MOSF FAVOURED NATION : ECONOMY

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

  1. 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.
  1. 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.
  1. Outcome:

o   The taxpayer pays tax only once or at a reduced rate, avoiding double taxation.