Will Switzerland’s decision to end India’s MFN status hurt investments?

Switzerland has officially revoked India’s Most Favoured Nation (MFN) status under the Double Taxation Avoidance Agreement (DTAA), marking a significant development in bilateral trade relations. The decision follows a critical ruling by the Supreme Court of India in 2023 that redefined how MFN clauses are applied under Indian tax law. This move will reshape tax obligations for Indian companies operating in Switzerland and could affect Swiss investments in India.

Why Did Switzerland Revoke India’s MFN Status?

The decision stems from a dispute over the interpretation of the MFN clause in the DTAA between India and Switzerland. The MFN clause, often seen as a cornerstone of international tax treaties, guarantees that treaty partners receive the same favourable tax treatment extended to other countries.

Switzerland believed the MFN clause entitled it to reduced tax rates on dividends, similar to those India had agreed upon with Lithuania and Colombia—both of which later joined the Organisation for Economic Co-operation and Development (OECD). The Swiss government anticipated that these reduced rates would automatically apply under the India-Switzerland tax treaty.

However, the Supreme Court ruling clarified that the MFN clause does not activate automatically when a country joins the OECD. Instead, a formal notification under Section 90 of the Income Tax Act is required for any adjustments. This interpretation invalidated Switzerland’s expectation of a 5% dividend tax rate, reinstating the original 10% rate.

What Triggered the Supreme Court Ruling?

The dispute can be traced back to Nestlé’s case in India. In 2021, the Delhi High Court ruled in favour of applying the reduced tax rates based on the MFN clause. Switzerland viewed this ruling as validation of its stance.

However, in October 2023, the Supreme Court reversed the High Court’s judgment. It stated that India’s DTAA obligations are governed by domestic tax laws, which require a notification for the MFN clause to apply. This ruling not only affected Nestlé but also overturned Switzerland’s broader interpretation of the tax treaty.

How Will This Decision Impact Indian Companies?

Beginning January 1, 2025, Switzerland will impose a 10% tax rate on dividends, up from the 5% previously claimed under the MFN clause. This change directly impacts:

Indian tax residents claiming refunds for Swiss withholding tax.

Swiss tax residents seeking foreign tax credits.

For Indian companies operating in Switzerland, higher withholding tax liabilities will increase operational costs. Additionally, this could deter new investments from Swiss companies, potentially reducing the flow of foreign direct investment into India.

What Are the Broader Implications for Swiss Investments in India?

Tax experts warn that the move could affect Swiss investments in India, as dividends from Indian entities will now face a higher tax burden. The Indian government’s emphasis on adhering strictly to its domestic laws may encourage other treaty partners to reassess their tax treaty frameworks with India.

Amit Maheshwari, Tax Partner at AKM Global, suggested that Switzerland’s decision reflects principles of reciprocity. He explained that taxpayers in both countries now face equitable treatment, but the increased tax rates could reduce the appeal of India as an investment destination for Swiss businesses.

Kumarmanglam Vijay, Partner at JSA Advocates & Solicitors, noted that Indian companies with Overseas Direct Investment (ODI) structures in Switzerland will face a higher tax burden, making Switzerland a less attractive base for global operations.

Is This a Retaliatory Measure?

While some view Switzerland’s actions as retaliatory, others suggest it is an exercise in asserting fairness and predictability in international tax frameworks. Sandeep Jhunjhunwala, M&A Tax Partner at Nangia Andersen, stated that the decision underscores the complexities of navigating evolving global tax treaties. He added that treaty partners must align their interpretations of key clauses, such as MFN, to ensure consistency and stability.

What Does This Mean for Global Tax Diplomacy?

Switzerland’s revocation of India’s Most Favoured Nation status highlights the challenges countries face in balancing domestic legal frameworks with international obligations. It underscores the importance of clarity in drafting and interpreting tax treaties, particularly in a rapidly evolving global economy.

The move also raises questions about the future of India’s tax treaties with other OECD countries. Will other nations follow Switzerland’s lead, or will India’s legal framework prevail as the standard?

Looking Ahead

The changes to the Double Taxation Avoidance Agreement will require companies on both sides to revisit their tax planning strategies. Indian firms with operations in Switzerland may need to account for higher withholding taxes, while Swiss investors must evaluate the long-term impact of reduced profitability.

As global tax frameworks evolve, this case serves as a reminder of the need for greater transparency, collaboration, and alignment between treaty partners to avoid disruptions to cross-border investments.