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August 26, 2021
2021-1570

Swiss authorities release statement on application of Most Favored Nation clause in India-Swiss tax treaty

Executive summary

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.

Detailed discussion

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:

  • Article 11 of the amending protocol dated 30 August 2010 in the Treaty contains an MFN clause, limiting taxation at source on dividends, interest, royalties or fees for technical services to a lower rate as prescribed in any subsequent tax treaty with an OECD member country.
  • Following the signing of the amending protocol, India concluded two new tax treaties:, (1) with the Government of the Republic of Lithuania dated 26 July 2011; and (2) with the Government of the Republic of Colombia dated 13 May 2011 (which are now OECD members as of 5 July 2018, and 28 April 2020 respectively), and in which it granted lower rates with respect to dividends.
  • On the basis of the MFN clause between Switzerland and India, Lithuania's and Colombia’s accession to the OECD has the effect of retroactively (from 5 July 2018 for qualified participations or from 28 April 2020 for all participations) reducing the residual tax rate in the source State for dividends from 10% to 5% applicable to relationships between India and Switzerland.
  • Thus, under the provisions of Treaty, Indian tax residents receiving dividends from a Swiss source can claim, as of 5 July 2018 or as of 28 April 2020 (see above), subject to the conditions set forth in the Treaty, a refund of the (additional) withholding tax in accordance with established procedures. Any refund for civil year 20184 (for qualified participations) should be claimed before the statute of limitations lapses on 31 December 2021.
  • For Swiss tax residents benefitting from this reduced withholding tax rate on Indian-sourced dividends, the foreign tax credit, if any, would be correspondingly reduced.
  • The Swiss competent authority reserves the right to reverse the retroactive interpretation and to readjust the treaty rates prospectively from 1 January 2023 if India were to have a different view to Switzerland.

Implications

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.

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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

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ENDNOTES

  1. From the date of accession of Lithuania and Colombia to the OECD.
  2. In the cases of Concentrix Services Netherlands B.V. and Optum Global Solutions International B.V. in the context of the India-Netherlands tax treaty and separately in the case of Nestle SA in the context of India-Switzerland tax treaty.
  3. State Secretariat for International Finance (SIF).
  4. Civil year 2018 relates to the calendar year starting on 1 January 2018 and ending on 31 December 2018.
 

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