19-December-2024-Special-Article

SWITZERLAND’S WITHDRAWAL OF MFN CLAUSE IN DTAA WITH INDIA

Switzerland has decided to withdraw the application of the Most-Favoured-Nation (MFN) clause in its Double Tax Avoidance Agreement (DTAA) with India. This move, effective from January 2025, will impact the withholding tax rates applicable to Indian entities.

What is the MFN Clause in DTAA?

DTAA Background:

• The India-Switzerland DTAA, signed in 1994, aims to avoid double taxation on income between the two nations.
• It was revised in 2000 and 2010 to address changing global economic conditions.

MFN Clause:

• Article 11 of the 2010 protocol includes the MFN clause, ensuring that tax benefits granted to OECD members by India automatically apply to Switzerland.
• The clause aims to create parity in taxation rates.

India’s Stand on MFN:

• India argues that the MFN clause does not automatically apply and requires notification under Section 90 of the Income Tax Act, 1961.
• It further clarified that the clause applies only to countries that were OECD members at the time of the 2010 protocol signing.

Why Did Switzerland Withdraw the MFN Clause?

Lower Tax Rates to OECD Members:

• After 2010, India signed agreements with Lithuania and Colombia, offering a reduced dividend tax rate of 5%.
• Lithuania and Colombia became OECD members in 2018 and 2020, respectively.

Supreme Court Ruling:

• In October 2023, the Indian Supreme Court ruled that the MFN clause does not apply to countries joining the OECD after 2010.
• Based on this ruling, Switzerland decided to revert to the earlier withholding tax rate of 10% starting January 2025.

Implications of Switzerland’s Decision

• Increased Tax Liabilities: The withholding tax on dividends for Indian businesses in Switzerland will rise to 10% from 5%.
• Cross-Border Tax Disputes: This could lead to disagreements between India and Switzerland over treaty interpretations.
• Global Tax Trends: Switzerland’s move reflects a broader trend of countries adopting stricter tax treaty terms to safeguard domestic revenue.
• Impact on Investments: While Switzerland clarified that its investment commitments to India remain unchanged, Indian entities operating in Switzerland may face higher costs.

India-Switzerland Economic Relations

Investment Flows:

• Between 2000 and 2023, Swiss investments in India totaled USD 9.95 billion, making Switzerland the 12th largest investor.
• Indian investments in Switzerland, as of 2021, were valued at USD 3.7 billion.

Key Sectors:

• Swiss companies in India: Pharmaceuticals, machinery, and ICT services (e.g., Nestle, ABB).
• Indian companies in Switzerland: Technology and life sciences (e.g., TCS, Infosys).

Trade Agreements:

• Switzerland is part of EFTA (European Free Trade Association), which signed the Trade and Economic Partnership Agreement (TEPA) with India in 2024.

DTAA and MFN

What is DTAA?

DTAA is a treaty between two or more countries to avoid double taxation on income.

Mechanisms:

• Credit Method: Tax paid in one country is credited in the other.
• Exemption Method: Income taxed in one country is exempt in the other.

What is MFN?

MFN status ensures non-discriminatory treatment among trading partners.

• In WTO: MFN is a core principle requiring equal trade conditions among all members.

Future Prospects

• Withholding Tax Adjustments: From 2025, Switzerland will impose a 10% withholding tax rate, impacting Indian businesses.
• Need for Treaty Revisions: This decision highlights the importance of clear and uniform interpretations of tax treaties.
• Impact on Trade and Investments: The move underscores the evolving landscape of international tax norms and the need for balanced agreements.

Conclusion

Switzerland’s decision to withdraw the MFN clause from its DTAA with India signifies a shift in its approach to international taxation. While this may increase tax liabilities for Indian businesses, the move is unlikely to disrupt the broader investment and trade relations between the two nations. As global tax policies evolve, clearer and more balanced treaty terms will be essential to ensure mutual economic benefits.

Mains Question

1. Examine the implications of Switzerland’s withdrawal of the MFN clause in its Double Tax Avoidance Agreement with India. (150 WORDS)