Why has Switzerland suspended 'Most-Favoured Nation' status to India?

In a move set to have far-reaching impact on Indian companies operating in Switzerland and Swiss investments in India, Switzerland has announced it will suspend the Most-Favoured Nation (MFN) status with India, effective January 1, 2025.

This unilateral action from the European country stems from a double taxation avoidance agreement (DTAA) between the two countries.

On December 11, the Swiss finance department issued an official statement, pointing to a 2023 ruling by the Supreme Court of India in the Nestle case as the reason for this significant decision.

But what exactly does the Most-Favoured Nation status mean? Why has Switzerland decided to revoke it? And how will this impact Indian businesses? Let’s take a closer look.

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What is the MFN status between India and Switzerland?

The Most-Favoured Nation (MFN) status is a term commonly used in international trade agreements to ensure that a country extends the best possible treatment or tariff rates to one nation, which it offers to others under similar circumstances.

In tax treaties, such as the Double Taxation Avoidance Agreement (DTAA) between India and Switzerland, the MFN clause ensures that the lower tax rates applied to residents of other OECD countries are extended to the treaty partner as well.

The OECD, or Organisation for Economic Co-operation and Development, was established in 1961 in Paris. It serves as a forum and knowledge hub for data, analysis, and best practices in public policy, aiming to build stronger, fairer, and cleaner societies- helping to shape better policies for better lives.

The OECD collaborates closely with policymakers, stakeholders, and citizens to create evidence-based international standards and address social, economic, and environmental challenges.

India and Switzerland initially signed the DTAA in 1994, with amendments made in 2010.

Also read: $100 bn trade deal sees Swiss firm turn businesses to India long geared towards China

Background

India had previously signed tax agreements with Lithuania and Colombia, which set lower tax rates on certain types of income compared to those offered to OECD countries. Both of these countries later became members of the OECD.

In 2021, Switzerland interpreted that the accession of Colombia and Lithuania to the OECD meant that a 5 per cent tax rate on dividends would apply to the India-Switzerland tax treaty under the MFN clause, instead of the 10 per cent rate specified in the agreement.

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However, a Supreme Court ruling during a long-standing case between AO v. Nestle SA over the interpretation of the MFN status ultimately resulted in a decision that went against Switzerland’s expectations.

What was the Supreme Court’s ruling?

According to the statement by Switzerland’s finance department, in 2021, the Delhi High Court while hearing the case against Nestle, upheld the applicability of the residual tax rates after taking into account the MFN clause under the double tax avoidance treaty.

This was in line with how Switzerland had interpreted it and ensured that companies and individuals were not subject to double taxation while working in or for foreign entities.

However, the Indian Supreme Court, in a decision dated October 19, 2023, reversed the lower court’s decision and concluded that the MFN clause between two nations does not automatically apply when a country joins the OECD. It added that the prior tax treaty takes precedence in such cases unless the MFN clause is specifically mentioned in a ’notification’ in accordance with Section 90 of the Income Tax Act.

Switzerland opposes SC ruling, revokes MFN status

Switzerland has responded to the situation by unilaterally revoking India’s MFN status, explicitly citing the “Indian Supreme Court” as the reason for its decision.

This means that starting January 1, 2025, Switzerland will impose a 10 per cent tax (up from the current 5 per cent) on dividends payable to Indian tax residents and entities seeking refunds for Swiss withholding tax. The same will apply to Swiss tax residents claiming foreign tax credits.

In an official statement, the Swiss Finance Department cited the “2023 ruling by the Indian Supreme Court” and announced the “Suspension of the application of the MFN clause of the protocol to the agreement between the Swiss Confederation and the Republic of India for the avoidance of double taxation with respect to taxes on income.”

How will it impact businesses?

Switzerland’s decision to revoke India’s MFN status is viewed by experts as a retaliatory step following the Supreme Court ruling, while others interpret it as a measure of reciprocity.

Nangia Andersen M&A Tax Partner, Sandeep Jhunjhunwala, described the unilateral suspension of the MFN clause as a significant shift in bilateral treaty dynamics.

“This suspension may lead to increased tax liabilities for Indian entities operating in Switzerland, highlighting the complexities of navigating international tax treaties in an evolving global landscape," he told PTI.

He further emphasised the importance of treaty partners aligning on the interpretation and application of tax clauses to ensure “predictability, equity, and stability in the international tax framework.”

AKM Global Tax Partner, Amit Maheshwari, pointed out that reciprocity is the primary reason for Switzerland’s decision.

“Swiss authorities announced in August 2021 that based on the MFN clause between Switzerland and India, the tax rate on dividends from qualifying shareholdings would be reduced from 10 per cent to 5 per cent, effective retroactively from July 5, 2018. However, the subsequent Supreme Court ruling in 2023 contradicted this,” Maheshwari told PTI.

He added that this change could impact Swiss investments in India, as dividends will now face higher withholding tax rates. From January 1, 2025, income earned may be taxed at rates outlined in the original double taxation treaty, regardless of the MFN clause.

JSA Advocates & Solicitors Partner, Kumarmanglam Vijay, highlighted that this would particularly affect Indian companies with overseas direct investment (ODI) structures involving subsidiaries in Switzerland. The Swiss withholding tax on dividends will increase from 5 per cent to 10 per cent starting January 1, 2025.

With input from agencies