Nestlé judgment jolts Swiss MFN provision

Consider a scenario where State A signs a bilateral treaty with State B that includes an MFN provision. If State A later grants benefits to a third country, State C, those benefits should also be extended to State B due to the MFN clause. Switzerland’s recent decision is not retaliatory but rather a reciprocal action stemming from a ruling issued by the Supreme Court of India in October 2023 in the case of Assessing Officer v. Nestlé. In this case, Nestlé sought a preferential dividend tax rate of 5%, instead of the standard 10%, by referencing the MFN provision in the India-Switzerland DTAA. Nestlé argued that India offered a lower dividend tax rate to companies from OECD member countries such as Colombia and Lithuania. The MFN provision in the India-Switzerland DTAA provides that the benefits given to a country “which is a member of the OECD” should be extended to the signatory state.

However, the Supreme Court disagreed. The court held that when India signed DTAAs with Colombia and Lithuania, these countries were not yet OECD members, as they joined the organisation later. Thus, the court concluded that India is not obligated to extend the preferential rates granted to Lithuania to Switzerland under the MFN clause. This interpretation suggests that the MFN provision in the India-Switzerland DTAA is frozen in time. Such a reading gainsays the purpose of the MFN provision, which is meant to ensure that future benefits provided to a third country by one of the treaty-signing countries are automatically available to its treaty partners. Furthermore, there is no indication in the text of the India-Switzerland DTAA that the phrase “which is a member of the OECD” applies only to countries that were members at the time India signed its DTAA with them, excluding those that may become members later.

Another reason advanced by the apex court was the lack of a notification under Section 90(1) of the Income Tax Act implementing the MFN provision of the India-Switzerland DTAA. The court held that a notification under Section 90(1) is a necessary and mandatory condition to give effect to a DTAA.

As a direct consequence of Switzerland’s action, Indian businesses operating in Switzerland now face a higher tax burden, with withholding tax increasing from 5% to 10%. Estimates suggest this change could affect several companies. Other OECD countries, such as the Netherlands — on whose companies India imposes a 10% dividend tax — might also consider rescinding the MFN obligation in their DTAAs with India. If this occurs, it will increase costs for Indian businesses operating in those countries. Moreover, there are concerns about the potential negative impact of this decision on the flow of Swiss investments into India.

It is critical to note that earlier this year, India and the European Free Trade Association (EFTA), of which Switzerland is a vital participant, signed a free trade agreement (FTA). According to this FTA, EFTA countries shall aim to increase foreign direct investment from EFTA investors into India by $100 billion over the next 15 years. However, given that there has been no change in Indian tax rates on Swiss companies, it is unlikely that Swiss investments in India will be adversely affected. However, India not offering an MFN rate to Swiss companies does impact the overall investment climate. 

India does have the option to issue a notification under Section 90(1) of the Income Tax Act to reduce the dividend tax rate on Swiss companies to 5%. This action would compel the Swiss government to reverse its decision and lower the rate from 10% to 5%. However, this would also entail two significant implications. First, India would need to issue similar notifications for other OECD countries. Second, India would have to forgo the revenue it expected to collect from the increased dividend tax rate. The question remains: Is New Delhi prepared to make this concession?

Beyond the tax implications, this development serves as a stark reminder to Indian policymakers that the MFN principle is a two-way street. If non-discrimination cannot be guaranteed for foreign players in India, one must be prepared for Indian companies to encounter discrimination or non-MFN treatment abroad. This consideration is pertinent not only in the context of tax agreements but also extends to other bilateral treaties, such as investment agreements.

Prabhash Ranjan is professor and director, Centre for International Investment and Trade Laws,Jindal Global Law School, O P Jindal GlobalUniversity. The views expressed are personal

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