Switzerland's Suspension of MFN Clause Requires India to Strategically Rethink Taxation Treaties

The suspension of the most favoured nation (MFN) clause by Switzerland highlights the need for India to adopt a more strategic approach to international taxation treaties, according to the Global Trade Research Initiative (GTRI). This change introduces tax challenges for Indian companies operating in Switzerland, especially in sectors like financial services, pharmaceuticals, and IT.

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From January 1, 2025, these firms will face a 10% tax on dividends and other incomes, up from the previous 5%. GTRI emphasised the importance of proactive negotiations to clarify treaty provisions and protect Indian businesses abroad. It also stressed that India's treaty frameworks should reflect modern business realities, particularly in digital and service sectors, to reduce tax uncertainties and enhance global competitiveness.

Impact on Indian Firms

The Swiss government's decision to suspend the MFN clause in the Double Taxation Avoidance Agreement (DTAA) with India could affect Swiss investments in India and lead to higher taxes for Indian companies operating in Switzerland. The Swiss finance department announced this move on December 11, following an Indian Supreme Court ruling last year. The court stated that the MFN clause doesn't automatically apply when a country joins the OECD if India signed a tax treaty with that country before its OECD membership.

Ajay Srivastava, GTRI founder, noted that this suspension is a setback for Indian firms in Switzerland. Previously, these companies benefited from a reduced 5% tax rate on dividends due to Switzerland's earlier MFN benefits. With the reversion to a 10% rate starting January 1, 2025, these firms face increased tax liabilities, reducing their competitiveness compared to businesses from countries still enjoying MFN provisions.

Legal Interpretations and Challenges

The Supreme Court judgment sets a precedent that could influence India's handling of similar clauses with other trading partners. If disputes over MFN interpretations persist, Indian businesses might encounter similar challenges elsewhere, potentially deterring outbound investments. Srivastava highlighted that earlier issues with Australia also underscore India's need for a consistent approach to international taxation treaties.

DTAA agreements often face different interpretations due to vague language. For instance, Indian software firms have faced disputes over income classification under the India-Australia DTAA. Australia often categorises payments for software licenses as royalties subject to source taxation. Indian firms argue these should be treated as business income taxable only in India unless they have a permanent establishment in Australia.

Historical Context and Trade Relations

This mismatch leads to potential double taxation and compliance challenges, compounded by Australia's reliance on domestic laws that may override treaty provisions. The India-Switzerland DTAA was signed on November 2, 1994, and amended in 2000 and 2010. It aimed to facilitate smoother cross-border trade by mitigating double taxation risks.

The MFN clause ensures countries treat partner nations' investors no less favourably than investors from any third country. For example, if Switzerland offered reduced tax rates or benefits to another country, these were expected to extend to Indian firms under the MFN clause. In March, India signed a free trade agreement with the European Free Trade Association (EFTA), which includes Iceland, Liechtenstein, Norway, and Switzerland.

Trade Deficit and Investments

Switzerland is India's largest trading partner within EFTA, followed by Norway. In 2023-24, India's imports from Switzerland reached USD 21.24 billion compared to exports of USD 1.52 billion, resulting in a significant trade deficit of USD 19.72 billion. Between April 2000 and September 2024, India received about USD 10.72 billion in foreign direct investments from Switzerland.

The suspension of the MFN clause by Switzerland underscores India's need for strategic international taxation policies. Addressing these challenges is crucial for maintaining competitiveness and fostering favourable trade relations globally.