Switzerland’s MFN suspension: Consequences for trade ties

Switzerland’s decision to suspend the Most Favoured Nation (MFN) status under its Double Taxation Avoidance Agreement (DTAA) with India, effective January 1, 2025, could have significant implications for trade and investment. While it may not immediately disrupt trade, it will raise taxes for Indian companies operating in Switzerland, particularly those in the IT, pharmaceutical, and financial sectors. The withholding tax on dividends will increase from 5% to 10%, affecting Indian firms with subsidiaries in Switzerland.

Switzerland’s decision to suspend the most favoured nation (MFN) status under its double-taxation avoidance agreement (DTAA) with India, starting January 1, is a significant development, especially considering that Switzerland is India’s largest trading partner within the European Free Trade Association (EFTA).

This is a significant development, as the Trade and Economic Partnership Agreement (TEPA) with the EFTA nations—Switzerland, Iceland, Liechtenstein, and Norway—offers India valuable benefits, including a commitment to US$ 100 billion in investment and the creation of one million direct jobs over the next 15 years. The EFTA agreement is especially beneficial for India, as it allows duty-free market access for nearly all imports, with India committing to reduce tariffs on 80-85% of goods from EFTA countries. However, India has excluded some products, like gold, jewellery, dairy, cheese, and automobiles, from these reductions.

While the withdrawal of MFN status by Switzerland may not immediately disrupt trade, with India’s exports to the EFTA bloc standing at US$ 1 billion and imports at US$ 10.7 billion in the first half of FY’ 25, it could have long-term implications.  Starting January 1, 2025, Switzerland will impose a tax on dividends for Indian tax residents claiming refunds for Swiss withholding tax, as well as for Swiss tax residents claiming foreign tax credits. This move is expected to impact Swiss investments in India and may lead to higher taxes for Indian companies operating in Switzerland.

Switzerland’s decision could have significant consequences for Indian investors, particularly those in the IT, pharmaceutical, and financial sectors. The suspension disrupts the preferential trade framework India previously benefited from under the MFN principle, which is a key aspect of the World Trade Organization (WTO).

The move stems from a ruling by India’s Supreme Court last year, which stated that the MFN clause does not automatically apply when a country joins the OECD if India had signed a tax treaty with that country prior to its membership. This ruling followed tax treaties India had signed with Colombia and Lithuania, which offered more favorable tax rates than those applied to OECD members. After these countries joined the OECD, it raised questions about the automatic application of the MFN clause.

Starting January 1, 2025, Switzerland will levy a tax on dividends for Indian tax residents claiming refunds for Swiss withholding tax, as well as for Swiss tax residents claiming foreign tax credits. This move is expected to impact Swiss investments in India and may result in higher taxes for Indian companies operating in Switzerland, particularly those with Overseas Direct Investment (ODI) structures and subsidiaries there. As a result of this suspension, Indian companies operating in Switzerland will now face a higher tax rate on dividends and other income, with the Swiss withholding tax increasing from 5% to 10% starting January 1, 2025. This shift could create new tax challenges for Indian firms, particularly in sectors such as pharmaceuticals, IT, and financial services.

The suspension of MFN status also introduces broader concerns. It could lead to higher tax liabilities for Indian entities in Switzerland, complicating their operations and impacting their bottom line. In addition, Swiss and European Union markets may become less accessible due to the increased tariffs and trade barriers that Indian companies could face.

This change underscores the importance of clear and consistent application of tax treaty clauses and the need for alignment between treaty partners to ensure stability and predictability in international trade and taxation.  Switzerland’s decision to suspend the MFN status also brings attention to issues in India’s approach to MFN clauses in bilateral agreements. Given the importance of the EFTA agreement, this development could have wider implications for trade and investment flows, and it remains to be seen how it will affect India’s future economic relations with the EFTA nations.