Introduction
Swiss-based foreign portfolio investors (FPIs) and private equity players are bracing for higher dividend taxes on their Indian income. Following a December 2023 announcement by the Swiss government, the previously beneficial 5% tax rate for dividends earned in India has been rolled back, increasing the rate to 10%. This move stems from the Indian Supreme Court’s recent ruling on the interpretation of the Most Favoured Nation (MFN) clause in the Double Tax Avoidance Agreement (DTAA) between India and Switzerland.
Background: The MFN Clause and the India-Switzerland DTAA
- The Original Agreement: India and Switzerland signed a DTAA in 1994, with the original tax rate on dividends set at 10%.
- Introduction of MFN: The MFN clause allows a treaty partner to benefit from reduced tax rates offered to another country. For example, India’s DTAA with Lithuania in 2011 provided a 5% tax rate, which Swiss entities argued should apply to them as well under the MFN clause.
- Indian Stance: Indian authorities maintained that MFN benefits must be explicitly notified to take effect, which had not been done.
Supreme Court Verdict and Swiss Response
The Indian Supreme Court ruled in favor of the tax department, stating that the MFN clause does not automatically trigger lower rates. Without a formal notification by the Indian government, the 10% rate under the original DTAA applies. Following this ruling, Switzerland withdrew its unilateral 5% tax interpretation, restoring the higher 10% rate.
Impact on Swiss Investors
- Higher Tax Burden: Swiss FPIs and private equity firms will now pay 10% tax on dividends instead of 5%, reducing net returns and potentially making Indian investments less attractive.
- Increased Uncertainty: Experts highlight the lack of consistency in applying the MFN clause, which could discourage cross-border investments and create double taxation risks.
- Reduced Appeal of Indian Markets: Amit Maheshwari, tax partner at AKM Global, noted that while the higher tax burden may deter some investors, India’s economic growth and other incentives could mitigate the overall impact.
What’s Next? Calls for Clarity
Tax experts urge the Indian government to review its position and issue notifications for the MFN clause in DTAA agreements to ensure consistent tax treatment. This could help rebuild trust with treaty partners and avoid disputes like this in the future.
Conclusion
The rollback of the beneficial 5% tax rate is a significant development for Swiss investors in India, raising concerns about the attractiveness of Indian markets. While the decision aligns with India’s legal interpretation of the MFN clause, it underscores the need for clearer policies to support foreign investments and maintain strong bilateral economic ties.
