Switzerland has announced the suspension of the Most Favored Nation (MFN) clause in its Double Taxation Avoidance Agreement (DTAA) with India, effective January 1, 2025. This decision will increase the withholding tax rate on dividends paid to Indian tax residents from 5% to 10%, aligning with the original terms of the treaty.
Key Highlights:
- Supreme Court of India Ruling (2023):
The ruling clarified that the MFN clause in India’s tax treaties cannot automatically apply when a country becomes a member of the Organisation for Economic Co-operation and Development (OECD) if the treaty was signed before the country joined the grouping. It requires formal notification under Section 90 of the Indian Income Tax Act. - Dispute Origins:
- India had signed tax treaties with Colombia and Lithuania offering lower withholding tax rates on dividends compared to the 10% rate in its treaty with Switzerland.
- After Colombia and Lithuania joined the OECD, Switzerland interpreted their membership as triggering the MFN clause, thereby applying a reduced 5% rate to Indian taxpayers in 2021.
- Nestlé India sought a refund of taxes under this interpretation, leading to a legal dispute.
- Supreme Court Decision:
The Court overturned a Delhi High Court judgment favoring Nestlé, ruling that applying the MFN clause required a formal notification. Consequently, Switzerland reassessed its position and decided to suspend the clause.
Implications:
- Higher Tax Burden: From 2025, Indian companies and residents receiving dividends from Swiss entities will face a 10% withholding tax, doubling the previous rate of 5%.
- Impact on Investments: The increased tax rate could make Swiss investments less attractive for Indian companies, potentially affecting the flow of cross-border dividends.
- Global Precedent: This case may influence how other countries interpret the MFN clause in their tax treaties with India, especially concerning the interplay between OECD membership and treaty benefits.
- Legal and Administrative Clarity: The ruling emphasizes the need for formal notifications to trigger changes under the MFN clause, ensuring greater clarity in tax treaty administration
