Switzerland MFN withdrawal: Pay 10% tax instead of 5% on dividend income from January 1, 2025;
know how it will impact taxpayers
Dec 21, 2024
Synopsis
Higher tax on dividend: From January 1, 2025 Indians need to pay witholding tax at 10% rate instead of 5% rate in Switzerland. Experts say this may result in burden for a company's cash flow and may also result in dead loss for certain trusts and individuals investing in Switzerland. Read below to know the impact of this decision by Switzerland.
The State Secretariat for International Financial Matters, which represents Switzerland's interests in financial, monetary and tax matters, has officially decided to suspend the most favoured nation (MFN) clause between Switzerland and India with respect to taxes on dividend income with effect from January 1, 2025. This means dividend income will be taxed at 10% rate instead of 5% in Switzerland for Indians in the new year 2025.
This decision by Switzerland comes against the backdrop of a recent Supreme Court of India (Case - Nestle SA [2023] 458 ITR 756 (SC)) ruling, which rejected the interpretation of the most favored nation (MFN) clause in India's Double Taxation Avoidance Agreement (DTAA) with Switzerland, Netherlands and France. While the geo-political consequences of this action are yet to unfold completely, it's also important to assess its impact and act especially for Indian residents and companies who got caught in the cross-fire of this action of the institutions in these two countries.
However, despite this unfavourable development for Indian investors the worse outcome was still avoided. Experts with whom we spoke said thankfully the Switzerland government ceased MFN clause for only dividend income and left royalty and other incomes outside it, so the impact might not be that deep. Nevertheless, an impact in the nature of stress on cashflows and ‘dead loss’ can be felt by Indian business and residents who have financial interest in Switzerland.
Read below to know how this decision by Switzerland will impact the business operations and how to tactfully minimise the negative impact.
Short brief of Switzerland and India’s position about most favoured nation clause (MFN)
MFN clause means if India signs a beneficial treaty with a country, then it must extend this beneficial treatment to other countries whom India signed MFN clause.
“...The statement of 13 August 2021 specified that, in the event that reciprocity regarding the interpretation of the most-favoured-nation clause was not guaranteed by the Indian competent authority, the Swiss competent authority would reserve the right to reverse the unilateral application of the most favoured nation clause and to readjust the treaty rates applicable to income accruing from 1 January 2023…… For dividends due from and including 1 January 2025, the residual tax rate in the source State is limited to 10%; The position adopted by the Swiss competent authority in its statement of 13 August 2021 remains applicable for income accruing during the 2018-2024 tax years,” said Switzerland Department in a statement dated December 11, 2024.
Impact of Switzerland withdrawing MFN clause for dividend income
ET Wealth Online has asked various experts about the impact of this decision.
“The suspension of the MFN clause and the consequent reversion to the 10% withholding tax rate introduces additional tax costs and compliance challenges for Indian companies and residents engaged in cross-border transactions with Switzerland,” says Sandeep Jhunjhunwala, Partner, Nangia Andersen LLP.
Here’s a summary of what they said:
Indian companies cashflow situation may take a hit
If a company has paid tax in Switzerland, then they can claim foreign tax credit at the time of filing ITR. But this exercise of ITR filing is done after the end of the financial year, but interim dividends are received during the financial year. So, companies need to pay the Switzerland tax and then wait for a year to claim this credit. Moreover, in some cases even the foreign tax credit is also not available, so for these taxpayers, it is a loss.
Gaurav Makhijani (Head of Tax for North India and Gujarat) at Roedl & Partner India, says, “The decision by the Swiss authorities to apply a 10% tax rate on dividends by revising the earlier unilateral concession of 5% would mean that Indian investments in Switzerland will now be subject to a higher tax rate. Under India’s domestic tax law read with the India-Switzerland Tax Treaty, Indian taxpayers should generally be able to claim a foreign tax credit. In most cases, a full tax credit should be available since the increased Swiss tax rate of 10% remains lower than India’s tax rates on dividend income, which range from 25.17% (for domestic companies) to 30% plus surcharge and cess (for trusts, LLPs, etc.), and as per slab rates for individuals.
There may be a few exceptions where full tax credit is unavailable. For instance, trusts or funds with investments in Switzerland that incur losses or operate on low profit margins which receive dividends classified as business income may not get full credit. This is because foreign tax credit will not be available with losses and India will allow a lower tax rate applicable in India and Switzerland (on net profit basis).”
Chartered Accountant Ashish Karundia agrees with Makhijani about the increase in pressure on the company’s cash flow situation. “The increase in withholding tax from Switzerland could impact the Indian parent company’s cash flow due to the additional 5% tax, which may need to be paid before the corresponding advance tax due dates. If the Indian company is in a no-tax situation under the domestic tax law, then the new 5% tax increase could create a cash flow burden,” he says.
“For example, a Swiss confectionery group with an Indian subsidiary faces a 10% tax deduction on dividends declared post-Supreme Court ruling, instead of the 5% MFN rate it may have previously enjoyed. Conversely, an Indian IT company with a subsidiary in Switzerland would have benefited from the MFN clause reducing withholding tax to 5% for dividends paid in 2023. However, starting January 1, 2025, the withholding tax rate will increase to 10%,” says Karundia.
Increased tax cost of investment for Indian residents due to ‘dead loss’
Many high-net-worth individuals invest in foreign countries through trust funds, direct, or through a stock broker, etc. Experts say these taxpayers need to replan their investment strategy before January 1, 2025 to minimise the impact.
Jhunjhunwala says, “Indian residents holding shares in Swiss companies will now face a higher withholding tax deduction at the standard 10% rate on dividends. While the India-Switzerland DTAA permits these residents to claim a foreign tax credit (FTC) against their Indian tax liability, the following scenarios may arise:
If the Switzerland withholding tax exceeds the Indian tax liability, the excess amount will represent an unrecoverable loss (commonly referred to as a dead loss) as Indian tax law does not provide for refunds of unused FTC.
For taxpayers in lower income brackets, this situation reduces the net return on investments, potentially discouraging further capital allocations to Switzerland securities.”
Makhijani says, “individuals receiving dividends from trust funds with pass-through status, which are taxed entirely at the individual level, could face a shortfall in tax credit if they fall within lower tax brackets. In such cases, this change effective from January 1, 2025 could result in a marginally higher tax cost.”
The Switzerland authority emphasized that its interpretation of the MFN clause remains applicable for income accrued till 2024. “This means Indian residents who received dividends before Jan 1 2025, can still claim a lower tax rate of 5% based on the previous interpretation,” says Chartered Accountant Deepak Chopra, Partner, Deepak Niraj & Associates
"It is important to note that the MFN clause has not been completely suspended. The withdrawal only applies to the reciprocity under the dividend article. The MFN provisions for interest, royalties, and fees for technical services (FTS) remain in effect. Additionally, if India and any OECD member (as of the date the India-Swiss DTAA was signed) reduce their dividend withholding tax rate in the future to below 10% under their respective DTAAs, the MFN clause will still apply under the India-Swiss DTAA," says Karundia.
Makhijani says: "Switzerland is predominantly a capital-exporting country, particularly in sectors like machinery, luxury goods, and dairy products. Moreover, with Switzerland being one of the four countries part of the Trade and Economic Partnership Agreement (TEPA), its economy benefits from relatively free access to India’s vast market. In my view, this differential tax rate is unlikely to have any significant impact on the broader India-Switzerland economic relationship. On the contrary, with enhanced market access under TEPA and committed Swiss investment into India, we anticipate stronger cooperation and a rise in bilateral business transactions between the two nations."
[The Economic Times]
