Swiss Withholding Tax Refund on Equity Finance Transactions: New Decision of the Federal Supreme Court

On 5 April 2017, the Swiss Federal Supreme Court issued a new decision concerning the Swiss withholding tax refund right of an Italian bank that was engaged in a combination of buy-sell and derivatives transactions with shares of Swiss issuers around dividend payment dates. To a large extent, the decision of the Court concentrated on the evaluation of taxpayers’ compliance with the concept of beneficial ownership requirements aimed at assessing whether relevant transactions entered into by the taxpayer constituted the mere setup of a dividend stripping. Subsequently, the Court denied Swiss withholding tax refund claims due to the failure of the taxpayer to provide the Federal Tax Authorities (“FTA”) with the required information for the identification of the counterparties to the relevant trades, considering this a failure of the taxpayer to cooperate since such information is, in the view of the Court (and of the FTA), an essential element of proof within beneficial ownership testing.

Previous jurisprudence

The judgment represents the further evolution of previous cases delivered by the Federal Supreme Court in similar situations, and in particular, with regard to two Swiss withholding tax refund lead cases dealing with Danish Banks (for further details, please see the following blog posts).

Decision of the Federal Supreme Court of 5 April 2017

Relevant facts:

A bank incorporated in Italy entered into a number of buy/sell and derivatives transactions (futures) with Swiss shares. The bank acquired these securities shortly before the dividend payment date and sold them shortly after the dividend receipt. Further to the dividend payments, the Italian bank filed several withholding tax refund requests with the FTA regarding dividends distributions arising from securities held on ex-dividend dates. While the claims were under consideration, the FTA requested the bank provide additional information regarding the transactions, and in particular, to disclose information enabling the identification of the counterparties to the transactions with underlying securities prior and post the dividend payment event.

Because the Italian bank was unable to provide this information, the FTA and the Federal Administrative Court rejected its Swiss withholding tax refund claims.

Federal Supreme Court decision highlights:

In its decision, the Swiss Federal Supreme Court reiterated its jurisprudence regarding the concept of beneficial ownership, and provided the following arguments:

  • The Federal Supreme Court re-established that Swiss withholding tax refund claim eligibility in the context of the application of a double taxation treaty requires that the claimant be the beneficial owner of the underlying income.
  • To qualify as a beneficial owner of income (a dividend in the case in question), the recipient should be free in determining further faith of income received (this means that the taxpayer should not have any contractual or legal obligation to pass on such income to third parties). The notion of beneficial ownership should be considered while taking into account economic circumstances and not just pure tax reasons (such as the attempt of the recipient of the dividend to benefit from a double tax treaty withholding tax reduction). Consequently, the Court mentioned that although the tax savings is effectively not present, this is not relevant for the double tax treaty eligibility analysis, which precluded the line of reasoning that all counterparties involved in the transaction were residing in treaty countries with the same residual Swiss withholding tax rate under the relevant treaty with Switzerland.
  • Moreover, the Federal Supreme Court recalled that Swiss Tax Law imposes information-sharing and cooperation duty on taxpayers. This duty should apply both to resident and non-resident taxpayers, even if the double tax treaty does not have a specific provision in this respect. The Court stated that during the procedure, the FTA may request information and documentation enabling it to appropriately review and assess a Swiss WHT refund claim. The rules are that the requested evidence must not be obviously inappropriate to make the required assessment (i.e., it must be reasonable and offer suitable proof) and should not result in disproportionate costs for the claimant. The absence of cooperation cannot create a comparative benefit for the taxpayer, and will have negative consequences if the case cannot be properly reviewed and assessed by the authorities.
  • The Federal Supreme Court also stated that brokers used in equity finance transactions will not be recognized as counterparties but only as intermediaries, and that it is the claimant’s duty to provide proof of the effective counterparty behind the broker.

After analysing the facts of the case, the Court found that:

  • The taxpayer could not establish its compliance with Swiss beneficial ownership requirements for double tax treaty benefits application purposes just by providing the names of the counterparties effectively involved in the transactions.
  • The FTA may request information and documentation to make a proper assessment of the facts and circumstances of the transaction which resulted in a Swiss WHT claim. The claimant must provide reasonable documentation as part of his information and cooperation duties. These duties are limited by the principle of proportionality, which means that the requested information should neither be obviously inappropriate to make the required assessment nor result in disproportionate costs for the claimant. Of course, these principles are open for legal interpretation and subject to scrutiny.
  • Moreover, the Court ruled that, by not providing the requested information, the Italian bank deliberately hid essential elements of the facts required for the analysis of its transactions by the authorities, meaning non-cooperation was in fact established. Without the documentation by the claimant, the FTA was put in a position where it was impossible to understand the effective flows and structure, or to analyse the claim against the practice established by the Court. Hence, the claimant was forced to face the consequences of the missing proof of its tax mitigating elements.

Further to the above, the Federal Supreme Court concluded that the withholding tax refund should be denied to the Italian bank (only a non-material claim was sent back to the tax authorities for reassessment due to violation of the formal requirements of the procedure).

What does it mean for you?

The new Court decision clearly shows, in line with previous jurisprudence, an overall trend for assessing compliance with beneficial ownership requirements, and for the detailed review of relevant documentation when withholding tax refund claims are filed within the scope of financial services industry transactions. Market participants using brokers in similar transactions will be required to disclose the effective parties behind the broker, which will in practice make it difficult to establish proof.

The recent jurisprudence makes it clear that all cases should be analysed on the basis of individual facts and circumstances, and that outcomes may vary depending on the analysis of transactions.

We encourage you to review present and previous withholding tax claims filed for similar transactions to determine whether any risks are present, and to develop and implement risk mitigating strategies for the future.

Martin Büeler
Partner, Tax & Legal
martin.bueeler@ch.pwc.com
+41 58 792 43 92
Luca Poggioli
Director, Corporate Tax
luca.poggioli@ch.pwc.com
+41 58 792 44 51
Victor Meyer
Partner, Tax & Legal
victor.meyer@ch.pwc.com
+41 58 792 43 40
Dieter Wirth
Partner, Tax & Legal
dieter.wirth@ch.pwc.com
+41 58 792 44 88
Dmitri Deniskin
Director, Tax & Legal
dmitry.deniskin@ch.pwc.com
+41 58 792 8258

Switzerland becomes white listed for Italian Financial Transaction Tax purposes

Swiss financial intermediaries in scope for I-FTT purposes must register and pay due FTT
The change

On 26 October 2016 the Italian Revenue Agency (Agenzia delle Entrate) has published a provision outlining that Switzerland has become whitelisted for Italian tax purpose further to amendment of the double tax treaty between Switzerland and Italy. The amendment notably foresees the agreement to exchange information and to provide assistance in the collection of tax credits, which is the driver for Switzerland’s whitelisting.

Further to this whitelisting, Swiss financial intermediaries can no longer rely on the previous treatment under the blacklisting rules, i.e. being treated as the end investor or purchaser in a transaction involving financial products subject to Italian FTT. Under this treatment, the white list financial intermediary counterpart would have charged the Swiss financial intermediary with Italian FTT on a pre-emptive basis and paid it to the Italian Revenue Agency. Although being treated as an end investor was not a substitute for FTT compliance, as a matter of fact being a resident of a black list Country provided a reasonable certainty that no audit by Italian tax authorities was ever going to take place (in the event a black list entity wanted to comply, a specific whitewashing procedure was available).

The issue

The whitelisting now leads to the situation where every Swiss financial intermediary (banks and brokers in the first place, but also asset managers, trust companies and notaries in residual cases) needs to levy and account for any Italian FTT due on transactions involving taxable financial products, which means that the intermediary has to fully comply with the duties imposed under the Italian FTT regulations. As the provision amends the whitelist with retroactive effect as of 13 July 2016, Swiss financial intermediaries will need to report taxable transactions and declare the due Italian FTT for the period since entering into force to 31 December 2016 no later than 31 March 2017 with the Agenzia delle Entrate.

The take away

Swiss financial intermediaries can no longer rely on being treated as the end investor for Italian FTT purposes. As of 13 July 2016 Swiss financial intermediaries must autonomously apply and levy any due Italian FTT to their transactions with chargeable financial instruments. It is of utmost importance that the relevant compliance procedures are implemented enabling the Swiss financial intermediary to assess the due Italian FTT and to pay it on time, i.e. no later than 31 March 2017.

Contacts:

Martin Büler
Partner, Tax&Legal
+41 58 792 43 92
martin.bueeler@ch.pwc.com

Luca Poggioli
Director, Tax&Legal
+41 58 792 44 51
luca.poggioli@ch.pwc.com

Victor Meyer
Partner, Tax&Legal
+41 58 792 43 40
victor.meyer@ch.pwc.com

The Swiss Federal Supreme Court has published the written motivations to the two Swiss withholding tax refund lead cases with Danish Banks

The Swiss Federal Supreme Court published the written reasons for judgement for the two Swiss withholding tax refund lead cases concerning Danish banks involved in derivative transactions over dividend ex-dates with Swiss equities on 28 October 2015. The two cases were previously discussed in a public hearing at the beginning of May. The Swiss Federal Supreme Court has ruled in favour of the Federal Tax Authority (FTA) in both cases and has overruled the previous decisions taken by the Federal Administrative Court.

The cases under scrutiny

In the first case, a Danish bank entered into several total return swap transactions with counterparties in the EU and the US relating to Swiss equites. To hedge the exposure from the total return swaps, the Danish bank bought the necessary Swiss equities from various parties. Upon the maturity of the total return swaps, the shares were sold to parties other than those from whom the bank had previously sourced the shares. Under the swaps the Danish bank had to pay an amount equivalent to the dividend received to the counterparty.

The second case relates to a Danish subsidiary of a Swedish bank that entered into derivative transactions by selling (OTC) SMI futures through EUREX and a broker, and who had hedged this short position by buying the SMI components from a different platform/broker. Both legs of the transactions were executed on 19 February 2007. Upon the maturity of the SMI futures on 15 March 2007, the derivative position was rolled into further SMI future contracts with an expiry of 15 June 2007. Upon expiry in June, the SMI futures position was closed and the long position in SMI components was also sold.

In both cases, dividends received during the maturity of the trade were subject to 35% Swiss withholding tax for which a full refund was claimed under the former Danish-Swiss double tax treaty (the current amended treaty only provides for a partial refund on portfolio holdings). For both cases, the FTA had denied the refund of Swiss withholding tax and was then overruled in the Federal Administrative Court.

Reasons for judgement of the Swiss Federal Supreme Court

The Swiss Federal Supreme Court analysed whether the notion of beneficial ownership was a requirement for Swiss withholding tax refund under the Danish-Swiss double tax treaty as the Federal Administrative Court did not analyse this notion in its appealed decisions. In application of the Swiss Federal Supreme Court’s practice, the interpretation of double tax treaties has to be based on international law and its inherent practice, in particular on the Vienna Convention on the Law of Treaties and the principle of good faith. In its analysis, the Swiss Federal Supreme Court has ruled that the requirement of beneficial ownership is implicitly demanded for the refund of Swiss withholding tax even if such a definition is not explicitly contained in the wording of the relevant treaty, which is aligned with the domestic interpretation of the two treaty countries in the case at hand.

The Swiss Federal Supreme Court defines beneficial owner as a person who has the power of disposition over the dividend income. This is the case, if and when a person having the beneficial use can utilise the dividend without any legal, contractual or factual obligation leading to a limitation of this right to use. According to the Swiss Federal Supreme Court, an actual limitation of beneficial ownership is a given if the following two conditions are met cumulatively: (i) the achievement of the income is dependent on an obligation to forward such income, and (ii) the obligation to forward the income must depend upon the achievement of that income. The Swiss Federal Supreme court states that such an obligation to forward income may be based on a (direct) legal obligation or on the basis of all the facts and circumstance of the case, i.e. by applying a substance over form approach.

In the swap case and by applying the above definition of beneficial ownership and considering the overall facts and circumstances of the case, the Federal Supreme Court came to the conclusion that the Danish bank had given up its beneficial ownership of the dividend payment when entering into the swap transaction. The main arguments used were:

  • The hedging with Swiss equities was carried out immediately after entering into the derivative liability with a full hedge (of dividends and positive price changes of the underlying components)
  • By entering into the swap transaction the Danish bank was able to fund the transaction with debt
  • The Danish bank did not bear any (meaningful) risks from the transaction and generated only a risk free return amounting to the interest on the swap transaction as the dividends were transferred under the swap agreement to the counterparties.

Against this background the Federal Supreme Court decided that there was a clear interdependence between the purchase of the underlying equities and the derivative, which led to a giving up of beneficial ownership. This ownership was given up at the moment in time where the funds received as dividends were paid out to the counterparty of the swap agreement as there was, in the view of the Swiss Supreme Court, an on-payment obligation under the total return swap agreements entered into by the Danish bank. Further to this obligation, the bank was no longer in a position to freely dispose of the dividend proceeds received and, in addition, entering into the total return swap put the bank in the position of being fully relieved from any risk associated to the underlying long position in Swiss equities.

In the SMI futures case the Federal Supreme Court also argued that beneficial ownership was lacking by relying on the interdependency principle laid out above. However, as the facts and circumstances of the SMI case were clarified in less detail by the FTA, in some instances due to a lack of cooperation from the taxpayer, the judges based their decision on factual indicia as well. Beneficial ownership was denied with the following arguments:

  • The large volume of the single transaction (3.7 billion CHF) being substantially more than the ordinary average daily trading volume at the stock exchanges involved, the use of brokers and the limited number of parties involved and the short term of the transaction were used as indicia that the transaction must have been agreed amongst known counterparties and that hence the transaction must have been of a circular nature
  • Only a small portion of the dividend income (between 0.04% and 0.06% of the overall transactional volume, respectively between 6.6% and 9% of the dividend income) was retained by the Danish bank. The fact that a portion of the dividend income was retained is not sufficient to prove that no harmful transfer on of dividend income occurred in the case at hand.
  • The Swiss Federal Supreme Court challenged the Danish bank’s ability to act independently as the Swedish parent company had fully debt funded the transaction; the court was of the opinion that the interest paid on the funding led to a partial transfer of dividend income to the Swedish parent, which would have benefitted from a less attractive double tax treaty if the latter had held the Swiss equities
  • A harmful transfer of dividends occurred via the purchase and sales price of the underlying SMI components where the relevant prices were bilaterally agreed with the broker involved acting as a principal for the Danish bank. As the purchase and sales prices were not set in standardised and anonymous transactions, but rather in a specific, tailor-made single transaction, the Swiss Federal Supreme Court assumed, on the basis of the indicia of the case, that prices were set in order to transfer the dividend income to the broker. The court also concluded that similar agreements must have been in place between the broker and its counterparties originally providing the SMI components to the broker.
  • The Danish bank’s refusal to disclose the counterparties of the broker was interpreted by the Swiss Federal Supreme Court as a violation of its information-sharing and cooperation duty even if the foreign country’s legal system does prohibit such a sharing of information. Although the court acknowledged that the Danish bank cannot be requested to infringe foreign law, it must face the legal consequence of such a missed disclosure of useful and reasonable information in the specific case. This because the Swiss Federal Tax Administration had various valid reasons to believe that the transaction was structured as a circular-like transaction between related parties. Because of this specific transaction structure, the Danish bank has an increased duty of disclosure and cannot just rely on the professional secrecy of the broker. The Supreme Court also concluded that the only reason for routing the transactions through a broker and for incurring the additional costs was to avoid the disclosure of the identity of the counterparty.

The majority of the judges of the Swiss Federal Supreme Court concluded that there was sufficient evidence to conclude that the bank had given up the beneficial ownership and had to forward the dividend proceeds, which were partially up-front priced in the sold OTC SMI futures.

Appraisal of the decisions

The Swiss Supreme Court has now issued two guiding decisions with regard to the question of beneficial ownership, which will have an important impact on the numerous other cases which are pending with the Swiss courts and the FTA. Both decisions were based on the notion of beneficial ownership in a double tax treaty environment and the Swiss Federal Supreme Court has clarified its view on how beneficial ownership in the double tax treaty with Denmark shall be defined from a Swiss perspective. Whereas the swap decision is substantially based on this beneficial ownership notion, the SMI futures decision does not seem to follow this notion totally as the Swiss Federal Supreme Court based its decision on conclusive indicia that were not fully evidenced by the FTA and that were not rebutted by the Danish bank.
In particular the following points were not addressed in the two decisions and may lead to a different assessment of an individual case:

  • How do “imperfect” hedges, i.e. non delta one, impact the question regarding beneficial ownership?
  • If the party holding Swiss equities as a long position is not the beneficial owner of the dividend, who is entitled to a refund (e.g. the counterpart of the derivative)?
  • If the long position in Swiss equities is not acquired before the dividend ex-date and is not sold after the dividend season, but hedged as a long term investment, would the court come to a different decision?

The two published decisions made it clear, that each case should still be analysed on the basis of its individual facts and circumstances and that the outcome may vary depending on the basis of the underlying facts and circumstances. The currently defined notion of beneficial ownership in a treaty context needs to be considered for those double tax treaties that do not embed a separate definition of beneficial ownership. Pending claims, as well as new derivative transactions that may give rise to a Swiss withholding tax refund claim, should be carefully evaluated on the basis of the recent decisions of the Swiss Federal Supreme Court.

Martin Büeler
Partner, Tax & Legal
martin.bueeler@ch.pwc.com
+41 58 792 43 92
Luca Poggioli
Director, Tax & Legal
luca.poggioli@ch.pwc.com
+41 58 792 44 51
Victor Meyer
Partner, Tax & Legal
victor.meyer@ch.pwc.com
+41 58 792 43 40
Dieter Wirth
Partner, Tax & Legal
dieter.wirth@ch.pwc.com
+41 58 792 44 88

 

Swiss Federal Supreme Court rules in Withholding Tax Case for Danish banks

The Swiss Federal Supreme Court has delivered two judgements regarding Swiss withholding tax refund cases for two Danish banks involved in derivative transactions over dividend ex-date with Swiss equities. In both cases, the Swiss Federal Supreme Court ruled in favour of the Federal Tax Authority (FTA) and overruled the previous decisions taken by the Federal Administrative Court

The cases under scrutiny

In the first case, a Danish bank entered into various total return swap transactions with counterparties in the EU and the US relating to Swiss equities. To hedge the exposure from the total return swaps, the Danish bank bought the necessary Swiss equities from various parties. Upon the maturity of the total return swaps, the shares were sold to different parties than those from whom the bank had previously sourced the shares. Under the swaps the Danish bank had to pay to the counterpart an amount equivalent to the dividend received.

The second case relates to a subsidiary of a Danish bank that had entered into derivative transactions by selling (OTC) SMI futures through Eurex and a broker and that had hedged this short position by buying the necessary Swiss equities from a different platform/broker. Upon the maturity of the SMI futures, the derivative positions were either closed (and the Swiss equities sold) or rolled into further SMI future contracts.

In both cases, dividends received during the maturity of the trade were subject to 35% Swiss withholding tax for which a full refund was claimed under the former Swiss-Danish double tax treaty (the current amended treaty only provides for a partial refund on portfolio holdings). In both cases, the FTA had denied the refund of Swiss withholding tax and was then overruled in the Federal Administrative Court.

Decisions of the Swiss Supreme Court

In its public hearing of 5 May 2015, the Swiss Supreme Court overruled the decisions taken by the Federal Administrative Court and decided in favour of the FTA.

Regarding the first case, the court was of the opinion that the Danish bank should not be regarded as being the beneficial owner of the dividends. This ownership was given up at the moment in time where the funds received as dividends were paid out to the counterparty of the swap agreement as there was, in the view of the Swiss Supreme Court, an on-payment obligation under the total return swap agreements entered into by the Danish bank. Further to this obligation, the bank was no longer in a position to freely dispose of the dividend proceeds received and, in addition, the total return swap entered into put the bank in a position of being fully relieved of any risk associated to the underlying long position in Swiss equities. Hence, the bank had given up its beneficial ownership of the underlying Swiss equities.

In the second case, the underlying facts were more abstract and, in the view of some judges, insufficiently established by the FTA. Nevertheless, the Swiss Supreme Court was of the opinion that it would have been the Danish claimant’s call to assist the FTA in establishing the right facts and circumstances. Hence, the majority of the judges were of the view that the volumes of SMI futures traded and the fact that only a limited number of parties were involved in the transaction were sufficient evidence to conclude that the bank had given up its beneficial ownership and had to forward the dividend proceeds, the prices for which had been partially pre-determined in the sold (OTC) SMI futures.

Appraisal of the decisions

The Swiss Supreme Court has now issued two leading decisions with regard to the question of beneficial ownership which will have an important impact on the numerous other cases pending with the Swiss courts and the FTA. Although the Swiss Supreme Court’s exact line of argumentation will only be available in a couple of weeks, after the entire decisions including the motivation have been published, these decisions are effectively increasing the hurdles for a refund of Swiss withholding tax for derivative transactions with underlying Swiss equities – not only in an international but also in a domestic context.

It is now clear that the Swiss Supreme Court is of the view that anyone transferring a received dividend to a counterpart of a derivative instrument while not being in a risk-taking position will most likely have relinquished their beneficial ownership to the underlying Swiss equity and with this their right to claim Swiss withholding tax.

Pending claims as well as new derivative transactions that may give rise to a Swiss withholding tax refund claim should carefully be evaluated on the basis of the recent decisions of the Swiss Supreme Court once the written decision is available.

Victor Meyer
Partner Corporate Tax
victor.meyer@ch.pwc.com
+41 58 792 43 40
Martin Büeler
Partner Corporate Tax
martin.bueeler@ch.pwc.com
+41 58 792 43 92
Dieter Wirth
Partner Corporate Tax
dieter.wirth@ch.pwc.com
+41 58 792 44 88
Luca Poggioli
Director Corporate Tax
luca.poggioli@ch.pwc.com
+41 58 792 44 51