Switzerland has announced the suspension of the Most Favoured Nation (MFN) status for India under their Double Taxation Avoidance Agreement (DTAA), effective January 1, 2025. This decision follows a significant ruling by the Indian Supreme Court in 2023, which clarified the conditions under which the MFN clause applies in tax treaties.

The MFN clause was introduced in the DTAA between India and Switzerland in 1994 and later amended in 2010. It was designed to ensure that if India agreed to lower tax rates with a third OECD country, those rates would also apply to Switzerland. However, the Supreme Court's ruling indicated that such automatic adjustments require formal notification under Section 90(1) of the Indian Income Tax Act, which Switzerland interpreted as a lack of reciprocity from India regarding the MFN clause.

Background of The Supreme Court Ruling

The Supreme Court's judgment clarified that the MFN clause in tax treaties does not automatically apply when a country joins the Organisation for Economic Co-operation and Development (OECD), particularly if India had signed a tax treaty with that country prior to its OECD membership. The ruling emphasized that for any benefits under the MFN clause to be applicable, explicit notification by the Indian government under Section 90 of the Income Tax Act is required.

Reasons For Suspension

The Swiss finance department cited the Supreme Court's interpretation as a key reason for suspending India's MFN status. The Court's ruling stated that:

The MFN clause does not automatically extend to countries that join the OECD after a tax treaty is signed.

The applicability of lower tax rates agreed upon with other countries requires explicit notification.

As a result, Switzerland determined that without this notification, it could not apply the lower withholding tax rates previously enjoyed by Indian entities.

Implications of The Suspension

The suspension will lead to several notable changes:

Increased Tax Rates: The withholding tax on dividends paid to Indian tax residents will rise from 5% to 10%. This change will significantly increase tax liabilities for Indian companies operating in Switzerland.

Impact on Investments: Swiss companies receiving dividends from India will continue to face a 10% withholding tax under the existing DTAA, but Indian firms will now be at a competitive disadvantage due to higher taxation.

Potential Renegotiation: The suspension may prompt India and Switzerland to renegotiate their tax treaty, particularly in light of India's trade agreements with members of the European Free Trade Association (EFTA), which currently enjoy different tax treatment.

Broader Repercussions: This decision could lead other countries to re-evaluate their own MFN clauses in treaties with India, particularly in light of similar legal interpretations regarding reciprocity and treaty obligations.

How Will This Suspension Impact Indian Companies Operating In Switzerland

The suspension of the Most Favoured Nation (MFN) status by Switzerland will have significant implications for Indian companies operating in the country, particularly affecting their tax liabilities and overall competitiveness.

Increased Tax Liabilities

Starting January 1, 2025, Indian entities will face a 10% withholding tax on dividends and other income repatriated from Switzerland, up from the previous 5% rate. This increase in tax burden directly impacts the financial performance of these companies, as they will have to allocate a larger portion of their profits to taxes rather than reinvesting them or distributing them to shareholders.

Competitive Disadvantage

The higher tax rate diminishes the attractiveness of Switzerland as a business hub for Indian firms, especially compared to companies from countries that continue to benefit from lower withholding rates due to existing MFN provisions. This could lead Indian businesses to reconsider their operational strategies and possibly shift investments to other jurisdictions with more favourable tax conditions.

Operational Challenges

The increased taxation is likely to lead to:

Higher Operational Costs: Companies may need to adjust their pricing strategies in Switzerland, potentially making them less competitive against local firms or those from countries that maintain lower tax rates.
  
Strategic Reassessment: Firms might explore relocating certain operations or investments to other European countries that offer better tax benefits, which could affect job opportunities and project scopes in Switzerland.

Impact on Growth Sectors: Sectors such as IT, pharmaceuticals, and finance—where many Indian companies have established a presence—could see reduced growth prospects due to the increased financial strain. This may also limit the ability of these firms to hire talent or undertake new projects in Switzerland.

Broader Economic Implications

The suspension of the MFN clause could set a precedent affecting India's future international tax treaties. If similar disputes arise with other countries, Indian businesses may face additional challenges in navigating complex tax frameworks, potentially deterring outbound investments and creating an atmosphere of uncertainty for international operations.

In conclusion, the suspension of the MFN status by Switzerland introduces significant challenges for Indian companies operating there. The increased tax liabilities and potential loss of competitive edge necessitate strategic reassessments and could lead to broader implications for India's international trade relationships.

Switzerland's suspension of India's MFN status marks a significant shift in international tax relations between the two nations. It underscores the importance of clear mutual agreements and notifications in interpreting international treaties, especially concerning taxation. The upcoming changes could reshape investment dynamics and necessitate diplomatic negotiations to restore favourable conditions for both Swiss and Indian entities operating across borders.