By Bijal Ajinkya (Partner) and Raghav Kumar Bajaj (Principal Associate) at Khaitan & Co, Mumbai
The Swiss tax authority confirmed on 13 August that dividends received by an Indian resident from a Switzerland company will be subject to only a 5% withholding tax rate in Switzerland. The Swiss notification also states that if India does not reciprocate, the Swiss Authority reserves the right to inter alia readjust the aforesaid withholding tax rate.
Tax treaty and MFN clause
The India–Switzerland tax treaty of 1994 provides for a 10% withholding tax rate in the source country for dividend payments. Thus, dividends paid by an Indian company to a Swiss resident are subject to a 10% withholding tax rate in India; similarly, dividends paid by a Swiss company to an Indian resident are subject to a 10% withholding tax rate in Switzerland. In 2010, the treaty was amended by way of an amending protocol, which added a “Most Favoured Nation” (MFN) clause.
The MFN clause stipulated that if, after the signing of the amending protocol, India – under any convention, agreement or protocol with a third country which is a member of the OECD – limits its taxation at source on inter alia dividends to a rate lower than the rate provided for in the India–Switzerland tax treaty, the same rate as provided for in that other tax treaty shall also apply between Switzerland and India as from the date on which such other tax treaty enters into force.
In 2011, India entered into tax treaties with Lithuania and Columbia which contained a lower rate of withholding tax (5%) in the source country. In the case of Lithuania, the 5% rate was applicable if the shareholder owned a prescribed percentage. In the case of Columbia, the 5% rate was the general rate. Lithuania became an OECD member on 5 July 2018, and Columbia became an OECD member on 28 April 2020.
Swiss notification
In line with the MFN clause, the Swiss notification has confirmed that with effect from 5 July 2018 / 28 April 2020 (as the case may be), dividends paid by a Swiss company to an Indian resident will be subject to only a 5% withholding tax rate in Switzerland. The Swiss notification also states that, accordingly, Indian tax residents receiving dividends from a Swiss source can claim a refund of the additional withholding tax (i.e., 10% minus 5%) in accordance with the applicable procedures, in cases where dividends were received after 5 July 2018 / 28 April 2020 (as the case may be).
Interestingly, the Swiss notification also expects that India will honor its treaty obligations and provide reciprocity for payments made to Swiss residents. In this regard, the Swiss Notification states that “Should reciprocity in the interpretation of the most favoured nation clause not be guaranteed by the Indian competent authority, the Swiss competent authority reserves the right to reverse this interpretation and to readjust the treaty rates applicable to income accruing as of 1 January 2023.”
Implications with respect to India
India does not have much jurisprudence or guidance in the context of interpretation of MFN clauses under its tax treaties, except for a recent ruling by the Hon’ble Delhi Court in the case of Concentrix Services Netherlands BV WP (C) 9051/2020 and Optum Global Solutions International BV WP (C) 882/2021.
Generally, MFN clauses in tax treaties are meant to operate automatically once some other tax treaty with a lower threshold for taxation / lower tax rate is entered into by India. Despite this, Indian tax authorities have argued that such clauses do not become effective unless a separate notification is issued by the government and have consequentially denied the benefits in certain cases. In such instances, to dispel such an argument, any notification/decree issued by a foreign government expressing its interpretation of the MFN clause is also resorted to by Indian courts.
The India–Switzerland tax treaty is beneficial for Indian companies setting up their global headquarters in Switzerland and benefitting from the 5% withholding tax rate. Conversely, multinational companies considering an investment in India, and looking to benefit from a lower withholding tax, should also consider Switzerland as an appropriate holding company jurisdiction, especially with the overhaul and shift to a shareholder level taxation for dividends distributed by Indian companies. As MFN clauses benefit other streams of income also – like interest, royalties, fees for technical services – foreign investors with Indian investments should evaluate the impact of such clauses on their India-sourced incomes.
It is interesting to note the recent attitude of foreign governments vis-à-vis the approach of the Indian tax authorities, in light of the recent international arbitration proceedings with Cairn UK and now with this Swiss notification.
—Bijal Ajinkya is a Partner and Raghav Kumar Bajaj is a Principal Associate at Khaitan & Co, Mumbai.
The views of the authors in this article are personal and do not constitute legal/professional advice of Khaitan & Co. For any further queries or follow-up on Indian law queries please contact us at [email protected].
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