Swiss Withholding Tax Implications for Credit Financing—in a Nutshell
Interest payments by a Swiss company are only subject to Swiss withholding tax under specific circumstances. A federal withholding tax at the statutory rate of 35% applies:
- if the debt instrument is classified as a bond or bond-like instrument or as a customer credit balance for tax purposes;
- if interest income is distributed by a Swiss collective investment scheme; or
- if the interest is paid by a related person and not at arm’s length and therefore reclassified as a constructive dividend.
Cantonal and federal withholding taxes at varying aggregate rates apply to interest paid to nonresidents on debt secured by Swiss real estate or rights in rem in Swiss real estate.
For credit financings, the federal interest withholding tax on bonds and bond-like instruments is most relevant in practice. According to the practice of the Swiss Federal Tax Administration (SFTA), a debt financing is generally reclassified as a bond-like instrument in scope of Swiss federal interest withholding tax:
- if there are more than 10 lenders and/or sub-participants who are not banks involved under the specific financing (the “Swiss 10 Non-Bank Rule”); and/or
- if the Swiss borrower has more than 20 lenders who are not banks in aggregate under all its relevant financings (the “Swiss 20 Non-Bank Rule”) (SFTA circular no. 47 dated July 25, 2019).
Tax treaty relief from Swiss federal interest withholding tax on bonds and bond-like instruments is only granted through a reimbursement procedure, rather than at source. Therefore, finance parties usually aim at preventing interest withholding tax on bonds and bond-like instruments even in situations where a lender is entitled to full tax treaty relief.
Against this background, the finance documents involving a Swiss borrower generally address the Swiss 10 and 20 Non-Bank Rules and require a Swiss borrower to comply with them. The usual clauses also require the lenders not to make assignments and transfers or sub-participations or other harmful exposure transfers that would result in a breach of the Rules.
Compliance with the Swiss 10 and 20 Non-Bank Rules limits both the flexibility for credit financings by non-banks for a Swiss borrower as well as syndication for the lenders.
Intragroup financings are basically out of scope of the Swiss 10 and 20 Non-Bank Rules. Therefore, an approach often chosen to prevent application of these Rules is to shift the external credit financing to a non-Swiss group company. This basically works if the non-Swiss borrowing company is an active company rather than a special purpose vehicle interposed for the purposes of the specific financing.
However, the SFTA may reclassify a non-Swiss financing into a bond-like instrument issued by the Swiss group company if:
- that Swiss company provides a harmful security for the external credit financing of its non-Swiss affiliate; and
- the non-Swiss affiliate directly or indirectly (e.g., through a cash pool) on-lends funds exceeding its net equity as per any balance sheet date during the term of the financing to the Swiss group company (Article 14a of the Swiss Federal Withholding Tax Ordinance).
If a Swiss guarantor (but no Swiss borrower) is involved, the finance documents often include a use of proceeds limitation clause limiting the forwarding of debt to the Swiss guarantor, unless a tax ruling is obtained confirming that such use of proceeds does not give rise to Swiss federal interest withholding tax exposure.
If the Swiss group company’s guarantee is merely up- and/or cross-stream and limited to the Swiss guarantor’s unrestricted available equity (which is required under Swiss corporate law for such guarantee to be valid), such guarantee is generally not considered harmful and it is a straightforward process to obtain a tax ruling confirming this practice.
If the Swiss group company’s guarantee is down-stream, however, it is generally considered harmful. In such context, a tax ruling can be obtained to achieve a consolidated approach, such that the forwarding of debt would only give rise to Swiss federal interest withholding tax exposure if the funds on-lent to all Swiss group companies (after deduction of the Swiss group companies’ intra-group loan receivables) exceed the consolidated net equity of all non-Swiss group companies (announcement of the SFTA dated Feb. 5, 2019).
Abolition of Swiss Federal Withholding Tax for Credit Financing
The Swiss federal interest withholding tax on bonds and debt instruments classified as “bond-like” as per the Swiss 10 and 20 Non-Bank Rules creates a serious disadvantage for Switzerland’s debt capital market. In order to strengthen the Swiss debt capital market and to facilitate financing by Swiss companies, a fundamental reform of the Swiss federal withholding tax legislation is now pending.
The Swiss Federal Council issued the dispatch and draft legislation in April 2021. The draft bill suggests abolishing Swiss federal interest withholding tax on bonds, bond like-instruments and customer credit balances entirely, except for interest paid by Swiss paying agents to Swiss tax resident individuals. However, payments by a Swiss company classified as (constructive) dividend, and payments by Swiss collective investment schemes to their investors, remain subject to Swiss federal withholding tax.
If and when this amendment of the Swiss federal withholding tax legislation becomes effective, debt investments involving Swiss borrowers and/or guarantors will generally be out of scope of Swiss federal interest withholding tax. That is, the finance documents will neither have to address the Swiss 10 and 20 Non-Bank Rules nor any use of proceeds limitation in Switzerland.
This will significantly improve flexibility for the debt financing of Swiss companies on the capital market. However, the revised draft legislation still has to pass in the parliament and will not enter into force before 2023. Until then, funds and other investors focusing on debt investments in Switzerland are advised to carefully analyze and mitigate Swiss federal interest withholding tax exposure.
Mitigation of Withholding Tax Exposure for Debt Financing by Funds in Switzerland
If a bank is involved in debt financing of a Swiss company, Swiss federal interest withholding tax generally only becomes relevant with respect to the Swiss 10 and 20 Non-Bank Rules if the lending bank wishes to syndicate a credit facility and involve additional lenders or sub-participants that are not classified as banks. Investment funds, however, are generally not classified as banks. Investment funds involved in credit financing of Swiss companies are therefore required to specifically ensure compliance with the Swiss 10 and 20 Non-Bank Rules in any case. This becomes even more important because non-Swiss investment funds are often not entitled to reclaim Swiss interest withholding tax based on a tax treaty with Switzerland.
A non-Swiss investment fund may be classified as either one single non-bank lender if treated opaquely as a separate taxpayer for Swiss tax purposes, or as several non-bank lenders if treated transparently and looked through to the investors for Swiss tax purposes.
A look-through approach to the investors would usually result in a breach of the Swiss 10 Non-Bank Rule. That is, credit financing of a Swiss borrower by a non-Swiss investment fund is generally only feasible if the fund is treated opaquely for Swiss federal withholding tax purposes. A non-Swiss vehicle is basically treated opaquely as a separate taxpayer for Swiss tax purposes if it has its own legal personality separate from its owners.
If, however, such legal entity (i) is more similar to a Swiss partnership than to a Swiss legal entity, (ii) is not subject to ordinary corporate income taxation under the applicable foreign tax laws, and/or (iii) has no significant substance or activities unrelated to the specific credit financing, the SFTA may deny its classification as an opaquely taxed legal entity separate from its owners and treat it transparently.
In any of the above-mentioned configurations , or if the fund or investing vehicle held by the fund is a partnership without its own legal personality, there is a risk for such lending vehicle to be treated transparently and therefore to count as more than one non-bank lender. This would usually result in a breach of the Swiss 10 Non-Bank Rule and consequently in Swiss federal withholding tax on interest payments.
According to the SFTA’s practice, there is an escape from transparent taxation if the investment fund is classified as a non-Swiss collective investment scheme.
Swiss collective investment schemes are treated opaquely for Swiss federal withholding tax purposes (while being treated transparently for Swiss income tax purposes, except for investment companies with fixed capital (SICAF) and funds directly investing in real estate). Non-Swiss vehicles classified as collective investment schemes may benefit from the same opaque withholding tax treatment for the purposes of the Swiss 10 and 20 Non-Bank Rules.
The SFTA generally recognizes funds authorized by the Swiss Financial Market Supervisory Authority (FINMA) for offering in Switzerland as foreign collective investment schemes. For funds without FINMA authorization, the SFTA analyzes the classification as a foreign collective investment scheme based on the similarity of its specific features to those of a Swiss collective investment scheme.
The following features are generally relevant for the classification of a fund as a collective investment scheme:
- the fund’s statutory purpose and actual activity is collective capital investments;
- the investors are not authorized to give any instructions on the specific investments;
- the fund or its asset manager is supervised by a non-Swiss financial market supervisory authority;
- the fund is organized similarly to a Swiss collective investment scheme, in particular having an asset management company and a custodian bank.
Until the Swiss federal withholding tax reform becomes effective, whenever a non-Swiss fund is not an ordinarily taxed legal entity with several investments, it is highly recommended to obtain a tax ruling from the SFTA to confirm its classification as one single entity/non-bank lender for the purposes of the Swiss 10 and 20 Non-Bank Rules. In recent practice, the SFTA has been accommodating with tax rulings confirming the treatment of non-Swiss funds as one single lender and often confirms such ruling requests within a few weeks or even sooner.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jonas Sigrist is a Partner at Pestalozzi Attorneys at Law Ltd.
The author may be contacted at: firstname.lastname@example.org