Old reserves practice

Profit distributions by a Swiss corporation are subject to 35% Swiss WHT. In the national context, the WHT fulfils a security function and can be refunded or reported - provided that the legally stipulated conditions for this are met.

In international relations, on the other hand, the WHT has a fiscal purpose and can therefore only be refunded or reported to the extent that a double taxation agreement (DTA) of Switzerland provides for relief in this regard.

In order to grant such relief on profit distributions of a Swiss corporation, it must be possible to exclude, in addition to the general eligibility and substance requirements within the meaning of the relevant provisions in the Swiss DTAs (cf. our blog post of 3 March 2022), in particular treaty abuse according to the old reserves practice, international transposition or representative liquidation.

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I. Base charges according to Swiss DTAs

Switzerland's right of taxation as a source state is numerically limited in all Swiss DTAs. According to most of Switzerland's DTAs, the source state's right to tax dividends from portfolio holdings is limited to 15 per cent of the gross amount.

For intra-group dividends, a large number of Swiss DTAs further restrict Switzerland's right as a source state to levy a final WHT . Most of Switzerland's DTAs require a stake rate of between 10 and 25 per cent for a reduction of the basic tax on intra-group dividends. Some DTAs also stipulate a minimum holding period for the shares.

According to Switzerland's DTAs with Australia, Albania, Algeria, Armenia, Azerbaijan, Bahrain, Belarus, Canada, China, Egypt, Ghana, Greece, Israel, Kazakhstan, Kyrgyzstan, South Korea, Kosovo, Croatia, Lithuania, Macedonia, Malaysia, Moldova, Mongolia, Montenegro, Qatar, Oman, Russia, Zambia, Saudi Arabia, Serbia, Singapore, South Africa, Tajikistan, Turkey, Turkmenistan, Ukraine, Uruguay, Uzbekistan, USA and the United Arab Emirates, the source state's right to tax intra-group dividends is reduced to 5 per cent.

Switzerland's DTAs with Argentina, Bangladesh, Brazil, Indonesia, Jamaica, Pakistan, Peru, Philippines, Sri Lanka, Taiwan, Thailand, Trinidad and Tobago, Tunisia and Vietnam provide for a higher residual rate of 10 percent.

Switzerland's DTAs with Austria, Belgium, Bulgaria, Colombia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Georgia, Germany, Hong Kong, Hungary, Iceland, Ireland, Japan, Latvia, Liechtenstein, Luxembourg, Malta, Mexico, Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, United Kingdom and Venezuela provide for the so-called zero rate (0 percent) for intra-group stakes.

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II. Old reserve practice

a. Facts

If the refund position (i.e. the extent of the remaining base tax) on profit distributions of a Swiss corporation is improved by means of restructuring or sale of the participation, the so-called old reserve practice must always be observed in international relations.

According to the Federal Supreme Court and the FTA's established practice, this is applied on the basis of the unwritten abuse proviso if a restructuring or a third-party sale reduces the residual withholding tax burden on distributable, non-operating funds already existing at the time of the restructuring without the restructuring being justified by sufficient economic motives. The applicability of the old reserves practice in the case of a third party sale was only recently confirmed by the Federal Supreme Court(see Federal Supreme Court ruling of 29 July 2021 (2C_80/2021)).

b. Example

In practice, the constellations where the old reserve practice applies can be manifold and not always easy to understand. However, a simplified standard situation where the old reserve practice can be applied can generally be summarised as follows:

A Swiss corporation is directly 100% owned by a US group company. As part of a group-internal reorganisation of the worldwide participation structures, the Swiss participation is transferred to a Dutch group company. The transfer of the participation is primarily motivated by tax considerations. Since the basic tax rate according to the DTA between Switzerland and the USA is 5% in the group relationship, but the so-called zero rate applies to the Netherlands, the practice of old reserves must be observed.

Example of an old reserve practice by Bucher Tax AG.

c. Legal consequences

The old reserves practice leads to the refusal of the Swiss WHT to the new shareholder of the Swiss corporation at the time of later distributions to the extent that so-called old reserves exist.

The acquirer is thus treated with respect to the refund of WHT on the old reserves already existing at the time of acquisition as if it were in the refund position of the former unitholder. In the preceding example, a non-refundable WHT of 5% would still have to be levied on distributions to Dutch Co from so-called old reserves of SwissCo in line with the refund position of US Co. The further 30% withholding tax can be reported via the international reporting procedure using form 108, provided that the Dutch Co's eligibility has been requested in advance using form 823B.

d. Determination of the old reserves

Central to the practice of old reserves is the fact that at the time of the transfer there were reserves in the Swiss company which the company could have distributed from its free resources.

According to the practice of the FTA, old reserves are the non-operating funds available and distributable at the time of the transfer. Funds not required for operations are therefore only potential "old reserves" to the extent that they are distributable under commercial law.

i. Passive test

A company's equity capital as reported under commercial law, less the company's share capital (share capital or nominal capital) and the legal reserves, is distributable. For a holding company, 20% of the share capital is considered non-distributable, regardless of the actual amount of the legal reserves. For all other companies this amount is 50%. If there are additional capital contribution reserves (so-called "KER"), these additionally reduce the "distributable reserves" that are decisive for the determination of the old reserves.

ii. Active test

For the purposes of the asset test, non-operating funds are those funds that are not required to fulfil the operating purpose of the company. When assessing the extent to which liquid assets are to be considered "not required for operations", the liquidity needs of the respective company must also be taken into account. Liquid assets (e.g. bank accounts etc.) are not per se "not necessary for operations". The time of the transfer of the shares is decisive for the assessment of the asset test.

e. Justification by sufficient economic motives

In order to avoid the application of the old reserves practice, it is possible to prove that a transfer is made for economic reasons and is therefore not abusive with regard to WHT (exculpation). The abusive element in the context of the old reserves practice is not simply the improvement of the refund position, but the combination of (past) distribution policy (i.e. high retention) and transfer to improve the refund position. However, experience shows that it is difficult to convincingly provide this exculpation evidence to the FTA.

III. Conclusion

If a current shareholder is not or only partially entitled to a refund of the Swiss WHT , the residual WHT can be reduced by an intra-group restructuring or by a third-party sale. If this proves to be abusive, the FTA may - based on the supreme court ruling Jurisprudence - refuse to refund the Swiss WHT in whole or in part to the new dividend recipient with reference to the old reserve practice. In this respect, it is important that transactions which may lead to an improvement of the refund entitlement are always analyzed in detail and discussed with the FTA in advance. In particular, with regard to the scope of the old reserves, there is usually considerable scope for discretion and thus also for argumentation.