In recent years, debt issued in the form of bonds to fund mergers and acquisitions (M&A) has reached a record high, as companies look to take advantage of cheap financing due to the low interest rates. Low borrowing costs provide an opportunity to create a return for shareholders via debt-financed M&A.
Swiss withholding tax and transfer stamp duties are an obstacle for debt financing using Swiss bonds. Interest paid on Swiss bonds is subject to a 35% withholding tax. Furthermore, the trading with Swiss bonds is subject to transfer stamp duties. The envisaged tax reform will eliminate these obstacles in order to make the Swiss capital market more attractive for debt financing. The debt market in Switzerland will be strengthened by means of this tax reform.
During its meeting on April 3 2020, the Federal Council initiated the consultation on amendments to the Swiss withholding tax law. The Swiss Federal Council proposed to exempt Swiss domestic legal entities and foreign investors from withholding tax on interest-bearing investments. This will enable corporate groups to issue their bonds in Switzerland without withholding tax hurdles.
On the one hand, Switzerland offers a high level of legal security in addition to a competitive corporate tax environment. On the other hand, due to increased substance requirements in the light of BEPS, there is likely to be a tendency towards centralisation of group activities.
This involves a partial switch to the paying agent principle. As a rule, banks would levy the reformed withholding tax in the future. As a complementary measure, the transfer stamp duty on domestic bonds will be abolished.
At the same time, the switch to the paying agent principle will also close a loophole with regard to individuals in Switzerland, and make income from foreign interest-bearing investments subject to withholding tax.
The reform means that bonds previously issued abroad can be issued in Switzerland in the future. Furthermore, it is expected that more intra-group financing activities will be located in Switzerland, which will strengthen the Swiss debt market. It will also provide stimulus for value creation and financial sector jobs in the medium to long-term.
The need for action
The existing withholding tax and transfer stamp duty system has led to unsatisfactory results for Switzerland as a business location, while also causing issues for the tax authorities, particularly in the area of debt capital markets and in concern of the security purpose of the withholding tax.
Debt capital market
Interest payments on bonds of Swiss companies are subject to a withholding tax of 35%. The withholding tax must be deducted by the interest-paying company. A refund of the tax may be granted by application of a tax treaty. Swiss bonds are therefore unattractive for most investors, even if they are entitled to a partial or full refund of the tax.
The levy of the withholding tax, even if refundable, leads to a temporal liquidity disadvantage for the investor and there are administrative burdens in connection with the refund. In response, Swiss groups regularly avoid the withholding tax by issuing their bonds through foreign affiliated companies.
Furthermore, transfer stamp duties are levied on bond trading. The transfer stamp duty is due if at least one Swiss security dealer is involved in the trading (e.g. a bank). The transfer stamp duty, calculated on the trading price, is 0.15% in the case of Swiss bonds and 0.3% in the case of non-Swiss bonds. Especially in the case of bonds with a short residual maturity, this is an obstacle and thus makes trading activities by Swiss securities dealers unattractive.
From a Swiss point of view, the current withholding tax system has security gaps. The income of Swiss taxpayers from foreign bonds are not secured and cannot be verified, although the income and the value of the bond still must be declared as income or assets in the tax return of a Swiss taxpayer.
Content of the reform proposal
The problems described above can be solved by changing to the so-called 'paying agent principle' for interest income and by abolishing the levy of the transfer stamp duty on Swiss bonds. Under the paying agent principle, the withholding tax is no longer paid by the debtor (e.g. the company that issues a bond and pays interest on it), but by the investor's paying agent (e.g. the bank where the investor holds the bond in a custody account). The new tax applies if the paying agent is domiciled in Switzerland.
Debt capital market
The paying agent knows the identity of the investor. The agent is therefore in a position to levy the withholding tax exclusively on Swiss resident individuals. By contrast, domestic legal entities and foreign investors will be exempt from the tax. Due to this differentiated levying, groups of companies can issue their bonds by the use of Swiss companies without any withholding tax obstacles. The same applies to intra-group financing activities.
As an additional measure, the levy of the transfer stamp duties on Swiss bonds shall be abolished. This measure will also strengthen the positive effect on the debt capital market.
From a technical point of view, the paying agents are able to levy withholding tax not only on income from Swiss, but also on income from foreign securities. As a result, foreign interest income will also be secured in the future, if the foreign investments are held by a Swiss domestic individual in a securities account at a Swiss domestic bank. In this way, a significant security gap will be closed and effective progress will be made to combating tax evasion. If the paying agent is located outside of Switzerland, the international automatic exchange of information usually applies.
Investing in Switzerland
The reform also indirectly covers earned interest income. Direct and indirect investment in an interest-bearing security will be treated equally in the future. This will also partially eliminate existing disadvantages for Switzerland as a fund location. In particular, the proposal has the following effects.
Strengthening bond issuing in Switzerland (external financing)
The reform enables domestic groups to issue their bonds from Switzerland at competitive conditions. It is assumed that issues previously made outside of Switzerland will increasingly be made from Switzerland. Under certain circumstances, foreign groups may also decide to issue bonds from Switzerland.
Strengthening intra-group financing (treasury and cash-pooling)
With the reform, it is expected that intra-group financing will increasingly be conducted from Switzerland. On the one hand, Switzerland offers a high level of legal security in addition to a competitive corporate tax environment. On the other hand, due to increased substance requirements in the light of BEPS, there is likely to be a tendency towards centralisation of group activities.
The withholding tax reform will remove the biggest Swiss tax obstacles, so that Switzerland's other locational advantages can take effect. This will lead to a strengthening of the debt capital market.
Upturn in securities and asset management business
Some of the securities assets managed from Switzerland are held via foreign custody accounts due to the security stamp duty. Although the reform of the security stamp duty is unlikely to be sufficient to repatriate these securities assets and the associated value added to Switzerland on a large scale, the reform will make it more attractive for investors to purchase domestic bonds through a domestic securities dealer, as the security stamp duty is no longer levied.
For a significant revival of the custody and asset management business, the security stamp duty would have to be abolished in its entirety.
Reduction of capital market distortions
From a corporate perspective, the withholding tax reform contributes to a reduction of distortions, as previous tax obstacles to the issuance of domestic bonds are removed. The abolition of the security stamp duty also eliminates the tax disadvantages of capital market financing compared to credit financing via a bank.
Furthermore, distortions such as those that exist between direct and indirect investments will be eliminated. From the investor's point of view, the reform will strengthen the decision-making neutrality of the tax system.
Strengthening of the fund location
At present, some income is secured from withholding tax in the case of domestic collective capital investments, which is, in general, not the case with a foreign collective capital investment or direct investment. If the domestic collective capital investment reports correctly, only domestic investment income will be subject to withholding tax for exempt investors in the future. This will lead to a general strengthening of the fund location.
An indirect strengthening is also to be expected, as interest income from foreign collective capital investments will also be subject to withholding tax.
For paying agents, the introduction of changes will have substantial administrative and technical consequences. This includes considerations such as the adaptation of IT systems, and the implementation of the corresponding processes and procedures. As a result, the processing of withholding tax will become increasingly more complex for them.
The Swiss Parliament expects to discuss the proposed reform in 2021. Therefore, any proposed reform will likely enter into force, if at all, at the earliest in 2022.
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Rolf Wüthrich is an international tax lawyer with expertise in national and international tax advisory, and inbound and outbound transactions, particularly between the US and Switzerland. He is an expert on corporate restructuring and acquisitions, as well as on general corporate secretarial services. He also specialises on the drafting, coordinating and the implementation of group internal restructurings.
burckhardt Ltd provides its clients and their businesses with comprehensive advice on national and international tax planning issues and structuring. It offers corporate, general, secretarial and notary services, and regularly supports clients with its professional expertise and broad international experience on restructurings, mergers and joint ventures. The firm has experience in advising on inbound and outbound investments, as well as on financing, and in all matters related to employment, trade and transport law.
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