Switzerland and India entered into a Double Taxation Avoidance
Agreement (DTAA) on 2 November 1994, with subsequent amendments
through protocols on 16 February 2000, and 30 August 2010. Notably,
the amending protocol of 30 August 2010 introduced a Most
Favoured Nation (MFN) Clause, which ensures that any
reduction in tax rates on dividends, interest, royalties, or fees
for technical services under any later treaty entered between India
and an OECD member state would also apply retroactively to the
India-Switzerland DTAA.
Subsequently, India concluded two new DTAAs with other countries
that include reduced dividend tax rates:
- DTAA with Lithuania (26 July 2011): Offers a reduced dividend withholding tax rate of 5% on dividends paid to a company owning at least 10% of the capital of the paying company. Lithuania joined the OECD on 5 July 2018.
- DTAA with Colombia (13 May 2011): Provides a 5% general tax rate on dividends. Colombia became an OECD member on 28 April 2020.
In light of the above, on 13 August 2021, the Swiss competent
authorities recognized the application of the MFN clause (i.e., a
lower rate of tax for dividends) following Lithuania's and
Colombia's OECD membership. This meant that Indian
Corporations/Tax residents having a presence in Switzerland could
claim reduced withholding tax on dividends as per the clarification
issued.
Pursuant to the above, the Central Board of Direct Taxes (CBDT)
issued Circular No 3/2022 dated 3 February 2022 on the application
of the MFN clause in certain tax treaties. Amongst others, the
circular clarified the following important aspects:
- The subsequent treaty is between India and a state that is a member of the OECD at the time of signing the treaty. This meant that the test of being a member of the OECD needed to be applied at the time of signing of the Tax Treaty.
- India has to issue a notification permitting the invocation of the MFN clause for the application of beneficial treatment as provided in the subsequent Treaty.
Further, in October 2023, the Indian Supreme Court ruled that
the MFN clause did not apply retroactively in the case of Nestle
SA, as it required formal "notification" under Section 90
of the Income Tax Act, 1961 (ITA). This decision effectively
negated the retroactive tax relief claimed by Swiss residents under
the MFN clause. Thus, while Switzerland granted a retroactive 5%
residual tax rate for Indian firms starting from July 2018, the
Indian authorities did not extend reciprocity and applied a higher
tax rate of 10% on dividend payments.
Accordingly, on 11 December, the Swiss finance department issued a
statement highlighting that Swiss tax authorities have waived the
unilateral application of the MFN clause from 1 January
2025, aligning the tax rates on dividends between India
and Switzerland with those stated in the original DTAA. The impact
is summarised below:
- For tax years 2018-2024, Indian tax residents are eligible for a lower withholding tax rate of 5% in Switzerland, applying the MFN clause.
- From 1 January 2025 onwards, India tax residents cannot apply the reduced withholding tax rates on dividends in Switzerland and shall suffer a withholding tax of 10%.
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Our Comments According to a public report from April 2024, nearly 140 Indian
companies have invested in 180 entities in Switzerland. If the tax
treatment of income from Switzerland becomes less favourable, these
companies could face higher withholding tax rates on dividends paid
to Indian entities. However, they may be able to offset this impact
by claiming a foreign tax credit in India, which would neutralize
the tax impact. On the other hand, if these Indian companies are
unable to claim a tax credit due to losses in India, it could
result in an increasing overall tax burden for them. It is
pertinent to note that this primarily affects dividend income, as
no other OECD country tax treaty with India currently offers a
lower tax rate than what was provided under the Swiss DTAA. |
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