Federal Supreme Court clarifies capital contribution principle for WHT

Abstract of the article

The Federal Supreme Court has clarified the conditions under which bequests are deemed to be capital contributions and can be repaid tax-free. It confirms the constitutive nature of the disclosure in a separate account and the notification to the FTA. Subsequent transfers are permitted as long as they comply with commercial law. Without timely notification, however, a distribution remains subject to withholding tax.

Context  

The ruling of the Federal Supreme Court 9C_690/2023 of March 21, 2025 deals with a central aspect of Swiss withholding tax law, the tax-free repayment of capital contributions pursuant to Art. 5 para. 1bis VStG (so-called KER). The decision focuses on the question of the conditions under which a bequest to a stock corporation is considered a capital contribution and how this is to be booked correctly under commercial law in order to enable a withholding tax-free distribution. Key questions regarding the requirements for the accounting and reporting of KER are clarified.

Presentation of the facts  

A. AG, based in Zurich, received real estate worth around CHF 51.5 million as a legacy from its deceased shareholder on November 9, 2012. After deducting mortgages, the company recognized CHF 50 million as extraordinary income in the annual financial statements and also made provisions for inheritance taxes due to the bequest. The profit for the year under commercial law amounted to around CHF 32 million.

In the balance sheets for 2013, 2014 and 2015, A. AG reported the approximately CHF 32 million in the general reserves and statutory retained earnings. In the balance sheet as at December 31, 2016, the amount of CHF 50 million was then transferred to the "Reserve from capital contributions" (KER) for the first time.

On April 21, 2017, the Annual General Meeting of A. AG resolved to pay a dividend of CHF 1.08 million (for the 2016 financial year) from the CFRs. As a precautionary measure, the WHT was paid with the note that the relevant CERs had not yet been reported using form 170 and had therefore not yet been approved in advance by the FTA. Since A. AG was of the opinion that no WHT was actually owed because, in its opinion, it was a KER, it reserved the right to reclaim the WHT once the KER had been approved by the FTA. At the end of 2017, A. AG reported KER of around CHF 31 million (around CHF 50 million less around CHF 18 million in inheritance taxes and around CHF 1 million in distributions).

In 2018, the FTA refused to recognize the KER in full. It also confirmed the obligation to pay the WHT of 35% relating to the distribution in 2017.

The Federal Supreme Court had to assess whether the FTA was correct in determining that A. AG did not have any KER as at 31.12.2017 that it could have distributed free of withholding tax and, secondly, whether WHT was owed on the distribution in 2017.

Considerations of the Federal Court  

In a first step, the Federal Supreme Court confirms the opinion of the lower court, according to which the wording of Art. 5 para. 1bis VStG requires that KER must be shown in a separate account in the commercial balance sheet. This accounting requirement has a constitutive character for the tax exemption of the repayment and is not merely a regulatory provision.

Furthermore, the Federal Supreme Court recognizes that the bequest of the deceased shareholder to A. AG can in principle be a capital contribution within the meaning of Art. 5 para. 1bis VStG. The decisive factor is that the company's equity capital was effectively increased by the bequest. Although a bequest initially leads to a claim against the heirs, this claim can already be capitalized as soon as a future inflow of funds or economic benefit appears to be very likely, which in the case of bequests is often already fulfilled at the time of the acquisition of the claim for surrender against the burdened heirs and not only when the bequest is executed.

The Federal Supreme Court bases its assessment of the KER on the (net) inflow. Both the mortgage debt assumed (CHF 1.5 million) and the inheritance tax paid (around CHF 18 million) must be deducted from the market value of the properties (around CHF 51.5 million), resulting in an eligible capital contribution of around CHF 32 million. An issue tax of 1 percent was levied on the net inflow. According to FTA practice, this was not deducted when determining the KER.

The Federal Supreme Court is also examining the accounting of the capital contribution in accordance with commercial law. The original recognition of the bequest in profit or loss in the 2012 financial year was permissible under the law at the time. Under the new accounting law, however, it is appropriate to report the capital contribution received under the statutory capital reserves. The transfer to the separate account was permissible under commercial law. The amount of KER reported in the 2017 commercial balance sheet (and adjusted downwards compared to the previous year) is therefore not objectionable.

With regard to the time of booking, the Federal Supreme Court states that there is no convincing reason to exclude a withholding tax-free distribution pursuant to Art. 5 para. 1bis VStG from open capital contributions solely because it was not booked separately immediately or promptly. Such a formalistic interpretation would be exaggerated and is also not supported by the circulars of the FTA. The booking of the capital contribution to a separate account at the time of repayment is sufficient.

The same applies to the notification to the FTA. In the opinion of the Federal Supreme Court, this is also not bound by any deadline. In the case of open capital contribution reserves, the purpose of the reporting obligation is already fulfilled if the company has reported all changes to the separate account to the FTA at the time the repayment is due.

In summary, the Federal Supreme Court found that A. AG had KER in the amount of around CHF 31 million as at December 31, 2017. Nevertheless, the distribution made in the same year was subject to withholding tax, as the corresponding notification to the FTA had not yet been made at the time it was due.

Effects of the Federal Supreme Court ruling on tax practice  

With this decision, the Federal Supreme Court provides important clarity on the application of Art. 5 para. 1bis of the Withholding Tax Act. The Federal Supreme Court's finding that the accounting requirement in withholding tax law - in contrast to income tax law - is of a constitutive nature is particularly important in practice. Only capital contributions that are recorded in a separate account in accordance with commercial law can be repaid tax-free.

The Federal Supreme Court also states that it is sufficient if the KER can be withdrawn from the corresponding account in the commercial balance sheet at the time of the distribution. The posting requirement therefore does not have to take place at the same time as the capital contribution. Contrary to the FTA's previous practice, a subsequent transfer is permissible as long as it is in line with commercial and accounting standards. This practical interpretation deserves approval, as it gives weight to formal requirements, but does not interpret them in an excessively formalistic manner.

At the same time, the Federal Supreme Court clarifies that the notification to the FTA is also a constitutive element for tax exemption pursuant to Art. 5 para. 1bis VStG. A distribution can only be made without WHT if the corresponding KER has been reported by the time the payment is due. Although there is no fixed deadline for reporting the amount, a subsequent notification can no longer eliminate a tax claim that has already arisen.

Overall, the decision brings more clarity and consistency to the application of the capital contribution principle. At the same time, it makes it clear that formal requirements must continue to be met with care, but without falling prey to excessive formalism, which would contradict the actual purpose of the regulation.