Swiss withholding tax - status quo, or is it?
On Sunday, 25 September 2022, the Swiss population rejected the withholding tax reform that sought to
- abolish withholding tax on Swiss bond interest payments
- partially abolish withholding tax on interest on bank accounts
- abolish securities transfer tax on the trading of Swiss bonds
The intention of the reform was to promote the Swiss debt capital market. Though the rejection of the reform means no legislative change, the current environment is rapidly changing with rising interest rates around the globe. In our view, it is therefore time to remind market players of what they need to consider with regard to withholding tax when issuing or trading Swiss bonds. A particular focus is made in this blog on the relevance of withholding tax in derivative transactions with notional Swiss bonds.
1 Withholding tax in general
Generally, 35% withholding tax is levied in Switzerland on income from movable assets, in particular on income from:
- bonds, serial mortgage certificates, and debt register credits issued by a Swiss resident person;
- units in collective investment schemes issued by a Swiss resident or by a non-Swiss resident person in conjunction with a Swiss resident person; and
- customer deposits with domestic banks and savings banks.
Withholding tax is also generally due on dividends paid from Swiss shares. However, this blog focuses on interest payments (with reference to dividend payments where appropriate).
2 Derivative transactions and Swiss withholding tax
The seller of a derivative with a notional Swiss bond as the underlying asset usually hedges the derivative by holding the notional bond in its own books. In case the notional bond’s interest is subject to Swiss withholding tax, the issuer of the notional bond pays only 65% of the interest to the holder of the bond and 35% of the interest to the Swiss Confederation. Reclaiming such withholding tax can be tricky in cases where the final recipient of the interest that suffered withholding tax and the person who initially received the interest are not the same – which is typically the case in derivative constellations.
3 Reclaim of Swiss withholding tax
3.1 Reclaim of Swiss withholding tax for Swiss investors
Swiss-resident investors can usually reclaim Swiss withholding tax by declaring the revenue that suffered withholding tax in their annual tax return. The withholding tax should then be credited against the ordinary income tax, provided the investor had the “right to use” the revenue that suffered withholding tax at the time when the revenue was due to be paid.
3.2 Reclaim of Swiss withholding tax for non Swiss investors
A non Swiss investor can generally reclaim Swiss withholding tax under the following conditions:
- The non Swiss investor’s country of residence has concluded a double tax treaty (“DTT”) with Switzerland;
- The non Swiss investor is “resident” in the sense of the applicable DTT;
- The DTT covers withholding tax;
- The DTT limits Switzerland’s right to levy tax on the respective type of revenue (dividend or interest);
- The non Swiss investor is the beneficial owner of the revenue that suffered Swiss WHT; and
- No treaty abuse or other sort of tax avoidance scheme has occurred.
4 Beneficial ownership
4.1 Swiss investors vs. non-Swiss investors
As stated above, a non Swiss investor in Swiss bonds must be the beneficial owner of the interest from such bonds in order to be entitled to reclaim Swiss withholding tax (provided all other conditions are met). According to Swiss case law, the term “right to use” in Swiss domestic withholding tax law and the term “beneficial ownership” in Swiss international tax law are identical to a large extent (without specifying why they are not entirely identical). Accordingly, the elaborations below on beneficial ownership and the implications on derivative transactions should equally apply for both Swiss and non-Swiss investors.
In derivative transactions, the condition of beneficial ownership plays a prominent role as the recipient of the Swiss bond’s interest usually must pass on this interest to a third party.
4.2 The definition of beneficial ownership
The term “beneficial ownership” is not defined in Swiss tax legislation. Rather, appropriate interpretations of the term have been left to be determined by the courts and the Swiss Federal Tax Administration (“SFTA”). According to the Swiss Federal Supreme Court, the dividend or interest recipient is generally the beneficial owner if they can fully dispose of the amount (i.e. can fully benefit from such dividend or interest without being legally, contractually or factually obliged to pass on the dividend or interest to a third party) (BGE 141 II 447, the “Denmark Case”).
4.3 Beneficial ownership in derivative transactions
The SFTA regularly states that they usually qualify the buyer of a derivative (with a Swiss notional security) as beneficial owner of the notional security’s revenue. This is in line with the Swiss Federal Supreme Court’s definition of beneficial ownership – provided the buyer of the derivative has itself no obligation to pass on the notional security’s revenue to a third party, which is often not the case or difficult to prove.
In this regard, it is worth noting that the SFTA obliges Swiss banks and custodians acting as the “short” party on the sale of Swiss securities to levy 35% withholding tax on the manufactured dividend or interest paid to the buyer of the shares. This practice is – after the rejection of the withholding tax reform – still short of a legal basis (which would actually be required to levy a tax), but is generally accepted in the market. As such a tax cannot be enforced against foreign banks or custodians, the SFTA generally requires foreign banks and custodians to issue a tax voucher to its client that confirms that the withholding tax or a withholding tax substitute has been deducted on the credit advice and that the appropriate amount has been paid to the SFTA.
Increasing interest rates makes withholding tax more relevant and will lead to a more thorough consideration of the respective tax clauses in derivative transaction contracts. Sellers of derivatives with notional Swiss bonds should be aware that they may most likely not be able to reclaim Swiss withholding tax levied on the interest from the Swiss notional bond. Sellers of derivative transactions on the one hand should make sure withholding tax is priced into the derivative.
On the other hand, beneficial owners (usually buyers of derivatives) should make sure they receive all necessary documents to reclaim the Swiss withholding tax. As the SFTA assesses reclaims on a case-by-case basis, we highly recommend the party wanting to reclaim Swiss withholding tax (regardless of whether the Swiss securities’ revenue is interest or another kind of revenue), to obtain a ruling from the SFTA that
- confirms the beneficial owner;
- outlines the exact procedure to reclaim Swiss withholding tax;
- lists the evidentiary documents to be filed together with the reclaim.
Notably, such a ruling must be obtained before the transactions is executed.
If you would like to discuss more on this topic, please do reach out to our key contacts below.
Key contacts
Comments
You can follow this conversation by subscribing to the comment feed for this post.
Verify your Comment
Previewing your Comment
This is only a preview. Your comment has not yet been posted.
As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.
Having trouble reading this image? View an alternate.
Posted by: |