SC’s Nestle Judgement reason behind the Swiss revoking of India’s Most Favoured Nation (MFN) treatment

Introduction -

On 11th December 2024, Switzerland announced that with effect from 1st January 2025, India’s Most favoured nation (MFN) tittle under the Double Tax Avoidance Agreement (DTAA) is being revoked. This means that Indian entities operating in Switzerland will have to face higher tax liabilities from the coming year. This move by the Swiss government comes in response to India’s apex court’s ruling in the Nestle case where the court held that the MFN clause will not be enforced until it has been notified by Central Government under section 90 of Income tax act. “On the basis of the Indian Supreme Court ruling, the Swiss competent authority acknowledges that its interpretation of para. 5 of the Protocol to the IN-CH DTA is not shared by the Indian side. In the absence of reciprocity, it therefore waives its unilateral application with effect from 1 January 2025,” said Swiss officials.

What is Most Favoured Nation (MFN) tittle and Double Tax Avoidance Agreement –

The Double Tax Avoidance Agreement or the Tax treaty is any treaty between two countries that mitigates the situation of double taxation i.e. when tax is levied in two or more places on the same income or financial transaction. It is a common practice for countries to enter into DTAAs in order to increase capital investment, import, export, etc.

Now an MFN clause in the DTAA refers to a tittle given to a country which ensures that host counties give all its trading countries equal trade benefits. For Instance, If Switzerland gives a lower tax rate to Vietnam than another county, it would have to match the same benefit to all of its other trading partners. This is aimed to ensure equality between all a country’s global trade partners.

The most favoured nation clause is not only restricted to the world of global trade but is a very common term in finance and commercial transactions. MFN clauses can be found in commercial transactions as most-favoured-customer clause, prudent buyer clause, or non-discrimination clause where the sell promises to the buyer that it would not give any better terms to any other buyer and if it would do so then the same will be matched for the former as well. It is very much used in insurance contracts involving multiple agreements where MFN clause allows for better or as good covenants in second agreement than in the first agreement.

SC’s Nestle Judgement -

A supreme court bench of Justice Ravindra Bhat and Justice Dipankar Dutta on 19th October 2023 held that the DTAA cannot be enforced unless it is explicitly notified by the Central Government under section 90 of the Income Tax Act. The matter came as an appeal to set aside the order of the Delhi High Court which upheld the applicability of residual tax after accounting for the MFN clause under the DTAA. But the Supreme Court’s adverse order has contradicted Swiss notification issued which said that “Based on the MFN clause between Switzerland and India, the tax rate on dividends from qualifying shareholdings would be reduced from 10 per cent to 5 per cent, effective retroactively from July 5, 2018”

Originally, India had signed treaties with Lithuania and Columbia before these countries were part of the organisation for Economic Co-operation and Development (OECD) which capped taxes of certain kinds at 5%. Later when they joined the OECD, Switzerland reduced their original rate with India from 10% to 5% which to match the rate India, Lithuania and Columbia maintained. But w.e.f 1st January the tax rates would be back to the orignial 10%.

Effects of this revocation –

Switzerland in its statement has stated that the sole reason behind the revocation of India’s Most Favoured Nation (MFN) status is the lack of reciprocity between India and Switzerland on the treaty. This suspension will now expose Indian entities operating in Switzerland to higher tax liabilities. The same treatment will be followed in India where Swiss companies would have to pay higher taxes from the new year. Overall the lack of a MFN clause between India and Switzerland is definitely going to adversely affect inbound-outbound investment and trade between both the countries.