The Aakhya Weekly #127 | A Taxing Diplomacy: Switzerland’s New Stance on MFN

Dec 20, 2024

In Focus: Switzerland's Withdrawal of India’s MFN Status

by Diksha Bharti

Switzerland, a country renowned for its affable diplomacy and knack for remaining above the fray, has decided to shake things up a bit. Known for its neutrality in global conflicts and ability to navigate complex international waters, Switzerland has now chosen to make a rather bold statement. In an unexpected move, it has withdrawn the Most Favoured Nation (MFN) status from India under its Double Taxation Avoidance Agreement (DTAA). Effective January 1, 2025, the decision comes following an adverse court ruling against Nestlé and other companies and marks a pivotal moment in the evolving landscape of international tax agreements, with profound implications for businesses, investors, and the trade relations between India and Switzerland.

What is MFN Status?

The Most Favourable Nation, or ‘MFN’ status is a principle in international trade that requires a country granting favourable trade conditions to one country to extend the same benefits to all other countries with which it has trade agreements. This ensures non-discriminatory treatment between trading partners and fosters an equitable global trading environment. The MFN principle is embedded in the World Trade Organization (WTO) agreements, including the General Agreement on Tariffs and Trade (GATT) and the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).

In the context of tax treaties, the MFN clause guarantees that if a country offers more favourable tax terms to a third nation, these terms must also be extended to the country with the MFN status. However, the clause is not absolute, and its application can vary depending on the specifics of the treaty and changes in global economic frameworks, such as membership in the OECD.

The Trigger for the MFN Status Suspension

The suspension of the MFN clause by Switzerland comes in the wake of a crucial Supreme Court ruling in India in 2023. The ruling clarified that the MFN clause, as per the DTAA between India and Switzerland, would not be automatically triggered if a country joins the Organisation for Economic Co-operation and Development (OECD), particularly when a prior tax treaty has already been established. In essence, the Supreme Court determined that countries such as Lithuania and Colombia, which joined the OECD after the 2010 protocol was signed, would not benefit from the MFN clause that would extend reduced tax rates on dividend payments.

This judicial interpretation contradicted Switzerland’s expectation that the MFN clause would apply to countries that joined the OECD after the 2010 protocol, thus entitling them to the same tax benefits. Following the ruling, Switzerland acknowledged the misinterpretation of the MFN clause, deciding to suspend the clause and revert to the previous withholding tax rate of 10%. The suspension of the MFN clause will not affect other provisions of the DTAA, such as those related to taxation on interest, royalties, and capital gains.

The DTAA between India and Switzerland

The MFN clause is an integral part of the Double Tax Avoidance Agreement (DTAA) offering additional benefits to businesses and investors by ensuring equitable tax treatment. The DTAA between India and Switzerland, signed in November 1994 was revised in 2000 and 2010 aims to prevent double taxation of income by establishing which country has the taxing rights over various forms of income, including dividends, interest, and royalties. The key provision for investors and businesses is the reduction in withholding tax on cross-border dividend payments. Before the recent changes, Switzerland applied a reduced withholding tax rate of 5% on dividend payments to Indian investors. Looking back in history, India revoked the MFN status to Pakistan in 2019 and even Russia lost its MFN status following the invasion of Ukraine.

Implications of the MFN Suspension

The suspension of the MFN clause has several significant ramifications:

Increased Tax Burden for Indian Companies: With the withholding tax rate on dividends from Switzerland increasing to 10%, Indian companies receiving dividends from Swiss entities will face a higher tax burden. This could affect the profitability of Indian firms with substantial investments in Switzerland.
Continued Tax Stability for Swiss Investments in India: Swiss companies investing in India and receiving dividends from Indian entities will continue to benefit from a 10% withholding tax as stipulated in the India-Switzerland DTAA. Therefore, Swiss investments in India will not be directly impacted by the MFN suspension.
Potential Re-evaluation of MFN Clauses by Other Countries: Switzerland’s move to suspend the MFN status could prompt other countries to reconsider how the MFN clause applies in their respective tax treaties with India. This might lead to changes in the taxation structure for international businesses operating across borders, especially in countries that have recently joined the OECD.
Global Tax Norms and Protectionism: Switzerland’s decision reflects a broader trend towards protectionism in international tax agreements. Many countries, including India, are tightening the interpretation of their tax treaties to safeguard their respective tax revenues. This shift could lead to greater uniformity in tax treaty negotiations globally, ensuring that key clauses like the MFN are more clearly defined.
Impact on Cross-Border Trade and Investments: The change in the tax treatment of dividends could potentially lead to a re-evaluation of investment strategies by both Indian and Swiss companies. However, Switzerland has assured that the broader trade relations, including the Trade and Economic Partnership Agreement (TEPA) signed between India and the European Free Trade Association (EFTA) in 2024, will remain unaffected. This agreement will see Switzerland becoming a key player in India's foreign direct investment (FDI) landscape, contributing to a projected USD 100 billion in FDI over the next 15 years.

India-Switzerland Investment Dynamics

Switzerland has long been one of India’s important trade and investment partners. Between 2000 and 2023, Switzerland invested nearly USD 9.77 billion in India, making it the 12th largest investor. In addition, Swiss investment stocks in India amounted to USD 35 billion by 2021. Prominent Swiss companies, including Nestlé, ABB, Novartis, Roche, and UBS, have invested across sectors like machinery, pharmaceuticals, finance, construction, and ICT services.

On the other hand, India has also made significant investments in Switzerland. Nearly 140 Indian companies, including technology giants TCS, Infosys, HCL Tech, and Wipro, have established a strong presence in Switzerland, primarily in sectors like technology and life sciences. This reciprocal investment flow underscores the mutual benefits derived from the two countries' bilateral economic relationship.

Charting the Path Ahead

Switzerland’s decision to withdraw the MFN status from its DTAA with India is a landmark event that underscores the complex and evolving nature of international taxation. While the immediate impact of the suspension will be felt by Indian companies receiving dividends from Swiss entities, the broader implications could affect the global tax landscape, prompting other countries to reassess the application of MFN clauses in their treaties.

Despite the tax changes, the strong economic ties between India and Switzerland remain intact, with both nations continuing to benefit from substantial investments and trade. The MFN suspension is a reminder of the importance of clear treaty interpretations and the need for countries to adapt their tax policies in response to evolving global norms and legal interpretations.

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