MOSF
FAVOURED NATION : ECONOMY
NEWS: MFN
clause freeze won’t hit investments in India
WHAT’S IN
THE NEWS?
Switzerland will
suspend the Most Favoured Nation (MFN) clause in its Double Taxation Avoidance
Agreement (DTAA) with India starting January 1, 2025, doubling the withholding
tax on dividends for Indian investors from 5% to 10%. This move follows an
Indian Supreme Court ruling that MFN benefits require government notification
to apply.
Understanding the MFN Clause in Tax Treaties:
·
The MFN
clause in tax treaties ensures that a treaty partner receives treatment no less
favorable than that extended to other countries. In the context of the
India-Switzerland DTAA, this meant that if India negotiated a lower withholding
tax rate on dividends with another country, Switzerland would extend the same
lower rate to India.
Reason for Suspension:
·
The
suspension follows an October 2023 ruling by the Indian Supreme Court, which
stated that the MFN clause does not automatically apply without official
notification under Indian tax laws. Consequently, Switzerland has aligned its
interpretation with India's stance, leading to the suspension.
Impact on Tax Rates:
·
Currently,
due to the MFN clause, dividend payments from Swiss entities to Indian
investors are taxed at a reduced rate of 5%. With the suspension, this rate
will revert to the standard 10% as stipulated in the original DTAA, effectively
doubling the withholding tax on such dividends.
Implications for Indian Investors and Companies:
- Increased
Tax Liability:
Indian companies and investors receiving dividends from Swiss sources will
face higher withholding taxes, impacting net returns.
- Cash
Flow Considerations:
The increased withholding tax may affect the cash flows of Indian parent
companies with Swiss subsidiaries, as they will receive reduced dividend
incomes.
- Potential
Reassessment of Investments: The higher tax rate might prompt Indian investors
and companies to reassess the attractiveness of investments in
Switzerland.
Effect on EFTA-India TEPA:
·
Swiss
officials have clarified that this suspension will not impact the Trade and
Economic Partnership Agreement (TEPA) between India and the European Free Trade
Association (EFTA). The suspension pertains specifically to the DTAA and does
not influence other international agreements.
Future Negotiations:
·
In
light of the suspension and the new EFTA-India TEPA, India plans to renegotiate
its DTAA with Switzerland to address the changes and potentially establish more
favorable terms for both parties.
Conclusion:
·
The
suspension of the MFN clause by Switzerland signifies a shift in the tax landscape
for Indian investors and companies engaged with Swiss entities. Stakeholders
should closely monitor these developments and consider their implications on
cross-border investments and tax planning strategies.
What is DTAA?
DTAA is a treaty signed between two countries to
avoid taxing the same income twice. It ensures that income earned in one
country by a resident of another is either taxed in only one country or taxed
at reduced rates.
Why is DTAA Needed?
- Prevents
double taxation on the same income (once in the source country
where income is earned and again in the residence country where the
taxpayer resides).
- Encourages
cross-border trade, investment, and economic cooperation.
Example of DTAA:
India-USA DTAA
- An
Indian software engineer works for a U.S. company and earns income in the
USA.
- The
USA taxes this income as it is earned there.
- Without
DTAA, the same income would also be taxed in India because the engineer
is an Indian resident.
- Under
the India-USA DTAA:
- The
income earned in the USA is taxed there.
- India
provides relief by:
- Exemption Method: Excluding the income from U.S. earnings in India's tax
calculation.
- Tax Credit Method: Allowing credit for the tax already paid in the USA against the
Indian tax liability.
- Outcome:
o The taxpayer pays tax only once or at a reduced rate, avoiding double taxation.