Switzerland has announced that it will suspend the most favoured nation (MFN) clause in its double taxation avoidance agreement (DTAA) with India, starting from January 1, 2025. This move will double the withholding tax rate on dividends paid to Indian tax residents to 10 per cent from 5 per cent. The decision follows a landmark ruling by the Supreme Court in 2023, which clarified that the MFN clause does not automatically apply when a country joins the Organisation for Economic Co-operation and Development (OECD), particularly if a prior tax treaty is in place.

       But what is MFN and what does this mean for India?

       What is the MFN clause?

       The MFN clause is a principle found in international treaties, including tax agreements, that ensures equal treatment for all parties involved. If one country offers favourable tax rates or conditions to another, it must extend those same benefits to all other countries covered by the treaty. This clause is designed to guarantee that no country is treated less favourably than any other in trade or taxation matters.

       What was the 2023 Nestle case?

       Swiss company Nestle had sought a refund of withholding tax paid on dividends, claiming the benefit of the MFN clause under the India-Switzerland tax treaty.

       Switzerland initially believed that these lower rates should automatically apply to India as well, under the MFN principle. However, the Supreme Court ruling in 2023 proved otherwise.

       Why has Switzerland suspended the MFN clause?

       The Supreme Court reversed a Delhi High Court judgment that favoured Nestle, stating that the MFN clause could not be automatically applied without formal notification under Section 90 of the Indian Income Tax Act. This clarification led Swiss authorities to reconsider the unilateral reduction of the withholding tax rate.

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       The 2023 Supreme Court ruling in India dealt with the interpretation of the MFN clause in tax treaties. The case involved the application of lower tax rates on dividends from India to countries such as Colombia and Lithuania, which had negotiated new tax terms after joining the OECD.

       However, the Supreme Court ruled that such automatic adjustments require formal notification under Indian law, not just a blanket application.

       As a result, Switzerland decided to suspend the MFN clause, which will increase the dividend withholding tax rate for Indian residents and companies with Swiss investments.

       What impact will this have?

       The suspension of the MFN clause will have several key consequences for businesses and investors:

       Higher tax liabilities for Indian companies: Indian companies receiving dividends from Switzerland will face an increased tax burden, as the withholding tax on those dividends will rise to 10 per cent from 5 per cent.

       Effects on Swiss investments in India: Swiss companies that receive dividends from Indian subsidiaries will continue to face a 10 per cent withholding tax, as this tax rate has always applied under the India-Switzerland DTAA.

       EFTA investments unaffected: Switzerland's decision is also unlikely to impact investments into India from the European Free Trade Association (EFTA), as these investments are already subject to the 10 per cent withholding tax rate.

       No change for other DTAA benefits: Indian companies operating in Switzerland will still be able to avail themselves of the other benefits provided under the India-Switzerland DTAA, such as tax relief on royalties and fees for technical services.

       Reevaluation of MFN clauses by other countries: This move could prompt other nations to reconsider how the MFN clause is applied in their own tax treaties with India, especially if similar legal rulings arise elsewhere.

       Importance of mutual agreement

       This decision highlights the importance of mutual agreement and clarity in interpreting international tax agreements. While the MFN clause aims to ensure fairness and equal treatment, it requires both parties to have a shared understanding of its terms. The suspension reflects a shift towards more cautious and clearly defined interpretations of tax treaty provisions, ensuring that changes to tax rates or conditions are based on mutual consent rather than automatic application.

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