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August 25, 2021
Swiss authorities release statement on application of Most Favored Nation clause in India-Swiss tax treaty
The Swiss competent authorities have released a statement clarifying that, on the basis of the Most Favored Nation (MFN) clause in the India-Switzerland tax treaty (the Treaty), Lithuania's and Colombia’s accession to the Organisation for Economic Co-operation and Development (OECD) has the effect of retroactively1 reducing the residual tax rate in the source State for dividends from 10% to 5% for qualified participations under the Treaty.
This Alert summarizes the statement and implications for taxpayers.
Under the Treaty, dividends paid by Indian companies to residents of Switzerland and vice-versa, who are beneficial owners of such dividends, are subject to withholding tax at a rate not exceeding 10%. The protocol of the Treaty contains an MFN clause, which states that if India enters into a tax treaty on a later date with a third country, which is an OECD member, providing a more beneficial rate of tax or restrictive scope for taxation of dividends, interest, royalties, etc., a similar benefit should be accorded to the India-Switzerland tax treaty as well.
Some Indian tax treaties with OECD member countries such as Lithuania and Colombia provide for a lower withholding tax rate of 5% for dividends, subject to conditions. However, these countries were not OECD members when the respective tax treaties were entered into by India, but became OECD members only at a later date.
There has been a lack of judicial guidance in India on whether the beneficial tax rate under the tax treaties with Lithuania and Colombia could be applied to other tax treaties with the MFN clause, until recently when an Indian Court (the Delhi High Court) ruled in two separate cases in favor of the taxpayers on the issue of the withholding tax rate applicable to dividend income earned by taxpayers under the India-Netherlands tax treaty and the India-Switzerland tax treaty.2
The Swiss competent authorities3 have now issued a statement clarifying the applicability of the MFN clause as follows:
The statement from the Swiss competent authorities provides additional guidance on the potential for applicability of lower withholding tax rates pursuant to the MFN clause amid the recent adoption of the classical system of dividend taxation in India from the tax year 2020-21 onwards.
The clarification from the Swiss competent authorities confirms that the MFN clause between India and Switzerland has automatic application and there is no requirement for any notification to trigger the MFN clause. Swiss tax residents who have already received dividend income from Indian companies subject to 10% withholding may explore options to seek a refund of additional tax withheld by filing their Indian tax return.
This clarification, along with the recent Indian judicial pronouncements, is a significant development as many tax treaties entered into by India with countries such as Netherlands, France, Switzerland, Sweden, and Hungary have comparable MFN clauses. Furthermore, as the MFN clauses also apply to income in the nature of interest, royalties and fees for technical services, it is recommended that multinational companies with Indian investments through these countries or operations in these countries evaluate the impact of this favorable development on dividends and other streams of income.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Ltd (Switzerland), Zurich
Ernst & Young Ltd (Switzerland), Bern
Ernst & Young Ltd (Switzerland), Geneva
Ernst & Young LLP (India), Mumbai
Ernst & Young LLP (India), Bangalore
Ernst & Young LLP (United States), Swiss Tax Desk, New York
Ernst & Young LLP (United States), Swiss Tax Desk, San Francisco
Ernst & Young LLP (United States), Indian Tax Desk, New York
Ernst & Young LLP (United States), Indian Tax Desk, San Jose
Ernst & Young Solutions LLP, Indian Tax Desk, Singapore
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
Ernst & Young LLP (United States), Asia Pacific Business Group, New York
Ernst & Young LLP (United States), Asia Pacific Business Group, Chicago