Context: Switzerland has withdrawn the Most Favoured Nation (MFN) status of India accorded to India under the Double Taxation Avoidance Agreement or DTAA treaty.
Relevance of the topic:
Prelims: Most Favoured Nation, DTAA and associated terms.
Mains: Scope of analytical question on impacts, benefits and issues associated with DTAA and MFN.
Major Highlights:
- This decision comes after an adverse ruling from the Indian Supreme Court (2023) regarding a tax dispute involving Nestlé (the Swiss food giant).
- In 2023, the Supreme Court ruled that India’s Income Tax Act (Section 90) requires explicit government notification to extend benefits of MFN clauses in DTAA agreements.
- In reciprocation to the decision, Switzerland invoked ‘Principle of Reciprocity' and unilaterally withdrew MFN status of India.
- From January 1, 2025, Switzerland will levy a 10% tax (instead of the current 5%) on dividends payable to Indian tax residents and entities who claim refunds for Swiss withholding tax.
What is MFN and the Principle of Reciprocity?
- Most Favoured Nation (MFN) status if given to a nation allows concessions in tax rates and tariffs. MFN works on the principle of reciprocity i.e., quid pro quo principle where both nations enjoy MFN status of each other.
- MFN status is one of the cornerstones of the World Trade Organisation (WTO) trade law.
- Each member of WTO treats all the other members equally as “most-favoured” trading partners.
- If a country improves the benefits that it gives to one trading partner, it has to give the same best treatment to all the other WTO members.
About Double Taxation Avoidance Agreement (DTAA):
- Double Taxation Avoidance Agreement is an understanding between two nations to reduce tax rate over already paid tax in one of the partner nations.
- DTAA allows reduction in tax compliance of the multinational firm working in both partner nations as it reduces cascading impact on tax, enhancing ease of doing business.
Indian-Switzerland Trade Relations:
- Switzerland's investment flows in India amounted to $9.9 billion from 2003 to 2023.
- As per the International Monetary Fund, Swiss investment stocks in India amount to $35 Billion in 2023.
Impacts of MFN Withdrawal:
- Tax burden on Indian Firms: As a result of MFN withdrawal, Switzerland will impose a 10% withholding tax on Indian entities. Higher tax liabilities would reduce profit margins.
- Reduced investor Confidence: The move may discourage Swiss business and investors from engaging with Indian entities due to the increased tax liabilities.
- Negatively Impact global position: The move can potentially affect ongoing Free Trade Agreement negotiations with the European Union.
- Increased regulatory barriers: As move can spill over into other trade dynamics leading to sanitary and phytosanitary compliance burden in sectors like pharmaceuticals.
- Loss of competitive edge to other competitive nations like China which can fill the vacuum of Swiss trade and investment.
- Possible retaliatory measures as India could impose strict measures on Swiss companies, affecting their operations in India and potentially slowing trade growth.
Way Forward:
- Renegotiating DTAA: The DTAA needs to be renegotiated to clarify the MFN terms and establish a body for a neutral arbitration mechanism to avoid arbitrary interpretation of trade clauses.
- Enhanced investment protection mechanisms like Bilateral Investment Protection Treaties to foster the confidence among the investors and to promote bilateral trade.
- Fasttrack India-EFTA trade agreement: Concluding EFTA will ensure new trade avenues to India ensuring mutual trade benefits with partner nations.
- Strengthening Domestic Competitiveness: Reducing regulatory barriers and improving Ease of doing business will help attract foreign investments.
- Digital and financial reforms: Adopting blockchain in trade agreements and developing fintech partnerships will boost trust and flexibility in the trade relations.
Conclusion: Switzerland withdrawal of India's MFN status highlights challenges in bilateral trade, including increased tax rates and investment uncertainties. However, it provides an opportunity to renegotiate clearer agreements, diversify trade, and foster collaborations. Strengthening dialogue and trust can ensure resilient, mutually beneficial economic ties for long-term growth and stability.