Switzerland has announced the suspension of a key tax agreement with India, which will increase the tax liabilities of Indian companies operating there and imperil a $100-billion investment pledge to India by a European trade bloc.

The decision, effective January 1, will halt the application of the Most-Favoured-Nation (MFN) clause under the Double Taxation Avoidance Agreement (DTAA) between the two countries.

Swiss authorities attributed the suspension to a ruling by India’s Supreme Court last year in the Nestle case, which stipulated that such treaty benefits cannot automatically take effect without formal notification under Indian law.

The withdrawal means Indian firms will face a higher withholding tax of 10 per cent on dividends earned in Switzerland, up from the 5 per cent rate they previously enjoyed under the MFN clause.

The clause enables treaty nations to access reduced tax rates on specific types of income such as dividends, interest, royalties or fees for technical services.

Experts have warned that the change could disrupt cross-border business ties and discourage investments from both sides.

Tax analysts said this decision may jeopardise the $100 billion investment commitment in India over a 15-year period by the four-nation European Free Trade Association (EFTA) — comprising Switzerland, Iceland, Liechtenstein and Norway — as dividends will be subject to higher withholding taxes.

The decision stems from an October 2023 ruling by India’s Supreme Court in the case of Nestle SA, which held the MFN clause in a DTAA cannot be automatically triggered without a formal notification under India’s Income Tax Act.

This ruling overturned a 2021 Delhi High Court decision that had allowed companies to benefit from lower withholding tax rates under the MFN clause.

Swiss authorities announced the suspension of the MFN clause, citing a lack of reciprocity in India’s application.

“In the absence of reciprocity, (Switzerland) waives its unilateral application of the MFN clause effective January 1, 2025. Accordingly, income accruing on or after this date will be taxed in the source state at the rates provided in the DTAA, irrespective of paragraph 5 of the protocol,” the Swiss government said in a statement.

“Switzerland’s decision to suspend the unilateral application of the MFN clause under its tax treaty with India marks a significant shift in bilateral treaty dynamics,” said Sandeep Jhunjhunwala, M&A tax partner at Nangia Andersen.

“This suspension highlights the complexities of navigating international tax treaties in an evolving global landscape.”

Switzerland is India’s 11th largest trading partner, with bilateral trade amounting to $21.34 billion in 2023-24. The higher withholding tax rate could dampen enthusiasm for cross-border investments, particularly for Indian companies with outbound direct investments (ODI) in Switzerland.

“This change, while significant, has a silver lining in its prospective application,” said Kumarmanglam Vijay, partner at JSA Advocates & Solicitors.

“Indian corporates are spared the pain of retrospective changes, but the higher withholding tax will impact Indian companies with Swiss ODI structures.”

The move also raises concerns about potential ripple effects across other MFN jurisdictions, as countries may re-evaluate the applicability of similar clauses in their DTAAs with India.