Switzerland Suspends MFN Status to India

Switzerland has decided to revoke its unilateral application of the most-favored-nation (MFN) clause in its Double Tax Avoidance Agreement (DTAA) with India.

Switzerland will revert to the earlier withholding tax rate of 10% on Indian entities starting 1st January 2025.

What are the Key Facts Regarding the MFN Clause in DTAA?

DTAA between India and Switzerland: The 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 withdrawing the MFN status by Switzerland under DTAA.

MFN Clause in Protocol: The MFN clause ensures that India’s lower tax rates 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.

India-Switzerland Investment Scenario

According to the Ministry of Commerce and Industry Switzerland’s investment flows in India amounted to USD 9.95 billion between 2000 and 2023 making it the 12th largest investor in India.

According to the IMF, Switzerland is the 8th largest recipient of Indian FDI stocks, amounting to USD 3.7 billion.

Over 330 Swiss companies, including Nestle, ABB, Novartis, Roche, UBS, and Credit Suisse, have invested in India across sectors like machinery, pharmaceuticals, finance, construction, sustainable technologies, and ICT services.

Nearly 140 Indian companies, including TCS, Infosys, HCL Tech, and Wipro, have investments in about 180 entities in Switzerland, mainly in technology (32%) and life sciences (21%).

Switzerland

Switzerland, officially the Swiss Confederation, is a small mountainous country in Central Europe, known for its Alps mountains, lakes, and valleys.

It is a landlocked country bordered by France, Italy, Austria, Germany, and Liechtenstein.

It has been well-known for centuries for its neutrality.

As a result, Switzerland, particularly Geneva, is a popular headquarters location for international organizations, such as the International Committee of the Red Cross and the United Nations.

It is not a member of the European Union and NATO.

It is also known for its secretive banking sector.

What is a Double Tax Avoidance Agreement (DTAA)?

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.

What is MFN Status?

About: MFN refers to a trade status granted by one country to another, ensuring non-discriminatory trade between them.

It does not mean preferential treatment but guarantees that the recipient country will not face disadvantages compared to other trade partners of the granting country.

MFN and WTO: MFN is a key principle of World Trade Organization (WTO) rules.

Under WTO rules, if a country grants special status to one trade partner, this status must be extended to all WTO members.

Non-Discriminatory Trade: MFN ensures that countries treat each other equally by offering the same trade conditions including:

Lowest possible trade tariffs and trade barriers.
Highest import quotas
Increased market access
Improved conditions for the flow of goods

Exceptions to MFN:

Free Trade Agreements (FTAs): Countries in a FTA offer special concessions to each other, excluding non-members.

Regional Trade Agreements (RTAs): Member countries negotiate better terms among themselves, often excluding non-members.

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.

With reference to the withdrawal of the Most Favored Nation (MFN) status by Switzerland under the Double Tax Avoidance Agreement (DTAA) with India, consider the following statements:

The MFN clause ensures that India extends any lower tax rates agreed with a third-country OECD member automatically to Switzerland.
Switzerland withdrew the MFN status citing the Indian Supreme Court’s ruling that Lithuania and Colombia joining the OECD after 2010 does not trigger the MFN clause.
The new withholding tax rate of 10% will apply retroactively from 2018.

Which of the statements given above are correct?

A) 1 and 2 only

B) 2 and 3 only

C) 1 and 3 only

D) 1, 2, and 3

With reference to the MFN clause in international agreements, consider the following statements:

MFN ensures that a country provides the most favorable trade terms to its partner, better than those given to any other country.
Under WTO rules, MFN is a principle that mandates non-discriminatory trade between member nations.
Free Trade Agreements (FTAs) are exceptions to the MFN principle.

Which of the statements given above are correct?

A) 1 and 2 only

B) 2 and 3 only

C) 1 and 3 only

D) 1, 2, and 3

Which of the following are possible impacts of Switzerland suspending the MFN clause with India?

Increased withholding tax on dividends for Indian businesses in Switzerland.
Negative effects on the Trade and Economic Partnership Agreement (TEPA) between India and EFTA countries.
Higher tax liabilities for Swiss investors in India.

Select the correct answer using the codes given below:

A) 1 and 2 only

B) 1 and 3 only

C) 2 and 3 only

D) 1, 2, and 3

Imagine you are a financial advisor for an Indian business planning to invest in Switzerland after the suspension of the MFN clause under DTAA. Which of the following considerations would most influence your advice?

The withholding tax rate on dividends will increase to 10% starting in 2025.
Switzerland’s investment policies for India remain unaffected by the MFN withdrawal.
The Trade and Economic Partnership Agreement (TEPA) ensures the continuity of favorable trade terms.

Choose the correct set of considerations that would be relevant to your advice:

A) 1 and 2 only

B) 1 and 3 only

C) 2 and 3 only

D) 1, 2, and 3

A great deal of Foreign Direct Investment (FDI) to India comes from Mauritius than from many major and mature economies like the UK and France. Why? (2010)

(a) India has a preference for certain countries as regards receiving FDI

(b) India has a double taxation avoidance agreement with Mauritius

(d) Impending dangers of global climatic change prompt Mauritius to make huge investments in India.