% was initially based on the assumption that India would continue applying the lower tax rates after countries like Colombia and Lithuania joined the OECD. However, the reversal of this assumption by the Indian Supreme Court led to Switzerland’s suspension of the MFN clause.
The potential impact of this decision is particularly significant for Indian companies with overseas direct investment (ODI) structures, especially those with subsidiaries in Switzerland. These companies could face higher withholding taxes on dividends, as the tax rate would revert to 10%, up from the 5% rate previously applied under the MFN clause. This could result in a higher tax burden on profits repatriated from Switzerland, affecting the profitability of Indian entities operating there.
Kumarmanglam Vijay, Partner at JSA Advocates & Solicitors, further emphasized that this change could complicate tax planning for Indian businesses that rely on tax treaties with countries like Switzerland. Companies involved in cross-border trade, investments, or holding structures may now need to adjust their tax strategies to account for the higher withholding taxes on dividends. This could lead to a more complex tax environment for Indian firms with international operations, requiring them to reassess their investment strategies in Switzerland.
As the suspension of the MFN clause takes effect in 2025, Indian companies and Swiss investors will need to navigate the new tax regime carefully. The changes to the tax treaty may have broader implications for future investments and business operations between the two countries, as well as for the broader international tax landscape. With tax rates and withholding obligations now set to revert to the terms originally outlined in the India-Switzerland tax treaty, businesses will need to adjust their strategies accordingly. This development is a reminder of the complexities and uncertainties that businesses face in the context of international taxation, and the need for continued dialogue between treaty partners to ensure stability, equity, and predictability in tax rules.
