Although Switzerland is a very attractive financial centre for international groups, financing activities including cash-pooling are often carried out outside of Switzerland. While the know-how and facilities for financing activities are readily available in Switzerland, the tax environment is not fostering group financing. Specifically, the Swiss withholding tax of 35% levied on bank interest, as well as interest payments on bonds issued by a Swiss resident company or the Swiss registered branch of a foreign resident company, is a big disadvantage and makes investments in Swiss bonds unattractive for many foreign investors. In 2010, an amendment to the Swiss Withholding Tax Ordinance (WTO) brought the first relief for foreign groups. In September 2016, the Federal Council initiated the consultation procedure to amend the WTO that will now further strengthen the financing activities of groups in Switzerland.
"Bonds" within the meaning of the Withholding Tax Act (WTA)
For withholding tax purposes, the term "bonds" is broader than under securities law and includes debenture certificates and other debt instruments issued for the purpose of collective fund raising.
The Swiss Federal Tax Administration (FTA) has issued guidelines on the Swiss tax definition of "bonds" (Merkblatt "Obligationen", dated April 1999; hereafter the "guidelines"). Under the guidelines, "bonds" are defined as written recognitions of debt made out in fixed amounts and that are issued in several numbers for the purpose of collective fund raising, or for the consolidation of debts.
Based on this definition, there are two categories of "bonds" that, for withholding tax purposes, could be relevant for Swiss borrowers (10 and 20 rule):
- Loan debentures (Anleihensobligationen), which exists where a Swiss resident person raises money from more than 10 creditors (whereby qualifying Swiss and foreign banks are not taken into consideration) against the issuance of recognition of debts at identical conditions, and the aggregate loan principal is at least CHF 500,000 ($493,000). The identical conditions test is met if the debt instruments are linked together through uniform terms of interest, term and repayment conditions or other circumstances (in particular the reference to the aggregate loan amount), under which they appear to form part of one whole debenture (i.e. also in cases of a syndication of a loan). However, the existence of a loan debenture subject to withholding taxes does not depend on the amount of loan principal granted by each relevant creditor, i.e. the tax liability cannot be avoided by issuing debt instruments with differing face amounts.
- Cash debentures (Kassenobligationen), which exist where a Swiss resident person raises money from more than 20 creditors (whereby qualifying Swiss and foreign banks are not taken into consideration) against issuance of recognition of debts on a continuous basis at differing terms, and the aggregate loan principal is at least CHF 500,000. Contrary to the loan debenture, a cash debenture does not require that the debt instruments are issued at identical conditions. Hence, a cash debenture exists even though the terms of interest and the term and repayment conditions differ from one instrument to another, provided that all the other above listed conditions are met.
"Bank" within the meaning of the WTA
The term "bank" for withholding tax purposes is much broader than commonly used and may also apply to group internal financing companies. A debtor is qualified as a bank for Swiss withholding tax purposes if:
- The aggregate number of non-bank lenders to that Swiss entity under all of its interest bearing liabilities exceeds 100; and
- The total of the company's interest bearing liabilities reaches at least CHF 5 million.
Earlier legislative measures to facilitate group financing activities
In order to facilitate financing and treasury functions in Switzerland, a new Article 14a was introduced to the WTO with effect as from August 1 2010. According to this provision, loans or deposits between companies that are fully consolidated in the consolidated financial statements of a group in accordance with an internationally accepted accounting standard do not qualify as bonds or bank deposits within the meaning of the WTA, irrespective of the currency, interest rate applied or duration of such borrowing. The consolidation criterion basically requires a participation representing more than 50% of the voting rights in a company. The benefit of the exception of intragroup loans and deposits from the definition of bonds or bank deposits is twofold. On the one hand, there is no withholding tax on interest payments on such instruments even if the Swiss resident borrower has issued bonds within the meaning of the WTA. On the other hand, such intragroup liabilities do also not have to be taken into account when applying the above outlined 10, 20 or 100 creditor thresholds.
However, this rule does not apply in cases where a Swiss parent company guarantees a foreign bond issued by one of its subsidiaries. The reason for this exemption for Swiss groups is that it would allow them to issue foreign bonds through one of its subsidiaries and to repatriate the funds to Switzerland via intragroup loans or deposits without having to pay Swiss withholding tax on the interest payments.
Reform of the withholding tax system
In order to sustainably resolve the problems of financing activities out of Switzerland, the Federal Council proposed a profound reform of the WTA and a switchover to the paying agent principle for interest payments.
The paying agent principle would – for interest withholding tax purposes – no longer differentiate between Swiss and foreign debtors, but rather between Swiss and foreign recipients, irrespective of the residence of the debtor of the interest. The project was sent for consultation to all interested parties in December 2014. However, the reform has been suspended because the Federal Council is awaiting the outcome of the vote on the popular initiative "Yes to protecting privacy".
The subsequent timetable is unknown and will certainly take some more years.
Proposal by the Federal Council to strengthen financing activities of Swiss groups
Against the background of the still uncertain timeline of a potential profound reform of the Swiss withholding tax system (switchover to paying agent principle) and in the light of the global trends such as the OECD's BEPS Project, the Federal Council is proposing a new amendment to the WTO to enhance the appeal of Switzerland as a business location.
The Federal Council fears that some structures used by Swiss groups for group internal treasury functions, group financing and cash pools lack adequate substance and functions and could therefore be challenged by foreign tax administrations based on substance requirements, transfer pricing rules or more generally based on information received through the country-by-country reports.
The proposed regulation would allow Swiss groups to locate group financing and cash pooling functions in Switzerland together with other main group functions. Structures designated for group financing and cash pooling activities should no longer be necessary and consequently, the risk of inclusion of profit from financing activities by foreign tax administrations should be reduced.
Groups established in Switzerland often carry out targeted financing activities abroad. In this way, they avoid withholding tax, which would be due in certain situations were they to conduct the financing via group companies established in Switzerland (e.g. when issuing a bond through a foreign group company with a guarantee by the Swiss parent company and at the same time, funds raised through the bond are used in Switzerland). The Swiss economy thereby misses out on some of the added value in the financing sector. The Federal Council aims to retain this added value in Switzerland.
The proposed amendment concerns those groups in which a Swiss group company provides a guarantee for a bond issued by a foreign group company belonging to the same group. Under the existing legal framework, the interest payments on the bond issued by the foreign group company are not subject to Swiss withholding tax, provided the funds raised through the bond are not used in Switzerland. According to the proposed amendment by the Federal Council, forwarding funds from the foreign issuer to a group company established in Switzerland will be possible up to the maximum amount of the equity capital of the issuer without triggering Swiss withholding tax on the interest payments of the bond. The burden of proof that the amount of funds forwarded from the foreign issuer to a Swiss group company is less or equal to the equity of the foreign issuer lies with the Swiss guarantor of the foreign bond.
The proposed amendment of the WTO which, in principle, aims to facilitate group financing activities in Switzerland for Swiss groups contains a further change that will be beneficial for group financing activities in general. According to the legal framework, only loans or deposits between companies that are fully consolidated in the consolidated financial statements of a group qualify for the intragroup exemption and, therefore, related interest payments are not subject to Swiss withholding tax. According to the proposal of the Federal Council, the exemption will be broadened to include not only loans and deposits between group companies that are fully consolidated, but also between group companies that are partially consolidated.
Appraisal of the proposal by the Federal Council
The Federal Council's proposal should be welcomed as it intends to facilitate group financing activities in Switzerland. As identified by the Federal Council, structures (solely) set-up for tax planning reasons will face more and more challenges at an international level. Various actions under the OECD's BEPS Project intend to combat low substance structures and potentially questionable risk allocations. At the same time, the global financial crisis has led to tremendous state debt and a search by tax administrations for new and/or broadened sources of income.
Multinational initiatives, as well as unilateral measures, intend to tackle tax evasion and at the same time exploit new revenue streams. New reporting obligations, such as country-by-country reporting, provide for more information being available to tax administrations. The risk of tax disputes and double taxation is on the rise. Against this background, the aim of the Federal Council to foster the combination of intragroup financing activities with other headquarter functions should be welcomed. However, the question remains over whether the proposed new rules will have the desired effect.
Given the uncertain timeline for the also uncertain switchover to the paying agent principle for interest payments, an interim solution based on the existing legal framework makes sense. While the broadened definition of loans and deposits, which fall under the exception of Article 14a of the WTO (i.e. loans and deposits between companies that are fully or partially consolidated in the consolidated financial statements of a group), will theoretically facilitate group financing activities in Switzerland, it is questionable whether the threshold of funds stemming from a foreign bond that may be used in Switzerland under the proposed new rules will be sufficient to repatriate group financing functions to Switzerland. The forwarding of funds from the foreign issuer to a group company established in Switzerland will be possible up to the maximum amount of the equity capital of the issuer. However, in practice the foreign issuers do not tend to be heavily capitalised. Therefore, the amount that could be forwarded to a Swiss group company is likely to be limited. Furthermore, the burden of proof lies with the Swiss guarantor of the foreign bond. Consequently, the administrative burden to adequately document any financial streams and closely monitor the threshold is likely to be significant. As the financial consequences of breaching Article 14a by forwarding funds in excess of the maximum amount that may be forwarded to Swiss group companies are significant, the option of a foreign group financing and cash-pooling activity might still be more appealing to many Swiss groups.
Overall, the proposed rules are a step in the right direction but cannot entirely solve the Swiss withholding tax issue related to group financing activities. It remains to be seen what will be the outcome of the consultation process and, more importantly, the potential changes that might be introduced by the Swiss parliament. However, in order to provide for a really attractive withholding tax environment for group financing activities in Switzerland, the WTA requires some profound reforms such as the switchover to the paying agent principle.
Rolf Wüthrich is an international tax lawyer, focusing his expertise on domestic and international tax planning, inbound and outbound transactions, especially between the US and Switzerland, corporate restructuring and acquisitions, as well as general corporate secretarial services.
Noëmi Kunz-Schenk's areas of expertise are domestic and international tax issues and tax planning, particularly in corporate reorganisations, restructurings, structured finance, financial products, acquisitions and divestments, as well as high-net wealth individuals.
burckhardt Ltd. provides its clients and their businesses with comprehensive, tailored advice on national and international tax planning issues and structuring, offers corporate secretarial and notary service, supports clients with professional expertise and broad international experience on restructurings, mergers and acquisitions, joint ventures and corporate financing. It also advises on inbound and outbound investments and in all matters related to employment, trade and transport law and private clients.