Vedansh Raj
Introduction
The recent removal of the Most Favoured Nation (“MFN”) clause by the Australian Government in double taxation avoidance agreements, effective in India from January 1, 2025, is strange in the international taxation regime’s practices. This decision unbalances the double taxation structure and poses unique challenges to the new digital economy. This was done against the backdrop of the Supreme Court (“SC”) decision in the case of Assessing Officer Circle (International Taxation) 2(2)(2) New Delhi v. Nestle SA where the SC reversed the judgement passed by the Delhi High Court in the favour of Nestle. The SC held that MFN clauses could not be automatically applied without formal notification under Section 90 of the Indian Income Tax Act. Due to this decision, Swiss authorities re-examined the unilateral decrease of the withholding tax rate.
This raises several questions regarding the nature of legal systems regulating international business especially concerning digital tax and what intergovernmental bodies act to regulate such decisions or these open lacunae on the description of the countries agreeing. This blog breaks down the social, legal, and compliance aspects of the DTAA amendment critically focusing on how it impacts Internet and technology industry businesses operating between the two countries.
Understanding the MFN Clause and DTAA Framework
The Role of the MFN Clause in Tax Treaties
Treaties between the two states are of mutual consent, and the parties ensure that they treat each other equally. The MFN clause in tax treaties makes such arrangements possible. This clause allowed companies to claim lower withholding tax rates on dividends, royalties, and technical services fees. This mechanism was essential in avoiding cases of tax evasion and encouraging international investment.
However, by suspending the MFN clause, the country raises the withholding tax rates relating to these forms of income, unfolding the hypothetical demerits to the digital and tech firms that have benefitted from the provision. The effects are not just related to taxes but extend to compliance, competitiveness, and contractual commercial disputes.
The Legal Framework of DTAA
The Double Tax Avoidance Agreements (“DTAAs”) are based on provisions of the Organization for Economic Cooperation and Development (“OECD”) Model Tax Convention together with the UN Model Tax Convention, which provides guidelines for avoiding double taxation while promoting no tax evasion. Such covenants are legally enforceable, inter-party contracts capable of modification and revision. In the case of India and Switzerland, the MFN clause played an important role in keeping a check on the balance of the tax-related measures for industries related to intangible assets and digital services.
The Digital Economy and Taxation Challenges
Unique Characteristics of Digital Taxation
The key aspects of the digital economy are the company’s reliance on intangible assets, limited physical presence in the target markets, and the quick scalability of services. The traditional DTAA frameworks fail to capture such aspects, resulting in under or over-taxation where cross-border transactions are involved. Currently, companies like Google, Amazon, and Infosys are conducting their business in a tax environment where unilateral measures like India’s equalization levy intersect with bilateral treaties, creating significant compliance challenges.
Impact on Tech Giants
The recent change would impact the ongoing taxation structure of the companies in both countries in a way firstly; the Swiss companies working in India may be faced with extra tax burdens on the royalties and technical fees, which will affect their operational costs and profit margins. These include multinational companies like Logitech and ABB.
Secondly; the Indian companies in Switzerland may face higher withholding taxes on dividends and royalties and this may directly affect their market competitiveness in Europe. The Indian IT firms such as TCS and Wipro who provides IT services to Swiss clients may encounter a negative aftermath of this change in the clause.
These challenges highlight that there is a need for policy revisions of the clauses of the DTTA that will proportion to solve the issues that relate to digital taxation.
Legal and Jurisprudential Implications
Precedents in Treaty Modifications
The recent suspension of the MFN clause is also in compliance with the International best practices of the re-negotiation of the tax treaties because of the emergence of dynamic and peculiar economic needs. In the last year, the Brazilian Government has amended its DTAAs to increase the withholding tax rates on royalties in cross-border Intellectual Property (“IP”) deals. This underlines the national sovereign right in tax over treaties’ concerns. The European Court of Justice (“ECJ”) looked at the Danish Beneficial Ownership Case in 2021, where the abuse of the treaty gains took place and the court restated the principle that the tax treaty would need to depict the existence of a real economic substance. This underlines the harmonization of tax treaties with national interests, while digital taxation is a new important area.
Legal Basis for the Suspension
The legal foundation of such MFN clause suspension lies in the principle of pacta sunt servanda that an agreement cannot be altered once signed and rebus sic stantibus that a treaty may be altered in the light of the fundamental changes in the circumstances. Switzerland’s action suggests a shift from the traditional view of the treaty being paramount to one prioritising economic policy and emphasizing equitable taxation over maintaining treaty benefits. However, such actions raise questions regarding the uncertainties and the reliability of international tax law.
WTO Implications
MFN clauses also have implications under World Trade Organization (“WTO”) law, particularly dealing with the General Agreement on Trade in Services (“GATS”). Though the taxes stand outside the preview of the GATS certain actions which disproportionately impact the services of the sector, such as those of digital services, could be challenged under the principles of non-discrimination and fair competition.
Compliance Challenges for Businesses
Overlapping Tax Regimes
Firstly, India has imposed safeguards of 2% for electronic commerce sales and 6% for e-commerce advertisement. These taxes, together with the higher withholding rates under the current revised DTAA, significantly impact the costs and compliance burdens. Secondly, the implementation of the Base Erosion and Profit Sharing (“BEPS”) framework put forth by the OECD to resolve the tax issues remains inconsistent and raises compliance complexity in business.
Legal Challenges
The current situation of increased tax burden results in legal disputes, including arbitration clauses in the DTAA’s agreement. The process of arbitration will increase the use of Mutual Agreement Procedures (“MAPs”) to resolve ambiguities which will further complicate the compliance process.
Proposed Solutions
The Permanent Establishment can be defined under the Standardised Approach of the OECD Pillar One and can use a Digital Permanent Establishment (“DPE”). DPE could redefine tax rights relying on the economic value generated within a specific jurisdiction. The OECD could prescribe multilateral solutions and the regime of tax laws could be harmonised with it. These are for instance the OECD’s Inclusive Framework. Thereby, both India and Switzerland can clear the existing uncertainties on digital taxation without affecting treaty benefits, with the help of these principles.
However, the countries may enhance effective instruments for alternative dispute resolution such as having mandatory bilateral and binding clauses which enhance legal security for taxpayers associated with these Multi-National Companies (“MNCs”). These mechanisms guarantee that treaty differences are settled in order and resolved efficiently.
The Swiss government has suspended the MFN clause is a testimony that shows balancing national self-interest in conjunction with foreign obligations is more important in providing stability of taxes. There must be the doctrine of equitable taxation to hold ground during treaty negotiation and the treaty should follow economic substance whereby fair share and distribution of taxing rights should dominate to boost international trade. This will foster even taxation systems across many nations to retain conformity and a uniform balance of laws.
Conclusion
The suspension of the MFN clause in the India-Switzerland DTAA, constitutes the turning point of international tax law. Through this measure an alteration of the nature of bilateral trade between the two countries will be realized, the chances of retaliation by measures of similar intensity being taken on the Swiss companies being high.
This raises fundamental questions about digital taxation, it equally presents new issues for businesses and policymakers. In constructing these complex models, including DPEs and building up multilateralism, both India and Switzerland could effectively deal with these issues, providing good practice of a fair tax approach to the digital economy on the international level. In this regard, as the above analysis has indicated, through the application of this course of action legal and economic certainty not only strengthens legal and economic predictability in international trade but also strengthens the principle of fairness and reciprocity in international trade.
Vedansh Raj is a second-year B.A. LL.B. (Hons.) student at Rajiv Gandhi National University of Law. He possesses a keen interest in corporate law.
NUALS Law Journal 