International transposition

In connection with international corporate restructurings, it is inevitable to deal with the issue of treaty abuse. In Switzerland, in addition to the practice of old reserves and representative liquidation, the legal concept of international transposition is regularly in the spotlight. This subject is presented in more detail in this blog post.

I. International transposition

a. Facts

Transposition describes a process in which a tax benefit is obtained by reorganizing the ownership structure of legal entities without changing the ownership structure.

In the case of international transposition, the withholding tax situation is improved by a person not entitled to a full refund of the WHT owed selling a domestic corporation to another domestic corporation controlled by the same person in return for the issue of a loan or, alternatively, contributing it to the acquiring corporation at fair market value (i.e. including goodwill/hidden reserves) in return for reserves from capital contributions.

This procedure allows in principle - as far as accepted by the competent Federal Tax Administration (in short: "FTA") - to "transfer" latent withholding tax substrate, which is subject to a base burden, into a withholding tax-free area, in that the reserves can now be returned to the original owner free of withholding tax by means of loan repayment or distribution of KER.

b. Legal consequences

As a rule, the FTA considers such a procedure as circumvention of WHT and therefore refuses the domestic reporting procedure (i.e. refusal to apply Form 103 or Form 110 in conjunction with Form 106) as well as, to the extent of the refund position of the original parent company, the refund of WHT on distributions of the transferred subsidiary to its new Swiss parent company.

c. Practical example

A Singapore resident corporation (here HoldCo 1) sells its previously directly held Swiss subsidiary OpCo (share capital: CHF 1 million, no KER) against issuance of a loan in the amount of CHF 50 million to a recently established Swiss subsidiary (here HoldCo 2) directly held by the Singapore resident corporation. At the time of the sale, there are no old reserves (i.e. distributable, non-operating substance) at the Swiss OpCo.

The sale of the participation in OpCo to the new Swiss intermediate holding company HoldCo 2 against the issuance of a loan creates substrate in the amount of CHF 49 million, which previously would have been subject to a residual WHT of 5%, to the extent realized, and can now be repatriated free of withholding tax by means of a loan repayment to HoldCo 1, which is domiciled in Singapore, since the domestic reporting procedure generally applies between Swiss corporations. Consequently, potential withholding tax substrate in the amount of CHF 2.45 million will be destroyed.

The transaction is assessed by the FTA as tax avoidance because the transfer to the Swiss intermediate holding company HoldCo 2 is only tax motivated. As a result, on future distributions of the Swiss sub-subsidiary (i.e. OpCo) to its Swiss parent company (i.e. HoldCo 2) in the amount of CHF 2.45 million, the reporting procedure as well as the refund of WHT will be denied.

Practical example from Bucher Tax: an international transposition.

II. Tightening of the practice

Recently, the FTA has further tightened the scope of application of international transposition and extended it to the context outside of group relationships. The FTA has recently applied the legal concept of international transposition under the title of so-called "extended" international transposition also to the acquisition of Swiss companies between independent third parties, if the acquirer was newly established shortly before the purchase by a person not entitled to the treaty (typically a foreign private equity fund) and was financed by the latter with a view to the acquisition of the Swiss corporation by means of loans or reserves from capital contributions.

The tightening of the practice comes into effect in particular if the financing of the Swiss acquisition company (and thus the purchase of the Swiss company) was made possible exclusively through shareholder loans or through reserves from capital contributions of the foreign private equity fund not entitled to the agreement and thus without the addition of external bank financing. The following simplified example illustrates this new application case of international transposition:

III. Concluding remarks

If a current or future shareholder is not or only partially entitled to a refund of the Swiss WHT, it is imperative that the legal concept of international transposition be observed in the event of a transfer of a Swiss company to another Swiss intermediate company. The practice of the FTA in this regard has been gradually tightened in recent years, which is exemplified by the new facts of the so-called "extended" international transposition.

Interestingly, the FTA applies the legal concept of international transposition only in the case of a transfer to a domestic, i.e. Swiss, intermediary company, although the same result may be achieved in the case of a sale to a foreign corporation, provided that the general requirements regarding the eligibility for the treaty are met. In the case of a sale against the issuance of a loan to a foreign company, the legal figure is therefore not applicable. This is mainly due to the fact that the legal basis for the application of the legal concept is found in the domestic withholding tax law.

Since the practice as well as the respective nuances regarding tightening and exceptions are not made publicly available or viewable by the FTA, a transfer to improve the withholding tax situation in the international relationship under the aspect of international transposition must always be proactively discussed or ruled with the FTA prior to each transaction.