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Luca Poggioli
Managing Director Tax & Legal Services, PwC Switzerland
On 4 September 2023, the Swiss Administrative Court issued a new decision concerning the right to a Swiss withholding tax refund of a Danish credit institute that was engaged in cross-currency swaps in USD/CHF. The Danish claimant of Swiss withholding tax had acquired Swiss government bonds and swapped a fixed payment in CHF (matching the gross coupon on the Swiss government bonds) against a floating rate in USD.
The Swiss Administrative Court confirmed the current practice of the Federal Supreme Court regarding beneficial ownership, notably arguing that the Danish claimant had a factual obligation to pay on the coupon received from its holding in the Swiss government bonds (fixed interest rate) to the counterparty of the cross-currency swap (against a floating rate).
The claimant was therefore not deemed to be the beneficial owner of the Swiss interest payment subject to Swiss withholding tax, and therefore the refund claim was rejected. For the first time, the Swiss Administrative Court also applied the same analysis as developed for the assessment of beneficial ownership regarding dividends to interest payments.
Relevant facts
A Danish credit institute filed claims for a refund of Swiss withholding tax levied on interest payments received on Swiss government bonds. Further to a review of the refund claim by the Swiss Federal Tax Administration, it was ascertained that Swiss government bonds were held as part of a cross-currency swap transaction. Under the cross-currency swap, the Danish claimant committed to swap a fixed interest rate matching the coupon of the CHF-denominated Swiss government bonds against a floating interest rate in USD.
To purchase the Swiss government bonds the claimant had to previously convert USD into CHF, and entered into a cross-currency swap to mitigate its FX exposure until the maturity of the bonds. Both the purchase of the Swiss government bonds as well as the cross-currency swap, although concluded as separate transactions, were facilitated by a third-party bank acting as broker. The term of the cross-currency swap matched the remaining time to maturity of the Swiss government bonds, and the swapped fixed rate also matched the coupon rate of the Swiss government bonds.
Highlights of the decision by the Federal Administrative Court
In its decision, the Federal Administrative Court reiterated the current jurisprudence of the Federal Supreme Court on beneficial ownership over income subject to Swiss withholding tax deductions developed in various decisions regarding equity finance transactions. Consequently, the Federal Administrative Court now also applied the same practice and principles regarding the assessment of beneficial ownership on interest payments subject to Swiss withholding tax.
The Court confirmed that eligibility to a Swiss withholding tax refund in the context of the application of a double taxation treaty requires the recipient to be the beneficial owner of the underlying income. In the case at hand, article 11 paragraph 1 of the Swiss-Danish double tax treaty explicitly mentions beneficial ownership as a requirement for a refund.
To qualify as a beneficial owner of income subject to Swiss withholding tax, the recipient should be free to decide on the further use of the income received, which means that the taxpayer should not have any contractual or legal obligation to pass on such income. Factual constraints to pass on income do not suffice to deny beneficial ownership, but can be used to assume that there is a contractual or legal obligation to pass on the income. Such obligations may lead to the situation where the recipient of the income does not have or only has limited decision-making powers regarding the use of such income. For such an assessment, all economic circumstances shall be considered (substance over form).
The court also reconfirmed the notion of double interdependency for the assumption of beneficial ownership being absent. A harmful transfer of income requires that there is a close connection or mutual dependence between the generation of income and the obligation to forward it. For this purpose, on the one hand the generation of income must be dependent on the obligation to pass it on (first dependency), and on the other hand, the obligation to pass on income must depend on the generation of this income (second dependency).
The latter would be fulfilled if there is no effective obligation to pass on income or if no income is generated. If such double interdependency is given, then beneficial ownership is denied. Finally, the Swiss Administrative Court has also confirmed the current practice in that the extent of income transfer is irrelevant in the assessment of beneficial ownership, which also means that the transfer of less than 100% of the income can be harmful.
After analysing the facts of the case, the Court concluded that:
Although the cross-currency swap agreement does not make any specific reference to the Swiss government bonds held by the claimant, and with this no explicit obligation to pass on the amount of interest received as a coupon to the counterparty of the swap (i.e. the fixed interest rate exchanged for a floating interest rate), all other facts can be considered as indicators in assessing such an indirect obligation.
This was considered proven by the court as both the acquisition date of the Swiss government bonds and the initial date of the cross-currency swap matched, as well as the date of redemption of the Swiss government bonds and the termination date of the cross-currency swap.
The initial payment under the cross-currency swap matched the acquisition price of the Swiss government bonds, which also included a surplus payment that compensated the Danish claimant for the loss to be incurred on redemption of the bonds at the difference between the market value of the Swiss government bonds at the inception of the transaction and the lower value on redemption at par.
This surplus payment was considered an indicator that the anonymous counterparty of the cross-currency swap was willing to remunerate the claimant for enabling the transaction under scrutiny.
The Federal Administrative Court also considered it an indication that the claimant had agreed to swap a fixed interest rate under the cross-currency swap that matched the interest coupon received from the Swiss government bonds against a floating interest rate. This indicator was qualified by the Court as a factual (indirect) obligation to pass on the interest generated from the Swiss government bond to the counterparty of the cross-currency swap.
When asserting the double interdependency the first interdependency was assumed, as the purchase of the Swiss government bonds and the conclusion of the cross-currency swap were offered by the broker as a package with matching maturity terms. For the assessment of the second interdependency, the Court focused on the question of whether the interest income generated on the Swiss government bonds was at risk of not being cashed in, e.g. due to default, credit risks, interest rate risks or similar.
The Court reviewed several such risks, and concluded that the claimant was not at risk of not generating the interest income, notably as Swiss government bonds are top-grade obligations with only a theoretical default or credit risk and that interest rate risks were eliminated by entering into the cross-currency swap.
Further to the above, the Federal Administrative Court concluded that the withholding tax refund should be denied to the Danish claimant due to missing beneficial ownership on the interest payments received on the Swiss government bond.
What does it mean for you?
In essence, the new Federal Administrative Court decision reconfirms the current practice of the Swiss Federal Tax Administration and the case law of the Federal Supreme Court developed when asserting Swiss withholding tax refund positions relating to equity finance transactions. The latest decision makes it clear that the Swiss Federal Tax Administration will also apply the latest practice on beneficial ownership to Swiss withholding tax refund claims on interest.
Whilst an appeal can be lodged against this decision with the Swiss Federal Supreme Court within 30 days of its official publication (i.e. until mid-October 2023), we encourage you to review any 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.
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