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Switzerland has taken a unilateral stand after the Supreme Court of India's ruling in the Nestle case. It has revoked the 'Most Friendly Nation' or MFN status accorded to India under the Double Taxation Avoidance Agreement or DTAA treaty.
Switzerland's move marks a significant shift in bilateral treaty dynamics and will result in a big impact on Indian companies operating in Switzerland as well as on Swiss investments in India.
In its official statement on December 11, the Swiss finance department named the Supreme Court of India and cited its 2023 ruling as the reason for its decision to remove India's MFN status. In its order, the Supreme Court had said that the MFN clause between two nations does not apply automatically when a country joins the OECD, especially if the Indian government already had a prior tax treaty with that country before joining the grouping.
The OECD or Organisation for Economic Co-operation and Development was established in 1961 and is headquartered in Paris. It calls itself a forum and knowledge hub for data, analysis, and best practices in public policy to build stronger, fairer, and cleaner societies - helping to shape better policies for better lives. It works closely with policy makers, stakeholders and citizens to establish evidence-based international standards and to find solutions to social, economic and environmental challenges.
A HISTORY TO THE CASE
India had signed tax agreements with Lithuania and Colombia under which the tax rates on certain types of income were lower than the rates it provided to OECD countries. Both countries later joined the OECD.
Under the OECD, the effect of an MFN clause is that one country obligates itself to its treaty partner with respect to offering it a 'more favourable' tax treatment.
Switzerland assumed that Colombia and Lithuania joining the OECD meant a 5 per cent rate for dividends would apply to the India-Switzerland tax treaty under the MFN clause, instead of the 10 per cent which was mentioned in it.
But the Supreme Court ruling meant otherwise -- that the MFN clause between two nations does not apply automatically when a country joins the OECD, and that the prior tax treaty takes precedence, unless the MFN clause is specifically mentioned in a 'notification' in accordance with Section 90 of the Income Tax Act.
WHAT THIS MEANT FOR THE NESTLE CASE
According to the statement by Switzerland's finance department, in 2021, the Delhi High Court while hearing the case against Nestle, upheld the applicability of the residual tax rates after taking into account the MFN clause under the Double Taxation Avoidance Agreement. This was in line with how Switzerland had interpreted it.
However, in a ruling dated October 19, 2023, the Supreme Court reversed the high court's judgement and stated that, the applicability of the MFN clause was not triggered automatically. The top court ruled that the MFN clause "was not directly applicable in the absence of 'notification' in accordance with Section 90 of the Income Tax Act" - a ruling that impacted Nestle and in-turn went against what Switzerland had hoped for.
SWITZERLAND'S RESPONSE
Switzerland has now responded by unilaterally revoking India's MFN status and squarely named the "Indian Supreme Court" as the reason for its decision.
This means that from January 1, 2025, Switzerland will levy a 10 per cent tax (instead of the current 5 per cent) on dividends payable to Indian tax residents and entities who claim refunds for Swiss withholding tax and for Swiss tax residents who claim foreign tax credits.
The Swiss Finance Department released a statement in which it announced "Suspension of the application of the MFN clause of the protocol to the agreement between the Swiss Confederation and the Republic of India for the avoidance of double taxation with respect to taxes on income."
The statement cited the "2023 ruling by Indian Supreme Court" in a case relating to Nestle for its decision to withdraw the MFN status.
WHAT EXPERTS SAY
Some see Switzerland's move as a retaliatory measure to the Supreme Court ruling, while others see this as a measure of reciprocity.
Nangia Andersen M&A Tax Partner Sandeep Jhunjhunwala called Switzerland's move unilateral and said "This suspension may lead to increased tax liabilities for Indian entities operating in Switzerland, highlighting the complexities of navigating international tax treaties in an evolving global landscape."
"It also underscores the necessity of aligning treaty partners on the interpretation and application of tax treaty clauses to ensure predictability, equity, and stability in international tax framework," Mr Jhunjhunwala told news agency Press Trust of India.
AKM Global Tax Partner, Amit Maheshwari, said that "The main reason behind the decision to withdraw MFN is of reciprocity, which ensures that taxpayers in both countries are treated equally and fairly."
"Swiss authorities announced in August 2021 that based on the MFN clause between Switzerland and India, the tax rate on dividends from qualifying shareholdings would be reduced from 10 per cent to 5 per cent, effective retroactively from July 5, 2018. However, the subsequent Supreme Court ruling in 2023 contradicted the same," Mr Maheshwari told PTI.
He added that "This could impact Swiss investments in India as dividends would be subject to higher withholding now and income accruing on or after January 1, 2025, may be taxed at the rates provided for in the original double taxation treaty between Switzerland and India, regardless of the MFN clause."
JSA Advocates & Solicitors Partner Kumarmanglam Vijay said "This would especially impact Indian companies having ODI (overseas direct investment) structures with subsidiaries in Switzerland and will raise the Swiss withholding tax on dividends from 5 per cent to 10 per cent from January 1, 2025."
(Inputs from PTI)