India-Switzerland DTAA: Suspension of MFN Clause and its Implications on Investments

Switzerland has suspended the Most-Favoured-Nation (“MFN”) clause under its Double Taxation Avoidance Agreement (“DTAA”) with India. Switzerland’s recent decision to suspend the MFN clause is a significant development with potential implications on India-Switzerland relations beyond taxation. In this explainer, ELP provides a recap on the developments that led to the suspension, an insight on Swiss Government’s recent move and the potential impact on investments between Switzerland and India under India’s recent Trade and Economic Partnership Agreement (“TEPA”) with the European Free Trade Association (“EFTA”).

In 1994, India and Switzerland entered into a DTAA, an agreement for avoidance of double taxation and prevention of fiscal evasion. Notably, the DTAA contains an MFN clause, which guarantees that both nations treat investors from other nations equally to those from any other third country.

On December 11, 2024, the Swiss Government decided to suspend the MFN clause under the DTAA. This move stems from a judgment rendered by the Supreme Court of India in 2023, on the interpretation of the MFN clause in India’s treaties with member nations of the Organisation for Economic Co-operation and Development (“OECD”).

The suspension of MFN status by Switzerland is expected to impact Indian investments in Switzerland.

• For example, dividends paid to Indian entities from Swiss sources will be subject to higher taxes. However, the tax position remains unaffected for Swiss entities with investments in India.
• The suspension could also impact investment decisions, increase tax liabilities, and create short-term uncertainty for businesses engaged in cross-border activities in Switzerland.

The root cause of Switzerland’s suspension of the MFN clause lies in the decision given by the Apex Court in the case of Assessing Officer (I. T.) v. Nestle SA. (“Nestle Judgement”),[1] which provided a clarification on the application of the MFN clause under the DTAA.

India entered into DTAAs with Colombia and Lithuania in 2011 which, among other benefits, provided a withholding tax rate of 5%. Conversely, India’s DTAA with Switzerland provided a withholding tax rate of 10% subject to the aforementioned MFN clause. This clause stated that if India entered into a DTAA with another OECD country that provided tax rates which were lower than that given to Switzerland under the India-Switzerland DTAA, these lower tax rates would also be applicable under the India-Switzerland DTAA.

Lithuania and Colombia became OECD members in 2018 and 2020, respectively, prompting Switzerland to claim a reduced rate of 5% for its entities under the DTAA. However, the Government of India disputed this interpretation, asserting that MFN benefits under the DTAA required formal notification under Section 90 of the Income Tax Act, 1961 (“IT Act”), and that Lithuania and Colombia were not OECD members when the DTAAs with these countries were signed.

The matter reached the Delhi High Court (“DHC”), which ruled in favor of companies seeking the reduced tax rate. However, in October 2023, the Supreme Court overturned the DHC’s judgement and held that:

• MFN benefits do not apply automatically, and an MFN clause must be made effective by issuing a formal notification under Section 90 of the IT Act.
• For benefits under the MFN clause to be received, the third country receiving lower tax rates must have been an OECD member at the time of signing of the DTAA. Since Lithuania and Colombia joined the OECD after signing their DTAAs with India, it was held that the 5% rate did not apply to Swiss entities.

Following the Nestle Judgement, the Swiss government issued a formal statement on December 11, 2023, announcing the suspension of the MFN clause in its DTAA with India.[2] It stated that the Nestle Judgement highlighted that Switzerland’s interpretation of the MFN clause in the DTAA was not shared by India. Pursuant to this “absence of reciprocity”, Switzerland suspended the MFN clause, according to which dividends due on or after January 1, 2025, will revert to the original 10% tax rate.

The suspension of the MFN clause comes at a critical juncture in Switzerland’s economic relations with India. In 2024, India signed the TEPA with the EFTA, comprising of Switzerland, Norway, Iceland, and Liechtenstein. While the TEPA is yet to enter into force, as part of this agreement, the EFTA pledged to “aim to increase” investments into India to USD 100 billion over a 15-year period. This aforementioned commitment of USD 100 billion is a binding obligation on EFTA states, with India possessing measures for its enforcement.[3] This obligation is also qualified by India’s obligation to “endeavour to ensure a favourable climate for foreign direct investment, while taking into account the need to identify, assess and mitigate potential risks for security or public order”.[4] Indeed, tax-related incentives (including concessional tax rates) are recognized as a component of investment promotion.[5] Conversely, the absence or revocation of tax incentives may be considered as antithetical to investment promotion by India.

That said, it is important to note the multitude of other factors governing EFTA’s USD 100 billion investment obligations under the TEPA. For example, the TEPA itself notes that the investment obligation on behalf of the EFTA states is a profit-seeking endeavour to benefit from India’s rapid economic growth.[6] Officials from the Swiss embassy in India have also clarified that Switzerland’s recent decision will not negatively affect investments from Switzerland into India.[7]

The suspension of the MFN clause in the India-Switzerland DTAA marks a pivotal moment in the tax and investment relationship between the two nations. While the decision stems from the Nestle Judgement and reflects divergent interpretations of the MFN clause, it underscores the need for clarity and alignment in treaty obligations to maintain investor confidence. With the TEPA offering a framework for substantial Swiss investments into India, the suspensions of the MFN clause raises questions about the interplay between tax policy and investment promotion.

We trust you will find this an interesting read. For any queries or comments on this update, please feel free to contact us at insights@elp-in.com or write to our authors:

Sanjay Notani, Partner, Email  – SanjayNotani@elp-in.com

Ambarish Sathianathan, Partner, Email  – AmbarishSathianathan@elp-in.com

Harika Bakaraju, Principal Associate, Email  – HarikaBakaraju@elp-in.com

Sarthak Yadav, Associate, Email  – SarthakYadav@elp-in.com

[1] Assessing Officer (I. T.) v. Nestle SA, (2023) 458 ITR 756.

[2] Suspension of the application of the most favoured nation 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, Département fédéral des finances DFF (Dec. 11, 2024), available at https://www.estv.admin.ch/dam/estv/en/dokumente/international/laender/int-laender-indien-suspension-mfn-en.pdf.download.pdf/int-laender-indien-suspension-mfn-en.pdf

[3] See India-EFTA Trade and Economic Partnership Agreement: Key Outcomes and Implications, ELP (Mar. 2024), available at https://elplaw.in/wp-content/uploads/2024/03/ELP-Update-India-EFTA-Trade-and-Economic-Partnership-Agreement-Key-Outcomes-and-Implications.pdf.

[4] Art. 7.2.2. of the TEPA.

[5] PP. 33-35, Investment Promotion Provisions in International Investment Agreements, UNCTAD Series on International Investment Policies for Development (2008), available at https://unctad.org/system/files/official-document/iteiit20077_en.pdf.

[6] Fn. 7, Art. 7.1.3.(a) of the TEPA.

[7] MFN clause freeze won’t hit investments in India: Switzerland, The Hindu (Dec. 14, 2024), available at https://www.thehindu.com/business/mfn-clause-freeze-wont-hit-investments-in-india-switzerland/article68986459.ece.