By CA Uttam Kumar Shivhare

India’s Most Favoured Nation (MFN) clause under the India-Swiss Double Taxation Avoidance Agreement (DTAA) faces suspension, risking a potential loss of $100 billion in Swiss investment. The MFN clause ensures non-discriminatory tax treatment by extending benefits offered to any third OECD member state. Controversy arose when Indian tax authorities, citing the DTAA with the Netherlands, denied reduced withholding tax rates on dividends. While the Delhi High Court ruled that the MFN clause was self-operational, the Supreme Court held otherwise, requiring specific notifications under Section 90 of the Income Tax Act for MFN benefits. Following this judgment, Switzerland suspended the MFN clause, increasing withholding tax on dividends from Swiss entities to 10%. This decision significantly impacts Indian companies receiving dividends and Swiss investment flows. Other DTAA provisions on royalties and technical services fees remain unaffected. The development underscores the complexities of treaty interpretation, emphasizing the need for clarity in international tax agreements.

Have you ever imagined how an auxiliary verb ‘is’ could make India lose 100 Billion US dollars in Investment?

Yes. You have heard right – India could lose 100 Billion USD in possible investment from SWISS investors due to the suspension of the MFN clause by the SWISS Government.

#1: Meaning of MFN:

A Most Favoured Nation Clause in the context of a Double Taxation Avoidance Agreement (DTAA) typically ensures that one contracting state does not discriminate against residents of the other contracting state in tax matters and provides the same benefits offered to residents of any third state with which it has a DTAA.

For example – in the Protocol to India-Swiss DTAA, the following clause highlights the MFN Clause:

“If after the signature of the Protocol of 16th February, 2000 under any Convention, Agreement or Protocol between India and a third State which is a member of the OECD India should limit its taxation at source on dividends, interest, royalties or fees for technical services to a rate lower or a scope more restricted than the rate or scope provided for in this Agreement on the said items of income, then, Switzerland and India shall enter into negotiations without undue delay in order to provide the same treatment to Switzerland as that provided to the third State.”

Basically, the MFN clause has following three key features:

Equal Treatment: It mandates that if one contracting state (e.g., India) agrees to more favorable tax terms (such as lower withholding tax rates or broader exemptions) with a third country, the same favorable terms automatically apply to the other contracting state (e.g., Switzerland) under the MFN clause.

Application Scope: The MFN clause generally applies to specific categories of income like dividends, interest, royalties, or fees for technical services.

Triggered by Subsequent Agreements: The clause is often triggered if the contracting state signs a more favorable DTAA with a third country, particularly one meeting specific conditions (e.g., being a member of the OECD).

#2 The Controversy: High Court, Supreme Court and Swiss Government

In the Nestle[1] case, Hon’ble Delhi High Court referred to Concentrix Netherlands[2] case wherein the tax authorities denied certificates under Section 197 of the Income-tax Act, 1961, allowing withholding tax on dividends at a reduced rate of 5%, based on the Most Favoured Nation (MFN) clause in the India-Netherlands DTAA and issued certificates pegging the withholding tax rate at 10%, prompting the petitioners to approach the Court.

Further, Delhi HC ruled in favour of Concentrix basis the following points:

• Held that the MFN clause in the India-Netherlands DTAA was self-operational and did not require separate notification. The clause mandates that if India agrees to a lower withholding tax rate with a third OECD member country, the same rate applies to the India-Netherlands DTAA.

• Clarified that the term “is” in the MFN clause “is a member of the OECD India” refer to the OECD membership status at the time the MFN benefit is claimed, not necessarily at the time of signing the DTAA with the third state.

• Rejected the argument that separate notification under Section 90 of the Income Tax Act was necessary to make the MFN clause operational, noting that the protocol forms an integral part of the DTAA.

The Indian tax Authorities were not satisfied and knock the door of the Hon’ble Apex Court. The Apex Court in the case of Nestle[3] ruled against Delhi HC view and find the following:

• A notification under Section 90(1) of the Income Tax Act is necessary and mandatory for a court, authority, or tribunal to give effect to a DTAA or any protocol changing its terms or conditions. This notification is required to alter the existing provisions of law.

• The court clarified that the MFN clause in a DTAA does not automatically lead to the integration of benefits extended to another OECD member country. The terms of the earlier DTAA must be amended through a separate notification under Section 90.

• The term “is” in the context of the MFN clause has a present signification. For a party to claim the benefit of a “same treatment” clause, the relevant date is when the DTAA is entered into with India, not a later date when the country becomes an OECD member.

• The court considered international practices and the Vienna Convention on the Law of Treaties (VCLT) for treaty interpretation. It highlighted that the treaty practice of countries like Switzerland, Netherlands, and France is dictated by their constitutional and legal regimes, which differ from India’s requirements for treaty integration into domestic law.

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[1] M/S Nestle SA vs. Assessing Officer, W.P.(C) 3243/2021

[2] Concentrix Services Netherlands B.V. vs. Income Tax Officer TDS & Anr W.P.(C) 9051/2020 and W.P.(C) 882/2021

[3] CIVIL APPEAL NO(S). 1420 OF 2023

As a result of the Apex Court judgment, Switzerland decided to suspend the MFN clause from the India-Swiss DTAA, which will increase the dividend withholding tax rate for Indian residents and companies with Swiss investments.

#3 Conclusion and Way Forward

This recent development from the Swiss side will lead to higher tax rates on dividends. Indian companies will face higher tax liabilities as the withholding tax on dividends from Swiss entities rises to 10%, aligning with the rate Swiss companies already bear for dividends from Indian subsidiaries post Apex Court ruling. While this impacts dividend-related tax burdens, other DTAA benefits, such as relief on royalties and fees for technical services, remain unchanged.

The increase in taxes on dividends in India vis-à-vis Switzerland will lead to curtailment of Swiss investment in India which shall impact 100 Billion Swiss investment. This all started with interpreting word ‘is’ in DTAA.