Participation exemption in Switzerland

The purpose of this instrument is to avoid multiple taxation of the same economic profit substrate (profit at the level of the domestic or foreign subsidiary and dividend income at the level of the Swiss parent company). As a result, investment income is not taxed in Switzerland if the relevant conditions are met. If further conditions are met, the participation exemption for corporations and cooperatives also extends to capital gains from the sale of participation rights.

The concept and the operation of the Swiss participation exemption is presented in this blog post, taking into account the latest Jurisprudence of the Federal Supreme Court.

Mechanism of the participation exemption

Dividends and capital gains from the sale of participations are generally taxable in Switzerland. However, if the legal requirements are met, such investment income may benefit from the so-called participation exemption.

The participation exemption is not a direct exemption of the participation income, but an indirect exemption method. This means that the Swiss CIT are reduced in proportion to the net investment income to the total taxable profit of the taxable corporation or cooperative on a percentage basis as part of the tax calculation.

A. Income from investments

From the gross income from the participation, i.e. from the distributed dividend amount, the receiving corporation or cooperative deducts, among other things, the financing costs associated with the participation (i.e. interest expenses attributed proportionally to the participation) as well as so-called administrative costs. According to published practice, the Swiss tax authorities generally assume administrative costs at a flat rate of 5% of the gross income, unless the company proves otherwise.

The result of this mechanism may be that investment companies with high financing (and administrative) costs nevertheless have to pay a reduced amount CIT in Switzerland on dividends from significant investments (so-called dilution effect).

B. Capital gains

The mechanism for determining the participation exemption on capital gains is in principle the same as for dividends.

In simplified terms, the relevant capital gain is the difference between the sale price and the so-called cost price. The cost of sales generally corresponds to the purchase price of the equity securities and the contributions to the company in question made by the shareholder since the acquisition. This includes, for example, open capital contributions. The cost of goods sold is reduced by depreciation in connection with distributions that have led to a reduction in the income subject to the investment deduction on dividends. Recovered write-downs on participations that are not related to distributions do not qualify for the participation deduction in this logic and are therefore fully subject to the CIT. This aspect of the participation exemption is unsatisfactory for investment companies that do not pursue any other activities and thus only receive investment income or capital gains, since they cannot use depreciations on participations for tax purposes, but must pay full tax on revaluations.

Requirements for the participation exemption

A. Dividends

In order for a corporation or a cooperative to claim the participation exemption on investment income (i.e., in particular, dividends), it must alternatively meet the following requirements:

• hold at least 10% of the share capital of the distributing company; or
• hold at least 10% of the profits and reserves of the other company; or
• hold equity securities with a fair value of at least CHF 1 million. 

B. Capital gains

In order for a corporation or a cooperative to claim the participation exemption for capital gains from the sale of participation rights, it must alternatively meet the following requirements:

• hold at least 10% of the share capital or capital stock; or
• have a share of at least 10% in the profits and reserves of the other company.

In the case of capital gains, it is therefore not sufficient if the total market value of the equity securities amounts to at least CHF 1 million.

In addition, the participation rights must have been held by the selling company for at least one year for the participation exemption on capital gains.

According to the latest Jurisprudence (ruling of December 17, 2021, 2C_950/2020), it is necessary that the conditions of a holding period of at least one year, a participation quota of 10% and a minimum sale quota of 10% are cumulatively fulfilled in order for the participation exemption on capital gains to apply.

In accordance with the wording of the law, the sale of a quota of less than 10% is only sufficient according to this latest Jurisprudence of the Federal Supreme Court if a sale of a block of shares of at least 10% has already taken place beforehand.

Final remark

The participation exemption makes it possible to avoid double taxation and, following the abolition of the holding company privilege, has become an even more important issue in connection with the attractiveness of Switzerland as a tax location. This brief outlook on the mechanics and mode of operation of the Swiss participation deduction has shown that the complex peculiarities of this instrument can be a particular challenge, especially for traditional holding companies. Particularly noteworthy is the issue of revaluation gains (i.e. reinvested depreciation), which are fully taxed under the indirect exemption system.