Switzerland will revoke India’s Most Favoured Nation (MFN) status under their Double Taxation Avoidance Agreement (DTAA) from next year, a move likely to raise taxes on Indian companies operating in Switzerland. Starting January 1, 2025, Indian companies will face a 10% withholding tax on dividends and other incomes, up from the earlier 5% rate.

The decision is expected to raise tax liabilities for Indian firms operating in Switzerland, particularly in sectors like financial services, pharmaceuticals, and IT, and could impact Swiss investments in India.

To understand the why of this decision, understanding what exactly is meant by an MFN clause is pertinent.

The MFN clause in the DTAA enables firms of the treaty nations to get a lower tax rate, particularly in the case for specific income types such as dividends, interest, or royalties.

The clause ensures equal treatment for all nations and their firms involved. If a country extends favourable tax rates or conditions to another, the same must apply to all other countries found in the same treaty. This way no country is found to be less favoured than others.

Which events led to the suspension?

The suspension decision stems from a 2023 Supreme Court ruling in India that clarified the application of the MFN clause in tax treaties. The case involved Swiss company Nestlé, which sought a refund of withholding tax on dividends, claiming benefits under the MFN clause in the India-Switzerland tax treaty. The Supreme Court overturned a 2021 Delhi High Court ruling that had favoured Nestlé, stating that the MFN clause cannot be applied automatically without formal notification under Section 90 of the Indian Income Tax Act. The court held that the MFN clause applies only to OECD member countries as of 1994, the year the treaty was signed, excluding countries like Colombia and Lithuania, which joined the OECD later.

Switzerland had previously interpreted the MFN clause to mean that reduced tax rates provided to newer OECD members like Colombia and Lithuania should also apply to India. Based on this understanding, Swiss authorities had unilaterally reduced the dividend withholding tax rate for Indian entities from 10% to 5% retroactively from July 5, 2018.

However, the Supreme Court ruling contradicted this interpretation, leading Swiss authorities to suspend the clause. The suspension, hence, reflects the lack of reciprocity in the application of the MFN clause from India. Swiss authorities expressed dissatisfaction, stating that India grants more favourable terms to other countries but, not to Switzerland under the MFN clause.

Many believe that this decision may push other countries to follow Switzerland's lead, as India’s approach to MFN clauses could be seen as inconsistent.

This is however, not the first time the country has faced recurring challenges with DTAAs, including disputes with Australia over the classification of income. The latest Swiss suspension of the MFN clause, along with the disputes with Australia, indicate the urgent need for India to adopt a consistent, strategic approach to international taxation treaties that addresses digital and service-sector complexities.

How can this affect India?

As a result of this decision, Indian companies will face higher tax liabilities. The withholding tax on dividends received by Indian companies from Switzerland will increase from 5% to 10%, reducing their competitiveness compared to firms from countries still benefiting from MFN provisions.

While the decision is not expected to affect investments into India from the European Free Trade Association (EFTA), it may prompt other nations to reconsider the application of MFN clauses in their own tax treaties with India.

The move could also deter Swiss investments in India, as higher withholding tax rates will apply to dividends and income.