Federal Court Decision: Crediting of Foreign Withholding Taxes for Mixed Companies

Although the decision was made on the basis of a now outdated regulation in the Implementation Ordinance (VPStA, now VStA), it is still valid for income due by the end of 2019 and, interestingly, could also prove to be a door opener for mixed companies for a higher crediting of non-recoverable foreign withholding taxes in Switzerland.

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Facts

A.A. and B.A. hold a qualifying 51% interest in the share capital of B. GmbH, which is domiciled in Germany. In the 2012 tax return, the taxpayers declared dividend income of Fr. 1,230,936 from this participation. In this case, the non-reclaimable foreign withholding tax in Germany amounted to Fr. 184,690.

In a refund ruling dated 31 October 2018, the Zug tax administration allowed a lump-sum tax credit for the German withholding tax totalling Fr. 125,898. The taxpayers objected to this. After the Zug Tax Administration had largely rejected the objection, the Administrative Court of the Canton of Zug upheld the taxpayers' appeal in its ruling of 28 January 2020 and set the amount of the creditable foreign taxes at a total of CHF 143,513.08. The taxpayers' appeal was dismissed.

In its appeal in public law matters of 19 March 2020, the FTA requested that the decision of the Administrative Court of the Canton of Zug be annulled and that the 2012 lump-sum tax credit for A.A. and B.A. be set at a total of CHF 125,914 (Confederation: CHF 61,563; Canton: CHF 64,351).

Considerations

As natural persons domiciled in the canton of Zug who held a participation of at least 10% of the share capital of a corporation in their private assets in the 2012 tax year, the respondents were subject to income tax on income from this participation at the federal level to the extent of 60% and at the cantonal and communal level to the extent of 50%.

Dividends from foreign sources are regularly subject to taxation in the source state. In its DTAs, Switzerland generally undertakes to grant recipients of such investment income, resident in Switzerland, relief for the foreign withholding tax with which the other contracting state may charge the income in accordance with the agreement.

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The tax relief on foreign withholding taxes for Swiss taxes is granted for income due by 2019 for the taxes levied by the Confederation, cantons and municipalities as a whole and is paid in a uniform amount.

Reduction of foreign withholding taxes

The lump-sum tax credit for foreign withholding tax is only granted in Switzerland if the income subject to withholding tax is subject to the income or CIT tax of the Confederation, the cantons and the municipalities. If the foreign income is subject either only to the federal income tax or only to the Individual Income Tax of the cantons and the municipalities, the lump-sum tax credit may be claimed only for a portion of the foreign withholding tax.

Under the so-called "one-third solution", the taxpayer's entitlement to a credit for foreign base taxes is reduced by a flat rate of two-thirds if the income subject to withholding tax is only subject to federal income tax or profit tax, and by a flat rate of one-third if it is only subject to cantonal and municipal income tax or CIT .

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Maximum amount

The amount of the lump-sum tax credit is limited not only by the amount of the base taxes levied by foreign DTA states, but also by the sum of the Swiss taxes due on these proceeds (maximum amount) (Art. 8 para. 2 PStAV; cf. ruling 2C_609/2019 of 13 July 2020 E. 5.2).

The Administrative Court of the Canton of Zug calculated the maximum amount for the Confederation on the one hand and the cantons and communes on the other separately and then added them together. This resulted in the total maximum amount of Fr. 143,513, which limited the relief for the German base tax of Fr. 184,690.

The FTA considers this calculation to be incorrect. The maximum amount for the Confederation on the one hand and the canton and the municipality on the other must be calculated separately in the sense that it is based on the amount of the tax of the respective municipality determined in accordance with Art. 9 et seq. VPStA, but also to one third of the foreign base tax (Confederation) or to two thirds of the foreign base tax (canton and municipality). If the federal tax is lower than one third of the foreign base tax or if the tax of the canton and municipality is lower than two thirds of the foreign base tax, only this lower (Swiss) amount is creditable at the federal or canton/municipality level. The FTA refers to this reduction mechanism as a "reduction of the maximum amount", for which it cites Art. 5 para. 4 VPStAV.

The FTA refers in particular to Art. 5 para. 4 sentence 4 ITA, which declares the reduction rule of Art. 12 ITA and the burden-sharing rule of Art. 20 ITA to be applicable mutatis mutandis. However, according to the Federal Supreme Court, Art. 5 para. 4 sentence 4 VPStA does not explain exactly how the analogous application of these regulations is to have an effect with respect to partially taxed dividends.

In its practice, the FTA apparently understands the reference to mean that taxpayers must put up with the apportionment of foreign base taxes according to the "one-third solution" if the canton and municipality tax the qualified investment income to a different extent than the Confederation or even in full.

However, in addition to the interpretation of the FTA, the reference in Art. 5 para. 4 sentence 4 VPStA could also mean, according to the considerations of the Federal Supreme Court, that only the federal, cantonal and communal taxes that are actually levied are to be taken into account for the calculation of the maximum amount (Art. 12 para. 1 sentence 2 and para. 2 sentence 2 VPStAV analogously). The lower value of the (total) maximum amount and the amount of the foreign base tax would then, according to the "one-third solution", be borne one-third by the Confederation and two-thirds by the canton and municipality for the purposes of domestic burden sharing under Art. 20 VPStA.

In view of the unclear wording of Art. 5 para. 4 sentence 4 VPStA, according to the Federal Supreme Court, the provision must be interpreted in a manner that is compliant with the DTA-D, according to which Switzerland must grant relief for German base taxes.

Taking into account Switzerland's obligations under international law, Art. 5 para. 4 VPStA is, according to the Federal Supreme Court, to be understood in such a way that a different extent of privileged treatment of qualified investment income at the federal level and at the cantonal and communal level is conclusively taken into account by determining the maximum amount at the federal or cantonal and communal level separately and then adding up the individual tax amounts. In doing so, the federal taxes on the one hand and the cantonal and communal taxes on the other hand are to be taken into account to the extent to which they are levied as a result of the privileged treatment of qualified investment income. According to the Federal Supreme Court, however, there is no additional reduction analogous to Art. 12 para. 1 sentence 1 and para. 2 sentence 1 VPStA if the Confederation on the one hand and the canton and the municipality on the other exempt a dividend from taxation to different extents. The Federal Supreme Court dismissed the FTA's appeal accordingly.

Comments

The VPTA has undergone numerous changes as of 1 January 2020, but these were not yet relevant to the case judged by the Federal Supreme Court. Nevertheless, the Federal Supreme Court anticipates the new rules and, contrary to the practice of the tax authorities, rules that the reference of Art. 5 para. 4 VPStA to Art. 12 VPStA should not be understood as meaning that the credit amount for qualified participations should be reduced for natural persons in the sense of the "thirds solution". In the latest version of the ordinance, the so-called "one-third solution" is deleted without replacement.

The Federal Supreme Court's ruling is remarkable and, in our opinion, should in principle also be applicable to so-called mixed companies, which are or were taxed at the cantonal and communal level at a reduced rate according to their domestic business activity.

Due to the reference of Art. 5 para. 3 VPStA to Art. 12 VPStA, the tax authorities have until now systematically reduced the creditable foreign withholding taxes for mixed companies according to the "thirds solution", analogous to the practice for dividends in the partial income procedure. In our view, this practice appears to be outdated in view of the new decision of the Federal Supreme Court.