"Swiss MFN Status Withdrawal: A Game Changer for Indian Pharma and IT Firms?"

Starting January 1, 2025, Indian companies in Switzerland will face a 10% tax on dividends and other income, an increase from the previous 5% rate. This change affects the financial landscape for Indian businesses operating abroad.

P24 News Media

December 13, 2024

1 minute

India

The recent decision by the Swiss government to revoke the most favoured nation (MFN) clause within the Double Taxation Avoidance Agreement (DTAA) with India has significant implications for Indian companies operating in Switzerland. This shift, especially affecting sectors like financial services, pharmaceuticals, and IT, is set to elevate operational costs for these firms. According to insights from the Global Trade Research Initiative (GTRI), the tax burden on dividends and other income will escalate from the current rate of 5 percent to a substantial 10 percent effective January 1, 2025.

Ajay Srivastava, founder of GTRI, articulated concerns about this change, emphasizing that the increase in the residual tax rate to 10 percent could adversely impact the competitive edge of Indian enterprises when compared to their counterparts in countries that continue to enjoy MFN advantages. Such financial repercussions could deter Indian investments in Switzerland, making it considerably more costly for these firms to operate.

This development is rooted in an October 2023 ruling by the Indian Supreme Court concerning the Nestlé case, which clarified India's stance on the interpretation of the MFN clause. The court determined that the benefits associated with the MFN clause cannot be applied to the India-Switzerland treaty unless expressly notified as per Section 90 of the Indian Income Tax Act. Therefore, the court's interpretation essentially restricted the MFN clause's application to OECD member countries as of 1994, the year when the treaty was established, thereby excluding countries that joined the OECD later, such as Colombia and Lithuania.

Switzerland's response to this ruling was to suspend the MFN clause entirely, increasing tax liabilities for Indian companies. The Swiss government had previously believed that MFN benefits should automatically extend to newer OECD members, thereby justifying the unilateral reduction of the residual tax rate on dividends from 10 percent to 5 percent. However, India's restrictive interpretation led to discrepancies that Switzerland found untenable.

GTRI further highlighted that this case underscores broader challenges regarding India's interpretation and management of MFN clauses in its bilateral treaties. The ruling could set a precedent affecting India's dealings with various trading partners, potentially leading to similar conflicts over interpretations of such clauses. GTRI warned that ongoing disputes regarding MFN interpretations might deter Indian enterprises from pursuing investments abroad, raising concerns about the impact on international economic engagement.

This is not the first occasion India has grappled with complications arising from DTAAs. For instance, Indian software companies have previously encountered issues concerning the classification of income within the framework of the India-Australia DTAA. Under Australian taxation norms, payments for software licenses and services are often classified as royalties, which subjects them to source taxation. Conversely, Indian firms contend that these payments should be recognized as business income, which would only be taxable in India unless they establish a permanent presence in Australia.

This divergent interpretation leads to the potential for double taxation and introduces additional compliance hurdles for Indian businesses. The situation is exacerbated by Australia's statutory laws, which may override treaty regulations, adding complexity to tax obligations for Indian companies.

The suspension of the MFN clause by Switzerland, coupled with past disputes involving Australia, emphasizes the urgent need for India to cultivate a more strategic and coherent approach to international tax treaties. To enhance its global competitiveness, India must ensure its treaty agreements are attuned to the realities of modern business, particularly in the rapidly evolving digital and services sectors. Srivastava's remarks highlight the importance of minimizing tax unpredictability to foster an attractive environment for outbound investments.