Switzerland Suspends MFN Clause in India Tax Treaty

Syllabus:

GS-2:

Government Policies & Interventions

GS-3:

Growth & Development , India and its Neighbourhood , Bilateral Groupings & Agreements , Inclusive Growth

Focus:

Switzerland has suspended the MFN clause in its DTAA with India, resulting in higher taxes on dividend payments from Swiss entities to Indian investors starting January 2025. This change follows a 2023 Indian Supreme Court ruling regarding MFN benefits, potentially impacting bilateral economic ties.

Switzerland Suspends MFN Clause in India Tax Treaty

Switzerland Revokes MFN Clause for India in Tax Treaty

  • Background: Switzerland has suspended the Most Favoured Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India.
  • Impact on Dividend Payments: Starting January 2025, Swiss dividend payments to Indian investors will face a 10% withholding tax, double the current 5%.
  • Reason for Change: Switzerland attributed this move to a 2023 ruling by the Indian Supreme Court regarding the MFN clause, particularly in the case of Nestlé SA.
  • Concerns: The change may lead to an increased tax burden on Indian businesses, potentially discouraging investments between the two countries.

Understanding DTAA and MFN

  • DTAA Purpose: Double Taxation Avoidance Agreements are bilateral treaties designed to prevent double taxation and encourage cross-border investments.
  • India-Switzerland DTAA: India first entered into a DTAA with Switzerland in 1995, amended in 2010. The MFN clause, an important component, ensures that favorable tax rates granted to one treaty partner are extended to others under similar conditions.
  • MFN in Practice: If India signs a treaty with another country offering lower tax rates, those rates automatically apply to Switzerland under the MFN clause.

About the Most Favoured Nation (MFN) : 

  • Definition:
  • The MFN principle mandates that favorable trading terms granted by one WTO member to another must be extended to all other WTO members.
  • Purpose:
  • To promote equality in international trade by preventing discrimination and ensuring all members are treated equally.
  • Importance:
  • MFN is a key priority in the General Agreement on Trade in Services (GATS) under Article 2 and the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) under Article 4.

Legal Precedents Leading to Change

  • Steria India Pvt. Ltd. Case (2014): The MFN clause gained prominence when Steria India sought to apply the India-UK DTAA’s provisions to payments made to its French parent company, arguing for more lenient tax rates under the MFN clause.
  • Nestlé Case (2021): Nestlé SA challenged the Indian tax department’s 10% withholding tax rate, arguing it should be 5% as per the India-Switzerland DTAA. The Delhi High Court ruled in Nestlé’s favor in June 2021.
  • Supreme Court Ruling (October 2023): The Indian Supreme Court overturned the Delhi High Court’s decision, stating that MFN benefits require explicit notification under Indian law. The Court also clarified that MFN benefits apply only if the third country was an OECD member at the time the treaty was signed, which excluded newer OECD members like Lithuania and Colombia.

Implications for India-Switzerland Trade and Investments

  • Higher Tax Burden on Indian Firms: Indian companies will face a higher withholding tax of 10% on dividends and other incomes from Switzerland, starting January 2025, which could reduce competitiveness.
  • Sectors Affected: The financial services, IT, and pharmaceuticals sectors are likely to be most impacted. Companies like TCS, Infosys, Wipro, and Dr. Reddy’s, with significant investments in Switzerland, will be affected.
  • Swiss Investments in India: Over 330 Swiss companies, including Nestlé, ABB, Novartis, Roche, URS, and Credit Suisse, operate in India across various sectors. Swiss Foreign Direct Investment (FDI) in India has reached $10.72 billion, with Swiss investment stocks totaling $35 billion in 2021.
  • Trade Deficit Impact: In 2023-24, India had a trade deficit of $19.72 billion with Switzerland, with imports totaling $21.24 billion and exports amounting to $1.52 billion.

Legal and Diplomatic Options for India

  • Review Petition: Experts suggest that India could file a review petition, seeking to revisit the Supreme Court’s decision in the Nestlé case.
  • Broader Strategic Considerations: The government may need to decide whether to accept the Supreme Court’s ruling or take action to ratify bilateral and multilateral agreements in Parliament to avoid future disputes over the MFN clause.
  • Engaging Partner Countries: India may also need to engage diplomatically with its treaty partners to align their positions and ensure smooth future treaty implementations.

Challenges:

  • Increased Tax Burden on Indian Companies:
    • Indian businesses will face a higher withholding tax of 10% on dividends and other incomes from Switzerland, starting January 2025, compared to the current 5%. This could increase operational costs for Indian firms.
  • Competitive Disadvantage:
    • Indian companies will be at a disadvantage compared to firms from other countries still benefiting from the MFN clause, potentially discouraging future investments between India and Switzerland.
  • Impact on Key Sectors:
    • Sectors like financial services, IT, and pharmaceuticals, where Indian firms like TCS, Infosys, Wipro, and Dr. Reddy’s have significant investments, will be most affected by the increased tax rates.
  • Deterioration of Trade Relations:
    • The tax changes could strain the India-Switzerland trade relationship, especially considering the existing trade deficit, and may lead to reduced investments from Swiss companies.
  • Legal and Procedural Hurdles:
    • The Indian Supreme Court’s 2023 ruling adds a layer of legal complexity, requiring explicit notification of MFN benefits under Indian law, which complicates future treaty implementations.

Way Forward:

  • Filing a Review Petition:
    • The Indian government could consider filing a review petition to challenge the Supreme Court’s decision in the Nestlé case, seeking clarification or revision of the ruling on MFN benefits.
  • Legislative Changes:
    • India could ratify bilateral and multilateral agreements through Parliament to ensure clarity and avoid future legal disputes over MFN clauses in DTAA treaties.
  • Diplomatic Engagement:
    • India should engage diplomatically with Switzerland and other countries to align tax policies and resolve issues arising from the suspension of the MFN clause, ensuring continued mutual economic benefits.
  • Strengthening Bilateral Trade Ties:
    • Both countries should work towards enhancing economic cooperation in other areas such as clean energy, sustainable technologies, and IT services, reducing the impact of the tax dispute on trade.
  • Developing Alternative Investment Strategies:
    • Indian companies could explore diversifying investments into countries with favorable tax policies, reducing reliance on Switzerland and mitigating the impact of higher taxes.

Conclusion:

The suspension of the MFN clause highlights the need for clear treaty notifications and raises concerns about tax burdens on Indian companies. India’s legal and diplomatic response will be crucial to maintain favorable economic relations with Switzerland and safeguard its interests in future tax treaty negotiations.

Source: The Hindu

Mains Practice Question:

Examine the implications of Switzerland suspending the MFN clause in its tax treaty with India. How should India address the legal and economic challenges arising from this decision to ensure continued bilateral cooperation?