Switzerland-based foreign portfolio investors (FPIs), including those managed by leading Swiss banks such as UBS and Credit Suisse, stare at higher dividend taxes from their India income after the European country decided to roll back the beneficial dividend tax rate for India income, say tax experts.
The move will impact about 90 Swiss-based FPIs along with dozens of private equity players who invested in companies through the foreign direct investment (FDI) route.
On December 13, Swiss government announced it was withdrawing the 5 percent beneficial tax rate for dividends earned in India following the 2023 verdict of the Indian Supreme Court regarding interpretation of the Most Favoured Nation (MFN) clause in the double tax avoidance agreement (DTAA) between India and five other countries, including Switzerland. The dividends will now be taxed at 10 percent instead of 5 percent earlier.
“In response to the Indian SC ruling, Switzerland has also withdrawn the beneficial tax treatment of 5 percent. This will certainly impact the FDI and FPI investments from Switzerland negatively,” Punit Shah, partner, Dhruva Advisors, said.
“Switzerland had unilaterally notified and extended the beneficial tax rate of 5 percent on dividend income based on the MFN clause. This treatment was based on the liberal interpretation of the MFN clause that even if the countries have become OECD member subsequently, the benefit should be granted.” Shah added referring to the Organisation of Economic Co-operation and Development.
Emails sent to UBS remained unanswered.
Tax experts say the move also creates uncertainty for the funds from the point of view of double taxation.
"This episode may create uncertainty and inconsistency in the application of the MFN clause across different DTAAs and could potentially undermine the objective of avoiding double taxation and promoting cross-border investment," said Suresh Swamy, Partner, Price Waterhouse & Co LLP. "It may be beneficial if the Indian government could review its position and issue appropriate notification or clarification to implement the MFN clause in the Swiss DTAA, as well as in other DTAAs that have comparable clauses, in order to enhance the certainty and consistency of the tax treatment for the taxpayers and build trust with treaty partners"
India and Switzerland interpreted MFN differently, leading to the dispute
At the heart of the case is a commonly employed clause in various tax agreements: MFN.
When a country, through tax agreement, gives another country the MFN status, it means if the country, which offered MFN, in future signs any tax agreement with some other country where the tax rates have been kept lower, then even the country with MFN status is eligible for these lower rates.
India signed a DTAA with Switzerland in 1994. It amended twice — in 2000 and 2010. The original rate of taxation for dividends was 10 percent in the India-Swiss DTAA.
However, July 2011, India signed a DTAA with Lithuania where it offered a 5 percent dividend tax rate to investors who held more than 10 percent stake in a company.
In the same year, India signed a DTAA with Columbia, wherein all investors were given a 5 percent dividend tax rate.
Now, Switzerland has interpreted that the MFN clause gets triggered and hence even Swiss entities were eligible for the beneficial tax. The Swiss authorities also expected reciprocity from India meaning income of Swiss entities being taxed in India will also be subject to beneficial tax rates.
“Swiss investors will face a withholding tax of 10 percent on dividends as per the original double taxation treaty instead of 5 percent. It effectively means paying more tax on dividends received from India and this will also reduce their net returns as shareholders. This can make Indian investments less attractive due to almost double the burden from erstwhile 5 to 10 percent now. This could result in some dip in FPIs and FDI from Switzerland as it is a capital exporting country. But overall, the impact might be mitigated by other factors such as India's growth potential and other tax incentives that may be offered by the Indian government,” Amit Maheshwari, tax partner, AKM Global, said.
MFN needs notifying: Tax department
Indian tax authorities interpreted the rules differently and eventually it turned into a legal dispute with companies such as Nestle.
The top court ruled in favour of the tax department in 2023.
The department argued that the presence of MFN clause in a DTAA doesn’t automatically trigger lower tax rates and the Indian government will have to notify it same. Without the notification, lower taxes cannot be unilaterally approved. The Supreme Court agreed with the tax authorities.
Since India is no longer providing the beneficial tax rates to Swiss entities, the Switzerland has now rolled back its unilateral interpretation of the MFN clause, experts say.
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