Switzerland Suspends MFN Clause in DTAA with India: Implications for Indian Entities

In a significant development, Switzerland has announced that it will suspend the application of the Most Favoured Nation (MFN) clause under its Double Tax Avoidance Agreement (DTAA) with India. Effective from January 1, 2025, this decision is poised to impact the tax landscape for Indian entities operating in Switzerland, potentially increasing their tax liabilities on dividend income.

Background of the Decision

This decision comes in the wake of a landmark ruling by India’s Supreme Court in October 2023 in a case involving the Swiss multinational, Nestle SA. The court clarified that the MFN clause embedded in the DTAA does not automatically take effect unless it is explicitly notified under India’s Income Tax Act, 1961.

The ruling resolved a long-standing ambiguity over the unilateral application of the MFN clause, which allowed taxpayers to claim benefits from more favorable treaty provisions extended to other countries. The Swiss competent authority, in light of the judgment, acknowledged the divergence in interpretation between India and Switzerland. “On the basis of the Indian Supreme Court ruling, the Swiss competent authority acknowledges that its interpretation of para 5 of the Protocol to the IN-CH DTA is not shared by the Indian side,” read a statement issued by Swiss authorities. “In the absence of reciprocity, it therefore waives its unilateral application with effect from 1 January 2025.”

Implications of the Suspension

1. Increased Tax Outgo for Indian Entities: The suspension of the MFN clause could lead to higher withholding tax rates on dividend income for Indian entities. This change may adversely affect Indian businesses and investors holding stakes in Swiss companies, as they lose access to more favorable tax treatment available under similar treaties with other countries.
2. Uncertainty in Treaty Application: The move highlights the criticality of clear notification processes and mutual agreement in international tax treaties. Businesses need to carefully evaluate the implications of this shift on their cross-border transactions and dividend repatriation strategies.
3. Revised Tax Planning Strategies: Indian entities operating in Switzerland will need to reassess their tax structures and explore alternative measures to optimize tax efficiency. This may involve exploring other treaty jurisdictions or restructuring investments to mitigate additional tax burdens.

Looking Ahead

The suspension of the MFN clause underscores the dynamic nature of international taxation and the importance of judicial clarity in resolving treaty disputes. It also emphasizes the need for proactive engagement between treaty partners to ensure reciprocity and alignment in tax policy.

For Indian businesses, the decision serves as a reminder to stay abreast of evolving tax regulations and rulings. Robust compliance mechanisms and strategic tax planning will be essential to navigate the complexities arising from this development. Additionally, stakeholders may look forward to potential negotiations between India and Switzerland to address the implications of the MFN clause suspension and explore pathways to restore equitable benefits under the DTAA.

As the January 2025 implementation date approaches, it is imperative for affected entities to consult with tax experts and prepare for the changes to safeguard their interests in the evolving tax environment.