Holding demerger

General: Demerger in restructuring law

According to Art. 61 para. 1 let. b DBG (= direct federal law) or the analogous provisions in the cantonal tax laws, hidden reserves of a legal entity are not taxed in the event of a demerger if the following cumulative conditions are met:

• the tax liability continues to exist in Switzerland;
• the values previously relevant for profit tax are adopted;
• one or more businesses or parts of businesses are transferred;
• the legal entities existing after the demerger continue to operate a business or part of a business (so-called double operating requirement).

Specifically: Operating requirement for holding companies

It should be noted that the holding and management of securities that merely serve to invest own assets does not generally constitute a business, even in the case of large assets. Rather, according to current practice, the following conditions must be met cumulatively for a "holding company" to exist from the perspective of restructuring law:

• In terms of value, investments are mainly those in active companies;
• Shareholdings generally represent at least 20 percent of the share capital or nominal capital of the other companies or otherwise offer the possibility of assuming significant control (e.g. through corresponding shareholders' agreements);
• After the demerger, holding companies assume a holding function through their own staff or authorized persons (strategic management, coordination of the business activities of several subsidiaries);

If an actual holding operation at the level of the holding company is not possible for the purposes of the tax-neutral demerger, e.g. because the holding company does not have its own staff, an operating requirement can now also be fulfilled at the level of the active company in which the holding company holds an interest (so-called "operating business") in accordance with the new Federal Supreme Court ruling of March 11, 2019 (application of the transparency principle). This principle is fulfilled if the holding companies each hold a stake of more than 50% of the votes in an active company after the demerger. In this case, the operating business managed by the active company can be fully attributed to the holding company based on the transparency principle. Control in terms of voting rights is primarily decisive for the assessment of the so-called operating business. This means that even if the calculated indirect shareholding does not reach the 50% threshold, an active company that is indirectly controlled by voting rights via one or more intermediate holding companies can be attributed to the holding company for the purposes of an operating business.

Case study

Facts

X (domiciled in Zug) is the sole shareholder of X Holding Ltd., domiciled in the canton of Zug. X Holding Ltd. is in turn the sole shareholder of the operating company A Ltd.. The market value of A Ltd. is CHF 5m, while the corresponding book value (=profit tax value) of the holding in X Holding Ltd. is CHF 3m. In addition, X Holding Ltd. holds a 20 percent stake in the production companies B Ltd. and C Ltd.. X finds buyer A for A Ltd., who offers him the market value of CHF 5m.

Question

What are the tax consequences if X Holding Ltd. first spins off the participation to a new holding company and X sells this participation to the third party A (variant 1) as opposed to a direct sale by X Holding Ltd. (variant 2)?

Reply

Variant 1

The requirements for a tax-neutral demerger in accordance with the DBG or the analogous provisions of the Zug Tax Act and thus also the double operating requirement are met in the present case. Due to the fact that X Holding Ltd. continues to hold two qualifying participations, a so-called "holding business" continues to exist in X Holding Ltd. Y Holding Ltd., on the other hand, has an "operating business", as the shareholding in the active A Ltd. with an operating business amounts to more than 50 percent of the votes (application of the transparency principle).

In terms of profit tax, the demerger can therefore be neutral and no lock-up period is imposed. As a result of the subsequent sale of Y Holding Ltd., X therefore realizes a private capital gain, which means that he receives 100% of the CHF 5m, i.e. tax-free.

‍Variant2

The sale of the participation to Y is subject to the profit tax at the level of X Holding Ltd. in the difference between the profit tax value and the sale price, whereby a net zero taxation results when applying the participation deduction. However, the repatriation of the gain on the sale in the difference between the book value of CHF 3m and the sale price of CHF 5m (i.e. around CHF 2m) is subject to Individual Income Tax at the level of X, whereby the partial taxation procedure is applied in this case (i.e. taxation at the federal level of 70% and at the level of the Canton of Zug of 50%). The distribution of the profit from the sale of the participation therefore results in a total income tax burden of approximately CHF 270'000 for X. The 35% withholding tax to be levied on the distribution is credited against the income tax charge or refunded to him as long as the dividend is properly declared.

Conclusion

The relaxed practice for holding company demergers introduced via Jurisprudence facilitates tax-optimized disposals of shareholdings and therefore also succession planning for SMEs with various operating businesses. The simplified case study shows that the difference to a simple direct sale by the holding company is considerable. It should be noted that in the situation where the buyer acquires the shareholding via its own acquisition company, indirect partial liquidation must always be taken into account in the case of a holding company demerger. Here too, however, taxpayers have planning options when structuring the demerger balance sheets.