Suspension of MFN Clause in India-Switzerland Tax Treaty

Sub: Eco

Sec: External sector

Why in News

The Swiss government has decided to suspend the Most Favoured Nation (MFN) clause under the Double Taxation Avoidance Agreement (DTAA) with India.

Background:

The decision involved 11 petitions, including one filed by Nestlé, challenging the automatic applicability of the MFN clause.
The Court ruled that the MFN benefits under DTAA do not apply automatically and require explicit notification under the Income Tax Act.
Switzerland issued a statement on December 11, 2023, acknowledging India’s interpretation of the MFN clause.
Effective January 1, 2025, Switzerland will suspend the MFN benefits for Indian entities, resulting in increased tax rates.

Implications of the Suspension:

Previous Benefits: Indian companies enjoyed a reduced tax rate of 5% on dividends and other incomes due to MFN provisions.
From 2025, the tax rate will revert to 10%, increasing tax liabilities for Indian businesses.
Key sectors impacted include financial services, pharmaceuticals, and IT, which have significant operations in Switzerland.
Indian firms may face reduced competitiveness compared to entities from countries still benefiting from MFN provisions.

Most Favoured Nation (MFN):

MFN is a principle in international trade that ensures equal treatment for all trading partners in terms of trade benefits.
Mandated under Article 1 of the General Agreement on Tariffs and Trade (GATT), 1994.
Applies to tariffs, import quotas, and other trade barriers for goods and services.
India has granted MFN status to all WTO members since joining in 1995.
Suspended MFN status for Pakistan in 2019 due to national security concerns.
MFN in Tax Treaties: Ensures non-discrimination in tax rates under DTAAs.
Benefits via the MFN clause require formal notification under domestic law (Section 90(1) of the Income Tax Act).

Double Taxation Avoidance Agreement (DTAA):

To prevent double taxation on the same income, facilitating cross-border investment and trade.
India has signed DTAAs with over 90 countries, including the USA, China, and Mauritius.
Covers various incomes such as salaries, business profits, and royalties.
MFN Clause in DTAA: If India agrees to a lower tax rate with a new OECD member, the same rate may apply to existing OECD members in specific treaties.
Conditions like mutual notification and OECD membership at the time of the treaty are required.

European Free Trade Association (EFTA):

Founded: 1960.
Purpose: Promotes free trade and economic integration among member states without forming a customs union.
Headquarters: Geneva, Switzerland.
Member Countries: Switzerland, Norway, Iceland and Liechtenstein.
EFTA negotiates free trade agreements (FTAs) globally, independently of the European Union (EU).
EFTA is not a member of the EU, but most members (except Switzerland) are part of the European Economic Area (EEA), allowing access to the EU single market.
Switzerland’s Role: Plays a key role in EFTA’s economic diplomacy while maintaining its non-EU stance.
Discussions under EFTA to finalize a Free Trade Agreement with India, focusing on industrial goods, intellectual property, and sustainable trade practices.
Why EFTA is Unique: Provides flexibility for countries not wanting to join the EU. Offers access to European markets while maintaining economic sovereignty.

India-Switzerland Relations:

Diplomatic Ties: Established in 1948, India-Switzerland relations are based on shared democratic values, neutrality, and mutual cooperation.
Bilateral trade was valued at around USD 25 billion in 2023, primarily in pharmaceuticals, chemicals, machinery, and precious metals.
Ongoing negotiations under the European Free Trade Association (EFTA) to finalize a Free Trade Agreement.
Double Taxation Avoidance Agreement (DTAA): Signed in 1994 to prevent double taxation and ensure tax transparency.
Automatic Exchange of Information (AEOI): Since 2019, Switzerland shares information on Indian account holders to curb black money.

Switzerland:

Capital: Bern
Largest City: Zurich
Bordering Countries: Germany (north), France (west), Italy (south), Austria and Liechtenstein (east)
Mountain Ranges: Swiss Alps, Jura Mountains
Major Rivers: Rhine, Rhone, Aare
Ranked 1st globally in the Global Innovation Index.
One of the world’s wealthiest nations by GDP per capita.
Major Industries: Pharmaceuticals, machinery, watches, banking, and financial services.
Export Strength: Known for exports of luxury watches (e.g., Rolex, Omega) and precision tools.
Currency: Swiss Franc (CHF)
Political System: Federal Republic with a direct democracy.
Neutrality: Switzerland has been a neutral state since the 1815 Congress of Vienna.
International Role: Headquarters of global organizations like the World Health Organization (WHO) and World Economic Forum (WEF) are based in Switzerland.