Vicarious liquidation

In connection with international corporate restructurings, it is inevitable to deal with the issue of treaty abuse. In Switzerland, in connection with the restitution of the Swiss WHT - in addition to the legal figures of the old reserves practice and the international transposition - the so-called representative liquidation is in particular in focus. This specific fact is presented in this blog post on the basis of a recent Federal Administrative Court decision.

I. Vicarious liquidation

a. Facts

In the case of a deputy liquidation, the withholding tax situation with regard to a Swiss company is improved in the same way as with the old reserves practice by selling the Swiss corporation to a resident or to a foreign person with a better refund position. However, in contrast to the practice of old reserves, the proxy liquidation does not require the Swiss company to have distributable, non-operating funds at the time of the transfer. Rather, a refusal to reimburse WHT under the title of proxy liquidation presupposes that the economic objective of the transaction is not a sale of the company itself, but a sale of the company's assets . In other words, the sale of the company by means of a "share deal" can only be explained by the fact that the sale of the company is more optimal for the seller party from a withholding tax perspective than an "asset deal". Possible indications for this assumption are a prompt liquidation of the Swiss company after the acquisition or if the company sold is ready for liquidation .

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b. Legal consequences

The legal consequences of the vicarious liquidation with regard to the refusal to reimburse the WHT to the new unit holder can be more serious than in the case of the old reserves practice. The refusal to reimburse the Swiss WHT to the extent of the reimbursement position of the former shareholder is not limited to the funds that are not necessary for operations and distributable under commercial law at the time of the sale or transfer, but also includes all hidden reserves as well as the goodwill on the assets concerned.

What this can mean in practice is shown by the following example of a recent Federal Administrative Court decision: 

c. Example (Federal Administrative Court of 10 March 2022, A-4347/2019)

In 2013, a foreign national sold a Swiss real estate company to a Swiss corporation for CHF 7.3 million through a legal structure in Liechtenstein. On the same day, the Swiss real estate company sold the main asset - a property - to a foundation in Liechtenstein for CHF 18.2 million. The book value of the property at the real estate company was CHF 5.1 million. After deducting further expenses, the Swiss real estate company realised a profit of approximately CHF 12.6 million from the sale.

At the annual general meeting of the Swiss real estate company in 2015, a dividend of just under CHF 10 million was subsequently approved in favour of the Swiss corporation.

Although the Swiss real estate company did not have any distributable reserves at the time of the transfer to the domestic shareholder, the Swiss real estate company was completely denied the application of the reporting procedure on the declared dividend of just under CHF 10 million on the basis of the legal concept of vicarious liquidation, and the new Swiss shareholder was treated as if the dividend was paid to "B Ltd." with regard to the reimbursement of WHT on the declared dividend. In the absence of "B Ltd.'s" entitlement under the agreement, this meant in the present case, according to the Federal Administrative Court, the full delivery of WHT to the extent of 35%.

According to the considerations of the Federal Administrative Court, the de facto liquidation of the Swiss real estate company was initiated in 2013 with the sale of the property and thus of the main asset of the company without reinvestment of the funds received as a result and was completed with the dividend in 2015. According to the court, this justifies the application of the deputy liquidation for the purposes of WHT.

The sale of the property by the Liechtenstein "B Ltd." to the Swiss company "A Ltd." by means of a "share deal" can therefore only be explained in the logic of the court as the latent residual withholding tax burden on the hidden reserves and the goodwill on the property as the main asset of the company, which would definitely have to be paid to the FTA on the liquidation dividend to the foreign shareholder "B Ltd.", could be eliminated in a tax-optimised manner by a share deal to a Swiss corporation such as "A Ltd.", which can report the WHT in full. This considerable tax saving is understood by the FTA and - repeatedly also by the Swiss courts - as circumvention of WHT, insofar as no other convincing reasons can be given for the chosen procedure.

II. Conclusion

If a current shareholder is not or only partially entitled to a refund of the Swiss WHT , the residual withholding tax burden can be optimised by means of a share deal instead of an asset deal. If it turns out that from the beginning only the transfer of the asset and not the transfer of the company (incl. its business) was intended by the seller, the FTA - based on the applicable Jurisprudence - may refuse to refund the Swiss WHT in whole or in part to the new dividend recipient with reference to the legal figure of vicarious liquidation.

However, the legal concept of vicarious liquidation may not stand in the way of a sensible restructuring of a group (e.g. intra-group transfers of business assets such as IP) after the acquisition, insofar as it is credibly argued by the buyer that this restructuring is based on business motives. In this respect, it is important that transactions that could lead to an improvement in the refund entitlement are always analysed in detail and discussed in advance with the FTA.