Swiss MFN status suspension poses tax challenges for Indian firms, may hit inbound investments

Switzerland's suspension of the Most-Favored-Nation (MFN) status under its tax treaty with India, effective January 2025, will raise withholding tax on dividends from 5% to 10%. Experts note the move could affect cash flow for Indian businesses but emphasize that tax credits under the Double Taxation Avoidance Agreement (DTAA) will mitigate financial impacts, offering India an opportunity to reassess its tax strategies.

In a significant development for India-Switzerland tax relations, Switzerland has decided to suspend the Most-Favoured-Nation (MFN) status under the India-Switzerland tax treaty, effective January 1, 2025. This follows the Supreme Court ruling in India regarding the interpretation of the MFN clause. The move is expected to impact dividend taxation, foreign investment flows, and business operations in both countries.

Switzerland has suspended the unilateral application of the MFN clause with India under the Double Tax Avoidance Agreement (DTAA). Under this treaty, Switzerland had reduced the withholding tax on Indian entities operating in that country from 10% to 5%.
The Swiss authorities cited India’s Supreme Court ruling in the case on Nestle from October 2023 as the trigger for this decision. The Supreme Court reversed a Delhi High Court judgment that favoured Nestle, stating that the MFN clause could not be automatically applied without formal notification under Section 90 of the Indian Income Tax Act. This clarification led Swiss authorities to reconsider the unilateral reduction of the withholding tax rate.

Switzerland views this as a breach of reciprocity, as they believe taxpayers in both countries should be treated equally. This has led them to suspend the application of the MFN clause and revert to the previous 10% withholding tax rate. This situation could have several implications for bilateral trade and business relations. Indian companies operating in Switzerland and vice versa will face a higher tax burden, potentially impacting their competitiveness.

According to experts, the suspension of the MFN status by Switzerland introduces new challenges but also provides an opportunity for India to reassess its tax treaties and investment strategies. While Swiss companies operating in India may face higher taxes on dividends, the overall impact on business relations may be less severe if India takes proactive steps to engage with Switzerland and reinforce its economic position.

While this does have an impact, it is primarily a timing issue. Under the Double Taxation Avoidance Agreement (DTA), Indian companies can still avail of tax credits, mitigating the immediate effects, opined experts.
Experts predict the increased withholding tax will affect cash flow for Indian companies, but the overall financial impact will be mitigated by foreign tax credits.

For Indian businesses operating in Switzerland, the MFN suspension adds complexity to the tax landscape. The increased withholding tax rate could affect the profitability of Swiss subsidiaries of Indian companies. However, Indian companies can still avail tax credits under the Double Taxation Avoidance Agreement (DTAA), experts said.
As both nations navigate these changes, their strategic relationship, particularly in trade and investment, will depend on careful negotiation and the ability to adapt to evolving global tax standards.

Increased Dividend Taxation for Indian Companies Receiving Swiss Dividends

With the suspension of the MFN status, Indian taxpayers receiving dividends from Swiss companies will now face a higher withholding tax rate of 10%, up from the previous 5% under the MFN clause.
The Indian government will have to give a higher foreign tax credit. Earlier, the Indian government would have given 5%, but now they’ll be able to give 10%, so the final tax outgo in the hands of the Indian entity will be reduced. The cost of repatriating dividends will be higher, but the group overall is not impacted. It’s mainly a cash flow issue Prashant Bhojwani, Partner at BDO India

India's Strategy to Mitigate MFN Suspension Impact: Strengthening Bilateral Relations

India can take several steps to mitigate the negative impact of the MFN suspension and maintain its position as an attractive investment destination for Swiss investors.

Rajat Mohan emphasizes the importance of strengthening bilateral ties: “India should proactively engage Switzerland in bilateral negotiations to clarify investment security and trade continuity.”

In addition, India could offer sector-specific incentives, especially in high-value areas such as pharmaceuticals, fintech, and precision manufacturing, to attract Swiss investors. Furthermore, India’s domestic market offers ample growth opportunities that Swiss companies may find compelling, especially in the context of initiatives like "Make in India" and production-linked incentives (PLIs).

Rajesh Nangia underscores the potential of these domestic measures: “India remains one of the world’s fastest-growing economies, offering a vast consumer base, diverse investment opportunities, and a strategic role in global supply chains.”

The bone of contention

The Most-Favored Nation (MFN) clause in tax treaties ensures a country provides equal or better tax treatment to residents of one country as it does to residents of any third country which has entered into DTAA afterwards. India’s DTAAs with Switzerland include this clause, where the benefit of a lower rate, if extended to another OECD member country, would also apply between India and Switzerland.

On 13 August 2021, the Swiss had unilaterally extended the beneficial rate of 5% (as available in the treaty India has with Lithuania and Colombia). It is to be noted that Lithuania and Colombia became members of the OECD at a later point in time and were not OECD members when the treaty was signed with these countries. Such a reading was applicable only if India reciprocated with a similar interpretation.

The Indian Supreme Court in the case of Nestle S.A. held that the benefit of a lower rate of tax to another country would not be read into the MFN clause just by another country becoming a member of the OECD (where it was not a member of the OECD when the treaty was entered into with that country). Since the Indian Supreme Court didn’t provide any reciprocity to the Swiss interpretation of the MFN clause, the Swiss Government deemed it fit to suspend the benefit granted, but prospectively from 1 Jan 2025.

Please note that it is not the suspension of the MFN clause by the Swiss Government, but rather that the MFN clause still remains, but it cannot be applied in treaties entered into with countries that became OECD members after the signing (i.e., Lithuania and Colombia).