Double Taxation Avoidance Agreement (DTAA): Meaning, Methods, India-Switzerland MFN Issue and Facts

Context: The India-Switzerland MFN Issue

• India and Switzerland signed their DTAA in 1994 and amended it in 2010; its protocol has a Most Favoured Nation (MFN) clause under which lower rates India later gives to another OECD member would also apply to Switzerland.
• In October 2023 the Supreme Court (Nestle case) held that MFN benefits do not apply automatically – India must notify them under Section 90 – and that the third country must have been an OECD member when India signed with it.
• In December 2024 Switzerland responded by suspending the MFN clause from 1 January 2025, so dividends paid by Indian companies to Swiss residents are taxed at 10% instead of 5% at source, and vice versa.

How a DTAA Works

• Residence rule: the treaty’s tie-breaker tests (permanent home, centre of vital interests, habitual abode, nationality) decide where a person is resident; a Tax Residency Certificate is needed to claim treaty benefits.
• Source rule: business profits are taxed only in the country of residence unless the enterprise has a Permanent Establishment (PE) – a fixed place of business, a dependent agent or a construction site beyond a threshold – in the other country.
• Reduced withholding rates on passive income: typically 5-15% on dividends, 10-15% on interest and 10% on royalties and fees for technical services, against the higher domestic rates.
• Capital gains are shared according to the treaty; the 2016 amendment of the India-Mauritius treaty and the 2017 amendment with Singapore gave India the right to tax gains on shares.
• Exchange of information and assistance in collection help detect undisclosed foreign income.

Methods of Relief

• Exemption method: income taxed in one country is exempt in the other.
• Credit method: both countries tax, but the residence country gives credit for the tax paid abroad (the method India generally uses).
• Tax sparing: credit for tax that would have been payable but for an incentive in the source country – found in some older treaties.

The Indian Legal Framework

• Section 90 of the Income-tax Act empowers the Centre to enter into DTAAs; Section 90A covers agreements with specified associations; Section 91 gives unilateral relief where no treaty exists.
• A taxpayer may choose the treaty or the domestic law, whichever is more beneficial, subject to the General Anti-Avoidance Rule (GAAR) in force since 2017.
• India has comprehensive DTAAs with more than 90 countries and has signed the OECD Multilateral Instrument (MLI) to insert BEPS-related anti-abuse rules, including the Principal Purpose Test, into its treaties.

FAQs

What is the Most Favoured Nation clause in a tax treaty?

A promise that if one party later gives a lower rate or narrower scope to a third country, the same benefit will extend to the treaty partner; India’s position is that it applies only after a notification.

Does a DTAA reduce tax for Indian residents earning abroad?

Yes – India taxes global income of residents but gives credit for foreign tax paid, so the income is not taxed twice.

Why is DTAA asked in RBI Grade B and NABARD exams?

It links international finance, FDI flows and tax policy; the Switzerland MFN suspension, the Mauritius amendment and the methods of relief are typical questions.