In an M&A transaction, a potential acquirer is usually faced with the challenge to identify – in a short timeframe and with limited information – the material tax risks and tax attributes of a target company and to optimise the acquisition and financing structure from a tax perspective.
Mastering the challenge enables the acquirer to consider tax exposures and attributes in the negotiation of the purchase price and the share purchase agreement (SPA). In addition, it allows the identification of potential risk mitigation strategies and synergies to be implemented in the post-closing period.
Tax due diligence
Upon a share acquisition, tax risks remain with the Swiss target company and will crystallise on the target company's level. The acquisition and following integration can impact tax attributes of the target, for example tax loss carry forwards, privileged tax status. As such, the qualification and quantification of material tax risks and tax attributes in the due diligence process is of major importance.
In Switzerland, taxes are generally levied on the basis of tax returns filed by taxpayers (the target company). Whereas the filing of corporate tax returns is monitored by tax authorities, the tax system for indirect federal taxes (for example withholding tax (WHT), VAT, stamp duty), is based on self-declarations and can trigger significant default interest and potential penalties in case of a breach of declaration duties.
Tax exposures can, in principle, only be ruled out in case of tax audits or ruling confirmations. For income tax purposes, a desktop assessment by the tax authorities provides certainty on tax exposures to the extent that all relevant tax information has been disclosed to the tax authorities. However, tax authorities are not bound by past assessments and can qualify the circumstances in each tax period.
Because tax audits are only performed on a random basis, a tax due diligence has to properly identify, qualify and quantify the tax risks and tax attributes of target companies taking into account the applicable statute of limitations. Based on our experience, the following items may have a significant impact on the value of a target company and should be considered accordingly:
Tax losses carried forward
Tax losses can be carried forward for a period of seven years, but are usually not approved by the tax authorities until the tax period in which a taxable profit is assessed after offsetting the tax losses. Swiss tax law generally does not restrict the use of tax losses carried forward in a target company following a change of ownership. When assessing the value of tax losses carried forward in the transaction, reductions due to existing tax risks or future dividend income should be reflected.
Switzerland has not yet implemented formal transfer pricing rules or documentation requirements for intercompany transactions with related parties and follows the arm's-length principle in accordance with OECD transfer pricing guidelines.
In case of intercompany financing, Swiss thin capitalisation rules and maximum / minimum interest rates apply. In case the interest rates differ from the safe harbour interest rates published by the tax authorities on an annual basis, supporting documentation is recommended to prove the arm's-length character in case of a possible tax audit.
Apart from add-backs subject to income taxes, an intercompany transaction not complying with the arm's-length principle can qualify as a deemed dividend subject to Swiss WHT of 35% or as a deemed capital contribution from direct shareholders subject to stamp duty of 1%. In case the WHT cannot be reclaimed by the target company from the beneficiary of the deemed dividend, the applicable WHT rate is increased to 54% (gross-up due to additional deemed dividend).
Whether, and to what extent, a refund of the WHT is possible depends on whether the direct beneficiary of the deemed dividend distribution (not necessarily the shareholder!) qualifies for a reduction pursuant to domestic or bilateral law. Such tax (including WHT) risks for periods until closing of a transaction should be covered in an indemnity in the SPA.
Blocking periods due to past intra-group reorganisations
If the target company has been party to a tax-neutral hive-down transaction between a parent and its subsidiary or asset transfer between Swiss group companies, a five-year blocking period applies on the assets transferred and the ownership structure of the transferee and transferor. Should the envisaged acquisition of the target company result in a breach of the blocking period, hidden reserves are retroactively taxed resulting in a step-up for the counterparty and depending on the reorganisation, WHT on a deemed dividend or stamp duty on a deemed capital contribution may be triggered. These are important factors for the valuation of the target.
Based on our experience, the level of information made available in a due diligence process seldom allows a VAT review which adequately copes with the complexity of VAT regulations and potential exposures. A more practical approach would be to conduct a high-level review to define key areas on which a detailed post-closing health-check should be performed, once full access to data is available. As a full indemnity in the SPA would only cover periods until closing, measures to improve procedures and mitigate risks going forward should be determined after the transaction.
Indirect partial liquidation
In case of Swiss-resident individuals selling a share quota of at least 20% in the share capital of a privately held Swiss (or foreign) company, an acquirer holding the acquired shares as business assets may face specific indemnities in the SPA that restrict the acquirer from using funds of the target during a five-year period after closing. This is because in this case the sellers would suffer from a requalification of tax-free capital gain into taxable dividend (indirect partial liquidation). The rules apply to the extent non-business required assets and distributable reserves available at closing are distributed.
Whereas arm's-length loans or guarantees granted by the target company in connection with the acquisition should generally not qualify as direct or indirect distributions, an impairment of such a loan within the five-year period could be detrimental. In particular in leveraged acquisitions of private equity investors, the upstreaming of cash can be critical.
Deferred WHT liability on retained earnings (old reserves theory)
With respect to Swiss WHT on dividends, the acquirer needs to consider the old reserves theory established by the Swiss tax authorities. This practice applies to retained earnings subject to a non-refundable WHT with respect to the current or former shareholders. If, due to a change in ownership, the refundable WHT is increased to a higher rate than before the transaction, the Swiss tax authorities may argue that distributable reserves are still earmarked at the previous lower refundable WHT rate. The amount subject to the previous WHT rate is usually the lower of distributable reserves and the non-business relevant assets at the time of the change in ownership. Such a risk may be mitigated by confirming a full WHT reduction entitlement of the sellers, by mitigating the amount of non-business relevant assets or pre-deal distributions. Otherwise, a buyer will likely deduct the amount from the purchase price. The old reserves theory does not apply on distributable reserves from approved capital contribution reserves.
The acquisition of a Swiss company should be carefully structured, because the choice of acquisition vehicle will impact the tax costs of the transaction and future tax charges, for example for the repatriation of profits or offsetting of financing costs with taxable income (debt push-down).
Quantification of tax costs on transfer
If the seller, the purchaser or another Swiss entity formally involved in the negotiations qualifies as a securities dealer (such as a Swiss bank, or Swiss company with more than SFr10 million ($11.2 million) in shares or securities on the asset side of the balance sheet), a securities transfer tax of 1.5‰ on the purchase price for shares in Swiss entities and 3‰ on foreign shares generally applies.
The acquisition of real estate holding companies and real estate companies may result in a deemed direct sale of real estate subject to real estate transfer taxes or real estate gains taxes, depending on the domicile of the real estate. Although the seller is liable for a capital gains tax, the tax authorities may have a pledge on the real estate in the target to secure such tax.
Substance requirements of foreign acquisition company
When determining a foreign entity as acquirer, the availability of tax treaties or bilateral agreements with Switzerland, for instance the Swiss-European Taxation of Savings Treaty, should be taken into account to benefit from a reduced or zero WHT on dividend distributions from the Swiss target.
For the purpose of assessing the treaty entitlement, Swiss tax authorities generally review the functions, activities and assets of foreign corporate shareholders. According to current practice, a foreign holding company should generally qualify for a reduced WHT provided that its level of equity financing complies with Swiss thin capitalisation regulation.
For cash management purposes, it is recommended to apply for the notification procedure with the Swiss tax authorities – the authorisation that only the net applicable treaty WHT rate is payable on dividend distribution, instead of paying the gross amount of 35% Swiss WHT and afterwards applying for a refund with the Swiss tax authorities. The treaty entitlement and potential old reserves (see above) are reviewed in this approval process and it is advisable to submit supporting documents with the application. In any case, all relevant WHT declaration forms need to be filed with the tax authorities within 30 days after the due date of the dividend distribution.
Leveraged takeovers (10/20 non-bank rule)
Interest payable by a Swiss borrower is generally not subject to Swiss WHT, unless (i) the loan qualifies as hidden equity, (ii) the interest is not arm's-length in case of related party loans, (iii) the loan is secured by Swiss real estate or (iv) qualifies as a bond loan or a cassa bond under Swiss WHT law.
A loan is considered a bond loan if a Swiss tax resident company borrows funds exceeding SFr500,000 in total under a facilities agreement with identical terms from more than 10 non-bank lenders (including sub-participations). In case of non-identical terms, a loan is considered a cassa bond if the funds exceed SFr500,000 in total and are borrowed from more than 20 non-bank lenders (including sub-participations).
If a transaction does not comply or does not provide for an appropriate mechanism to ensure compliance with the above 10/20 non-bank rule, a 35% Swiss WHT will be imposed on the interest payable under the relevant finance documents to non-bank lenders (a refund may be possible in case of double tax treaty protection of the individual lender).
Loans to foreign group companies can also be subject to the 10/20 non-bank rule if the loans are secured by a Swiss parent company. Subject to tax ruling approval by Swiss tax authorities, it should generally not be harmful if a foreign company takes up the funds and the security is provided by a Swiss subsidiary or sister company (up-stream or cross-stream security) in line with Swiss legal limitations.
As no tax consolidation exists in Switzerland for income tax purposes and a merger of a pure acquisition company with the target is generally considered as a tax avoidance scheme, typical debt push-down strategies involving Swiss target companies are limited. Since an existing Swiss operating entity as acquirer can deduct the financing expenses (subject to thin capitalisation limitations), a two-step acquisition might be possible in certain cases (with economic reasons): one Swiss operating target acquires an additional company or business with debt financing after its own acquisition. Alternatively, debt financed dividends or capital reductions can reduce the tax burden for the target.
There are a number of potential pitfalls in an M&A transaction from a Swiss tax perspective. A focused approach helps to structure the M&A process efficiently and enhance its added value to the deal negotiations and post-closing actions. It is through this process that tax risks and tax attributes can be properly identified and assessed, and decisions on an optimised acquisition and financing structure can be taken.
Partner Corporate Tax
Susanne is a partner with KPMG's M&A Tax and International Corporate Tax group in Zurich. She is a German attorney-at-law, German tax adviser and Swiss tax expert. Susanne started her career more than 12 years ago as a lawyer in the M&A and tax area of an international law firm and joined KPMG in 2006. She focuses on advising clients on tax aspects of cross-border transactions, including due diligence, structuring of acquisitions or disposals, tax modelling, contractual aspects and post-deal integration. Her client portfolio consists of multinational groups and private equity investors active in various industries. She regularly acts as a speaker in M&A and international tax seminars.
Senior Manager Corporate Tax
Simon Juon is a senior manager with KPMG's M&A Tax and International Corporate Tax group in Zurich. He has more than 10 years of experience in advising Swiss and multinational clients in M&A transactions and group restructurings. Among others, he is specialised in vendor and buy-side assistance of corporate clients in inbound and outbound M&A transactions.