Entitlement to treaty benefits (treaty clearance)

Profit distributions and non-cash benefits of a Swiss corporation are generally subject to a withholding tax at a rate of 35%. Provided that the relevant conditions are met however, a refund of the withholding tax is possible in international relations on the basis of a double taxation agreement (DTA ).

In recent years, the SFTA has repeatedly relaxed its requirements for claiming such treaty benefits, especially for personal holding companies.
The following article first explains the currently applicable requirements for the refund of Swiss withholding taxes on dividends in cross-border relations and illustrates these requirements in a practical example of a German personal holding company.

International tax consultancy

A. Substantive requirements for eligibility for the agreement

1. Residence in the other State

The dividend must be attributable to the shareholder of the Swiss company and the shareholder must qualify as a resident of the other State for the purposes of the applicable DTA. This criterion is always met if the shareholder is actually subject to (unlimited) tax liability in the other State.

2. Beneficial Ownership

Furthermore, the shareholder must have the effective right to use the dividend amount (beneficial ownership). According to the established practice of the Swiss Federal Supreme Court the beneficial owner is deemed to be the person who can fully use the dividend and enjoys its full benefit. If, on the other hand, the recipient is restricted in the use of the dividend by a contractual or statutory obligation, then the person may not be qualified as the beneficial owner.

According to the current version of the OECD commentary, the obligation to forward must be of a legal nature, i.e. have its basis in a contract or a law. However, whether such a legal duty to forward exists can be determined not only from contractual documents, but also from the circumstances. Purely factual forwarding obligations are no longer sufficient, even according to the latest Jurisprudence of the Federal Supreme Court, to deny the recipient of a dividend the right of use (cf. decision of the Federal Supreme Court of 19 May 2020, 2C_880/2018, E. 4.3).

International tax consultancy

3. Exclusion of Treaty Abuse

In addition, the granting of treaty benefits must exclude treaty abuse in the form of so-called "treaty shopping". Treaty shopping typically involves the attempt by a person to indirectly access the benefits of a DTA without being a resident of one of the involved jurisdictions.

According to the current practice of the SFTA, certain substance requirements must be fulfilled to rule out treaty abuse. These substance requirements can be divided into the following three substance tests:

  • Personnel- and infrastructural substance: The shareholder must have its own office facilities and at least one employee.
  • Functional substance: If the foreign company is a holding company (i.e. without any operating activity), then it should hold several active subsidiaries. In addition to the Swiss participation, the SFTA regularly requires at least one further domestic or foreign subsidiary.
  • Financial substance: For a pure holding company, the debt-to-equity-ratio should be at least 30% of total assets based on book values.

The three substance tests can be met alternatively in the case of a listed group parent (TopCo) and, more recently, also in the case of a personal holding company. The SFTA continues to apply stricter standards to private equity structures.

A personal holding company is a company that derives most of its income from passive income (i.e. dividends, interest, rents or royalties) and the majority of its shares are owned by one or a few individuals.

Private equity structures: Private equity is a form of investment in companies that are generally not listed on a stock exchange. The capital for private equity investments regularly comes from institutional investors and wealthy individuals. By pooling investment funds at the level of the private equity vehicle, the investor community combines investments to form a qualifying investment with a lower residual DTA rate.

B. Practical example

An individual resident in Germany and subject to ordinary taxation has held a Swiss subsidiary for more than 12 months via a holding company resident in Germany. The holding company has an equity ratio (based on book values) of 30%, but has neither personnel substance (staff and/or offices) nor functional substance (i.e. no other participations).

Pursuant to Art. 10 para. 3 DTA between Switzerland and Germany (DTA CH-DE), the German holding company is in principle entitled to a full refund of Swiss withholding tax, as it directly holds more than 10% of the capital of the Swiss company paying the dividends for a period of more than 12 months.

Although the individual itself would only be entitled to a refund of Swiss withholding tax up to a residual rate of 15% pursuant to Art. 10 para. 2 let. c DTA CH-DE, the holding company is entitled to a full refund under the current practice of the SFTA, as it meets one of the substance tests.

However, it should be noted at this point that other anti-avoidance rules, such as the so-called old reserves practice or the legal concept of international transposition, may still be applied by the SFTA.

C. Conclusion

If the Swiss corporation qualifies for the agreement, it can apply to the FTA for permission to use the international reporting procedure using Form 823B before the dividends become due. This allows profit distributions to be made without delivery of the WHT to the German holding company. In this case, the withholding tax obligation is fulfilled by reporting the dividend to the FTA. For this purpose, Form 103 or Form 110 (in the case of a GmbH) must be submitted together with Form 108 within 30 days of the dividend becoming due.

The example of the German personal holding company can in principle also be applied to any other personal holding company from another State, with which Switzerland has concluded a similar DTA as with Germany.

It is, however, always advisable for a personal holding company to clarify the treaty eligibility with the SFTA prior to the first distribution as the requirements for treaty benefits are not set out in a binding practice and have repeatedly changed significantly in recent years.