The most favoured nation (MFN) principle is a cornerstone of the multilateral trading system conceived after World War II. It seeks to replace the frictions and distortions of power-based (bilateral) policies with the guarantees of a rules-based framework where trading rights do not depend on the individual participants’ economic or political clout. Read here to learn more.
The suspension of the Most Favoured Nation (MFN) clause in the Double Taxation Avoidance Agreement (DTAA) between India and Switzerland from January 1, 2025, marks a significant shift in the tax treaty framework between the two countries.
This decision, driven by a 2023 Supreme Court ruling, has implications for tax liabilities, bilateral investments, and international treaty applications.
Suspension of Most Favoured Nation Status by Switzerland
- Supreme Court Ruling (2023):
- The MFN clause in DTAAs cannot be automatically triggered when a country joins the OECD.
- Enforcement of any benefits under DTAA requires specific notification under the Income-Tax Act, 1961.
- India-Switzerland DTAA:
- It came into effect in 1994 to avoid double taxation on income.
- Previously allowed 5% withholding tax on dividends under the MFN clause.
- Suspension of MFN Clause: Starting January 1, 2025, the MFN clause will no longer apply.
Impacts of the Suspension
Increased Tax Burden for Indian Companies
- Withholding tax on dividends from Switzerland will rise to 10% from 5%.
- Indian companies with Swiss investments face higher tax liabilities, reducing profit margins.
Effects on Swiss Investments in India
- Swiss companies receiving dividends from Indian subsidiaries will continue to face a 10% withholding tax, as stipulated in the DTAA.
- This could discourage further Swiss investments in India due to reduced post-tax returns.
Re-evaluation of MFN Clauses by Other Countries
- Switzerland’s decision may lead other countries to reconsider their interpretation and application of MFN clauses in tax treaties with India.
- This could result in revised tax treaty negotiations or increased disputes over tax liabilities.
No Impact on Other DTAA Benefits:
- Provisions other than the MFN clause, such as those on double taxation relief or income categorization, remain unaffected.
- Investments from European Free Trade Association (EFTA) members are also unaffected.
Economic Impact:
- Higher tax burdens may deter cross-border investments and reduce competitiveness for Indian businesses operating in Switzerland.
Legal and Policy Implications:
- Reinforces the need for explicit notification of DTAA benefits under Indian law.
- Highlights India’s growing emphasis on revenue protection over tax treaty concessions.
Global Repercussions:
- May encourage other nations to review how the OECD membership impacts the application of MFN clauses.
- Adds complexity to global tax treaty negotiations, especially in light of emerging global minimum tax frameworks.
Most Favoured Nation (MFN) Status
The most-favoured-nation (MFN) principle is a cornerstone of the multilateral trading system conceived after World
The Most Favoured Nation (MFN) status is a fundamental principle in international trade under the framework of the World Trade Organization (WTO).
It ensures non-discriminatory trade practices among member countries.
Key Features of MFN Status:
- Non-Discrimination: A country granting MFN status to another must extend the same trade benefits (such as low tariffs, fewer trade barriers, or favourable import quotas) to that country as it offers to any other trading partner.
- Automatic Application: MFN treatment is automatically extended between WTO member nations, unless explicitly excluded through exceptions.
- Reciprocity: While MFN status is not inherently reciprocal, many bilateral trade agreements include MFN provisions as a mutual obligation.
- Exceptions Allowed: Countries can form free trade agreements (FTAs) or customs unions without extending similar concessions to non-members.
- Special treatment is also allowed for developing countries under preferential trade agreements.
Significance of MFN Status
- Trade Liberalization: Promotes fair competition and reduces trade barriers, leading to smoother international trade.
- Boosts Economic Relations: Strengthens bilateral and multilateral trade ties by ensuring uniform treatment across partners.
- Predictability and Stability: Creates a consistent trade environment, fostering trust and long-term investment among trading nations.
- Compliance with WTO Rules: Reflects a nation’s commitment to the principles of the WTO, enhancing its global standing.
India’s Context with MFN Status
- MFN Status to Pakistan:
- India granted MFN status to Pakistan in 1996 as part of its obligations under the WTO.
- However, Pakistan has not reciprocated, citing political and security concerns.
- In 2019, following the Pulwama terror attack, India withdrew Pakistan’s MFN status, imposing higher tariffs on imports from Pakistan.
- MFN and FTAs: India incorporates MFN principles in its FTAs while negotiating preferential trade terms with specific countries or regions.
- MFN Disputes and Challenges: Global political and economic conflicts occasionally test the limits of MFN obligations, as seen in cases involving sanctions or geopolitical tensions.
Exceptions to Most Favoured Nation (MFN)
- Preferential Trade Agreements: Concessions within regional trade agreements like SAFTA (South Asian Free Trade Area) or ASEAN Free Trade Agreement.
- Developing Nations: Special provisions like the Generalized System of Preferences (GSP) allow developed countries to offer lower tariffs to developing nations.
- National Security Clause: Countries can revoke Most Favoured Nation (MFN) status citing national security concerns, as India did with Pakistan.
Criticism of MFN Status
- Disparity in Benefits: While the principle ensures equality, it does not address the economic disparity between nations, benefiting advanced economies more.
- Overdependence on WTO Framework: In cases of geopolitical conflict, Most Favoured Nation (MFN) provisions may be set aside, undermining its efficacy.
- Complex Implementation: Countries often exploit loopholes through non-tariff barriers or domestic subsidies, circumventing MFN principles.
Way Forward
- Revisiting Tax Treaty Provisions: India and Switzerland could renegotiate the DTAA to introduce mutually favourable terms, balancing tax revenue and investment incentives.
- Diversifying Investments: Indian companies may consider alternate markets or jurisdictions with lower tax burdens.
- Strengthening Compliance and Notification Procedures: India could streamline the process of notifying DTAA benefits to avoid future ambiguities.
Conclusion
Switzerland’s suspension of the Most Favoured Nation (MFN) clause is a strategic decision that aligns with judicial and policy considerations. While it creates immediate tax implications, it also sets a precedent for how MFN clauses are interpreted and enforced globally.
The MFN status is a cornerstone of international trade, fostering fair treatment and cooperation among nations. However, its effectiveness depends on nations adhering to its principles in both spirit and practice. Balancing the MFN framework with geopolitical realities and economic disparities remains a key challenge for the global trade system.
Frequently Asked Questions (FAQs)
Q. What do you mean by the most favoured nation?
Ans: The most favoured nation (MFN) principle is based on the idea that countries should treat all their trade partners equally—that no one country should be “more favoured.” It means no country should give special treatment to goods or services coming from one particular trading partner.
Q. What are the advantages of MFN?
Ans: The Most Favoured Nation (MFN) principle allows countries to increase market access for goods and services. Moreover, they can benefit from the reduced tariffs and other trade advantages granted to their trading partners.
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-Article by Swathi Satish
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