Switzerland's unique relations with the EU have been enhanced since summer 2005 through the enforcement of the Savings Tax Agreement (STA) and its Memorandum of Understanding (MoU) . After the rejection by the Swiss population of the EEA Agreement, Switzerland and the EC have entered into the so-called Bilateral Agreements, in particular the Bilateral Agreements I signed on June 21 1999 and the Bilateral Agreements II signed on 26 October 2004. The Savings Tax Agreement forms part of the Bilateral Agreements II. The agreement provides for measures equivalent to those laid down in Council Directive 2003/48/EC of June 3 2003 on taxation of savings income in the form of interest payments and the accompanying MoU. Under this agreement Switzerland committed itself to introduce a withholding tax on interest payments to EU tax resident individuals, initially at a rate of 15%, then 20% and from 2011, 35%. The foreign bank customers themselves can choose between the withholding tax retention and the notification of the respective interest income to the tax authorities in their state of residence.
An important component of the agreement is the abolition of withholding tax on dividends, interest and royalties between related companies, which significantly reduces the necessity for intermediary EU holding and finance companies eligible for the benefits of the EU directives, bringing Switzerland a step further as an optimal international business location. Below these withholding tax reliefs are discussed in more detail, taking into consideration the guidelines, circular and new forms published by the Swiss federal tax authorities on July 15 2005 and January 27 2006.
New rules
On July 1 2005 the STA between Switzerland and the EU entered into force.
This agreement is directly linked to the EU Savings Directive, through which the EU states want to ensure that individuals of one EU state effectively pay tax on interest income earned in another EU state. Primarily this is to be achieved by an automatic exchange of information. Austria, Luxembourg and Belgium have reserved the right, during a transitional period, to impose withholding tax retention instead of information exchange.
To prohibit the circumvention of this directive by EU tax resident individuals, the EU has concluded agreements with several third (non-EU) countries. The STA governs this cooperation with Switzerland: its core element is Switzerland's commitment to retain withholding tax on certain interest income of EU tax resident individuals, whereby these taxpayers alternatively may opt for the exchange of information. In addition Switzerland commits itself towards the EU to include in its double tax treaties (DTT) with the EU member states and on a reciprocal basis, administrative assistance in cases of tax fraud and similar offences.
As recognition of the concessions made in terms of savings taxation, the EU provided Switzerland with significant fiscal concessions, which should have a positive impact on Switzerland as a business location. Pursuant to article 15 of the Agreement, dividend, interest and royalty payments between associated Swiss and EU resident companies are in general exempt from withholding tax. This regime is being applied within the EU since 1992 (Dividends: EU Parent-Subsidiary Directive ) and 2004 (Interest and Royalties: EU Interest and Royalties Directive ).
Due to the clarity of its content, the agreement may be considered to be "self-executing" and as directly applicable to the contracting parties (Switzerland and the EU member states), not needing implementation into domestic law. This notwithstanding, it is recommended to always check ad hoc its applicability with the respective EU country in terms of the national law implementation and the views of the respective tax administrations.
The Agreement is valid for an unlimited period, but can be terminated either by Switzerland or the EC on 12 months-notice. According to article 13 of the STA, the Agreement is to be reviewed at least every three years or at the request of one of the contracting parties and, if necessary, revised.
Abolition of withholding tax on dividends
Conditions
Cross-border dividend payments between subsidiary and parent companies resident in Switzerland and the EU shall not be taxed in the source state if the following conditions are fulfilled:
Minimum holding: the parent company has a direct minimum holding of 25% of the capital of the subsidiary for at least two years.
Tax residence:
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one company is tax resident in an EU member state and the other company is tax resident in Switzerland
under any double tax agreements with any third (non-EU) states neither company is tax resident in that third state
No tax exemption: both companies are subject to corporation tax without being exempted
Legal form: both companies have the form of a limited company
Diagram 1: Withholding tax on dividends |
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Exceptions and transitional arrangements
In respect of Estonia and Spain the following transitional measures should be noted.
Estonia:
Distributions by an Estonian subsidiary company to its Swiss parent company may bear withholding tax until December 31 2008 at the latest. This rule does not apply in the reverse case, that is, distributions by a Swiss subsidiary to its Estonian parent company may – already since 1 July 2005 – benefit from the withholding tax exemption.
Spain:
In respect of Spain, the agreed withholding tax relief will be applicable upon enforcement of a revision of the DTT between Spain and Switzerland governing the exchange of information in cases of tax fraud or the like. A corresponding protocol was signed on April 27 2004 and it is expected to enter into force within this year.
Reporting (net remittance) procedure
The cross-border notification procedure for dividend withholding tax applying since January 1 2005 is also applicable with respect to the STA from July 1 2005. This procedure means that Swiss companies distributing qualifying dividends may directly apply the treaty withholding tax rate without having to make the full 35% prepayment.
The new rules apply to dividends distributed on participations qualifying for a partial or full exemption from Swiss withholding tax under a DTT or other international agreement (such as the STA). Switzerland however retains the right to deny the application of the new rules if reciprocity is not granted by the beneficiary's country of residence.
Swiss companies intending to make use of the reporting procedure have to obtain an approval from the Swiss federal tax authorities before distributing any dividends. The Swiss authorities will verify whether the shareholder is eligible for treaty relief and then grant a written authorization. Such an authorization is generally valid for three years, under the reservation that any changes in the facts and circumstances must be reported immediately by the distributing company. The company retains the right to levy the full 35% withholding tax if it is not convinced that the shareholder is eligible for treaty relief.
Abolition of withholding tax on interest and royalties
Conditions
Cross-border payments of interest and royalties between associated companies or their permanent establishments (PE) resident respectively situated in Switzerland and the EU shall not be taxed in the source state if the following conditions are cumulatively:
Associated companies, minimum holding: the one company has a direct minimum holding of 25% of the capital of the other company for at least two years (parent – subsidiary relationship) or a third company has a direct minimum holding of 25% of the capital of both companies for at least two years (sister relationship)
Tax residence:
-
one company is tax resident in an EU member state or maintains a PE there and the other company is resident for tax purposes in Switzerland or maintains a PE there
under any double tax agreements with any third (non-EU) states none of the companies is tax resident in that third state and none of the permanent establishments is situated in that third state
No tax exemption: all companies are subject to corporation tax without being exempt in particular on interest and royalty payments
As far as payments among sister companies are concerned, it is the current view of the majority of the Swiss commentators as well as of the Swiss federal tax authorities that the upper, common holding company may also be resident in a third country. Similarly, as far as payments from/into Swiss or EU PEs are concerned, the currently prevailing view in Switzerland is that the head office may also be situated in a third state. These views, allowing more creative tax planning, are based on a grammatical interpretation of the STA and are to a certain extent not in line with the regime applicable within the EU under the EU Interest and Royalties Directive ("...holdings must involve only companies resident in Community territory"; the term "permanent establishment" means a fixed place of business situated in a Member State through which the business of a company of another Member State is wholly or partly carried on"). It remains to be seen if this view will prevail in the STA's practical implementation and what the position of the EU member sates will be thereon.
Diagram 2: Withholding tax on interest and royalties |
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Transitional arrangements
With respect to the new EU member states as well as Greece, Spain and Portugal there are transitional arrangements for up to eight years:
These transitional arrangements are similar to those existing under the Interest and Royalties Directive within the EU. Nevertheless, a potential prolongation of such deadlines in the context of the Interest and Royalties Directive will not automatically apply to the STA.
Interpretation of certain provisions of the STA by the federal tax authorities
In connection with payments from Swiss sources, the federal tax authorities have published some guidelines on July 15, 2005 and January 27, 2006. These guidelines refer to article 15 paragraph 1 of the STA, that is, to dividend payments. It may however be assumed that an analogous interpretation should apply also with respect to interest and royalty payments. However, given that most inter-company interest payments as well as royalty payments are not subject to Swiss withholding tax, the practical relevance regarding Swiss interest and royalties will be small.
Territorial validity: the STA applies -subject to the mentioned transitional periods for certain EU countries-between Switzerland and the 25 EU member states, including the French overseas territories (Départements d' Outre-Mer (DOM) Gouadeloupe, Guayana, Matrinique and Réunion), Gibraltar, Madeira, Azores and the Canary Islands. The STA will also automatically apply to future EU-member states (for example, Bulgaria, Romania). The Channel Islands and Isle of Man are not covered by the STA.
Definition "Dividends": the term "dividends" will be interpreted according to the DTT interpretation (OECD Model Tax Convention). The term comprises in particular open and hidden profit distributions, as well as liquidation payments. Distributions of so-called "old reserves" may also benefit from article 15 paragraph 1 STA, if the originally applicable DTT referred to an EU-member state and the general conditions of article 15 paragraph 1 STA are met.
Direct holding of minimum 25% on the subsidiary's capital: a direct holding and a parent-subsidiary relationship are required. Hence, there is no relief for dividends or deemed dividends paid between related parties that are not in a parent-subsidiary relationship. The "direct holding" condition is met even if a partnership is interposed, if such partnership does not qualify as an autonomous tax subject but is treated as transparent for tax purposes in its country of residence.
Holding period: the fulfilment of the two-year holding period may also take place post-distribution (interpretation analogous to the jurisprudence of the European Court of Justice (Denkavit International BV, VITIV Amsterdam BV and Voormeer BV v Bundesamt für Finanzen (joint cases C-283/94, C-291/94 and C-292/94). According to the guidelines and Circular no 10 published on July 15 2005 by the federal tax authorities, there are guarantee measures to be taken in such cases (payment of the withholding tax at the residual DTT rate or at the full 35% rate for non-treaty recipients such as Cyprus and Malta, refund claim after completion of the holding period). No alternatives (for example, notification procedure instead of actual payment and refund) are available yet, even if the residual _ and refundable _ tax would involve significant amounts.
Concerning withholding tax relief on dividend payments from EU member states to Switzerland, it can be assumed (based on a communication from the European Commission departments dated May 11 2005) that all EU member states (with the exception of Portugal for the time being) will extend the application of the Denkavit judgement to holding structures including a Swiss parent.
No tax exemption: a company is deemed to be exempt from corporate tax if it is not subject to corporate income tax at federal, cantonal and communal level. Accordingly, the following companies are considered as corporate tax exempt and do therefore not qualify for the benefits of article 15 paragraph 1 STA:
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Companies enjoying a subjective exemption from corporate tax: legal entities mentioned in art. 56 DBG respectively art. 23 StHG (e.g. legal entities with public, non-profit or cultural objects, pension- and social security organisations et al.)
"tax holiday" cases: legal entities, which benefit from a full or nearly full tax holiday at cantonal and federal level.
The cantonal tax status of a holding, mixed or domiciliary company is on the contrary not harmful and such companies may benefit from article 15 paragraph 1 STA. Likewise, the participation relief is not harmful either.
To what extent the EU states will adopt an analogous position for payments into Switzerland is not yet known. This will depend on the domestic implementation of the STA in the EU state concerned, and an examination on a case by case basis has to be made for Swiss tax privileged companies wishing to make use of the STA.
Definition "Limited company": As far as Switzerland is concerned, qualifying company forms are the AG/SA, the GmbH/SARL and the Kommandit-AG. The list of qualifying legal entities in the EU states has not yet been defined, but it may be assumed that the annex to the EU Parent-Subsidiary Directive containing a list of qualifying entities may serve as a reference (that is,. the STA should apply, for example, to foreign AGs, GmbHs, the Societas Europaea).
Table 1: Transition arrangements |
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Interest |
10% withholding tax |
5% withholding tax |
Greece, Latvia, Poland, Portugal |
July 1 2005-June 30 2009 |
July 1 2009-June 30 2013 |
Lithuania |
July 1 2005-June 30 2009 |
July 1 2009-June 30 2011 |
Spain |
No withholding tax will be imposed upon entry into force of the revised DTT (expected during 2006 – current DTT rate: 10%) |
|
Royalties |
10% withholding tax |
5% withholding tax |
Greece, Latvia, Poland, Portugal |
July 1 2005-June 30 2009 |
July 1 2009-June 30 2013 |
Lithuania |
July 1 2005-June 30 2011 |
- |
Slovakia |
July 1 2005-April 30 2006 |
- |
Czech Republic |
July 1 2005-June 30 2011 |
- |
Spain (on entry into force of the revised DTT – current DTT rate: 5%) |
July 1 2005-June 30 2011 |
- |
Relationship of the STA to the double taxation treaties
With the exception of Cyprus and Malta, Switzerland has concluded DTTs with all the other EU member states. Should a DTT provide for a full withholding tax relief on dividends, interest and royalties at less stringent conditions (for example, no minimum holding period requirement), then these DTT provisions can take priority over the STA. In respect of dividend payments, a more beneficial regime is provided in the DTTs with, for example, Germany, Austria, Denmark, the Netherlands and Sweden. In respect of interest and royalty payments, the DTTs with, for example, Germany, Luxembourg and UK can under circumstances be more beneficial, whereas here one has to bear in mind the STA's applicability also to PEs, which are typically not entitled to claim benefits under DTTs.
It has to be examined on a case-by-case basis whether the STA or the DTT provide for a more beneficial regime. In connection with dividend payments the option taken (DTT or STA) will also affect the procedure to be followed, that is, different forms apply depending on whether the notification procedure is based on the STA or the DTT.
Relationship to the corresponding EU directives
Because the STA is an autonomous agreement and not a direct implementation of the corresponding EU directives, the amendments to the EU Parent-Subsidiary Directive applicable since January 1 2005 (for example, gradual reduction of the minimum holding quota required to 10% by 2009 – at present 20%), the proposed amendments to the EU Interest and Royalties Directive (for example, introduction of an effective 'subject to tax' clause) and in general any further internal EU developments do not automatically apply to Switzerland. Changes could potentially be made in the course of the review of the STA, to take place every three years.
Anti-abuse provisions
The application of the beneficial regime of article 15 STA can be denied in cases of abuse or fraud. This because of the explicit reservation made in the STA as to the use of domestic or agreement-based provisions for the prevention of fraud or abuse, both on the Switzerland side as well as from the side of the individual EU member states.
Switzerland has not introduced any special anti-abuse provisions with respect to the STA. However, the federal tax authorities confirmed in their guidelines of July 15 2005 that the existing principles (for example, beneficial ownership) will also apply with respect to article 15 of the STA, and further announced on January 27 2006 that the Swiss anti-abuse decree ('BRB 62') and the respective executive regulations shall also apply to payments falling under article 15 of the STA. Looking strictly at the wording of the Swiss anti-abuse rules, these typically refer to the proper application of the Swiss double tax treaties and not to other international agreements signed by Switzerland. The federal tax authorities have, though, based their above interpretation on the spirit and purpose of these rules, extending their scope to article 15 of the STA.
The federal tax authorities have also announced that, in relation to the Netherlands, the treaty anti-abuse measures will apply. Nevertheless, to what extent the special anti-abuse provisions in the DTTs with Belgium, France and Italy will continue to apply (for example, full taxation of interest and royalties in Switzerland) is at present subject to further negotiations with the countries concerned.
Interpretation and relationship to the judgements of the European Court of Justice
Since Switzerland is not an EU member state, European law has no direct influence on Swiss law. Accordingly, the ECJ has in principle no competence to interpret the STA, and its judgements are formally not binding on Switzerland. It is however expected that ECJ judgements will be used as a guide for interpreting the STA.
Hence, only the Swiss authorities are competent to interpret and apply the STA under Swiss law, while any disagreements between Switzerland and a specific EU member state are to be resolved through a consultation procedure, similar to the mutual agreement procedure of article 25 OECD Model Tax Convention. In such consultations the European Commission may also take part.
Practical relevance of the new rules
The new regime available under article 15 STA will provide internationally oriented Swiss companies with a significant tax relief as far as relations between Switzerland and the EU are concerned. The abolition of the withholding tax on dividend payments will not only further enhance Switzerland as a holding location, but will also encourage foreign investments into Switzerland, given the simplification of profit repatriation out of Switzerland.
Swiss financing and licensing companies will have a significant benefit from the abolition of the withholding tax on interest and royalties. In this context it should be noted that financing and royalty flows in multi-tier European group structures would need to be cascaded through the various tiers of the legal structure to take full advantage of the STA.
Even though the STA in principle should be self-executing, the practical application of the rules may be subject to varying interpretation by the tax authorities of the different EU member states. Also, payments from the EU into Switzerland have to be examined in the light of any potential country-specific anti-abuse regimes (for example, controlled-foreign-corporation rules). Internationally active companies are therefore advised to review their respective structures for opportunities arising from the STA and its practical application in the individual EU countries to be able to make best use of the withholding tax reliefs available since July 1 2005.
Biographies |
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Armin Marti is a tax partner and leader of the tax practice of PricewaterhouseCoopers in Zurich and leader of the firm's Swiss international tax structuring group.
Anna-Maria Widrig Giallouraki is a tax manager in the international tax structuring group of PricewaterhouseCoopers in Zurich. |
