Amendments to preclude dividend stripping transactions (applicable as of 1 January 2018)
On Friday 29 December 2017 the Federal Tax Administration (FTA) issued a revised version of Circular Letter 13 on securities lending and repo transactions. The amended circular letter contains important changes to the previous practice of the FTA, notably with regard to the Swiss Withholding Tax (WHT) refund position of foreign resident borrowers of Swiss securities.
Under the previous circular letter issued in September 2006, Swiss and foreign borrowers of Swiss securities receiving a dividend or interest payment were able to claim for a full or partial refund of WHT levied at a rate of 35% either on the basis of Swiss domestic law in case of Swiss borrowers or on the basis of an applicable double tax treaty.
This rule was perceived by the FTA as a cause of a market behaviour, which was not intended. Indeed, the old practice was intended by the FTA as a pragmatic approach to solve situations where a borrower had “over-borrowed” a position over the dividend ex-date. From the FTA’’s perspective, the old practice was, however, being abused deliberately by lending Swiss securities to foreign borrowers over the dividend ex-date, which in several cases led to perceived dividend stripping cases.
The impact for foreign borrowers:
As of 1 January 2018, the old practice, which generally provided for the possibility of refunding WHT to foreign borrowers of Swiss securities, is no longer applicable, irrespective of whether the transaction is a long borrowing transaction (i.e. the borrower or the last borrower in a chain of several borrowers keeps the share) or if the shares sourced under a securities lending transaction are sold or delivered to a third party (e.g. to cover delivery obligations from a short sale).
The new rules stipulate that a WHT refund in case of long borrowing (including in chain transactions where the last borrower keeps the shares) can only be claimed by the original lender. The original lender is, in our view, to be understood as the party that held the long position and that initiated the first transfer of the Swiss securities under a securities lending transaction. Further to this rule and as only the original lender can claim for a refund, he will receive a compensatory payment of 65% of the income payment subject to WHT. In order to be in the position to claim a refund of WHT under an applicable double tax treaty, the new circular letter introduces a new requirement, which is that the original lender can prove that the payment received from the borrower is effectively the original dividend. Although the circular letter does not further define this proof, it is the common understanding that this burden of proof can only be fulfilled if the borrower (or, in case of chain transactions, the ultimate borrower) provides the lender with the original dividend payment advice received by the borrower. Under this procedure, the borrower would no longer dispose of the original dividend payment advice enabling him to make a refund claim; instead, only the original lender now holding the original dividend payment advice would have this opportunity. This new procedure also requires the whole chain of the lending transactions to be disclosed, which may be a difficult task.
In transactions where the foreign borrower has sold or delivered the Swiss securities sourced via securities lending to a third party, e.g. to cover a short sale, the circular letter precludes both the original lender as well as the borrower from filing a claim for a Swiss WHT refund. In such circumstances only the final buyer of the shares shall be seen as entitled to a Swiss WHT refund under the applicable double tax treaty. This new practice may put the lender in a difficult situation, notably in chain transactions where his borrowing counterparty becomes lender to a subsequent securities lending transaction without his knowledge, as the original lender may no longer have control over whether his shares remain in the securities lending chain (resulting in a long borrowing situation for the final borrower) or if the shares are sold by the final borrower to a third party. In the first case, the lender may file for a refund claim, assuming that he is provided with the original payment advice by the final borrower (or through the chain of borrowers); in the second case no such dividend payment advice should be available, as the third party would have this document and the entitlement to a refund claim. Lenders should therefore review their contractual arrangements to either preclude delivery of lent shares to third parties in order to ensure their own right to file a refund claim.
The old practice of Circular Letter 13 applying to foreign resident borrowers has been changed. Under the new practice, the right to claim a WHT refund would lie with the original lender to the extent that the borrower (or the last borrower in a chain of securities lending transactions) held a long position on dividend day, the whole lending chain was disclosed and the lender proved that he had received the original dividend payment from the borrower. If the securities were sold or delivered to a third party by the borrower, only the third party would be entitled to file a claim for a WHT refund, with no possibility for the original lender or the borrower to do so.
It is worth noting that the old rules have not changed in cases where the borrower is resident in Switzerland, as the borrower has to levy a second WHT on any manufactured payment he makes to a lender in order to be in the position to claim the WHT levied on the original dividend payment received. In addition, the circular letter also contains amended rules with regard to the Swiss individual and corporate income tax treatment of the different income flows resulting from securities lending transactions, including a general corporate income tax anti-abuse clause in connection with participation relief.
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