16 April 2020

Reform of the withholding tax – Swiss government initiates consultation

The reform of the Swiss withholding tax with the aim of strengthening the Swiss capital market takes a further step. The Swiss government wants to switch from withholding tax to paying agent tax for interest and opened the consultation process on 3 April 2020. The Swiss withholding tax on interest is to be limited to individuals resident in Switzerland. All legal entities and all foreign persons should be exempt from Swiss withholding tax on interest. At the same time, it is intended to extend the Swiss paying agent tax on interest paid by foreign debtors and on indirect interest (investment funds) in order to close a loophole in Switzerland. Finally, the transfer stamp duty on domestic bonds is to be abolished.

Background to the reform

Today's Swiss withholding tax is based on the debtor principle and can therefore only be applied to bonds of Swiss issuers or debtors. This leads to a disadvantage for Swiss bonds, as even investors who are entitled to a full refund of the Swiss withholding tax avoid these bonds. In addition to the administrative expense and the liquidity disadvantage, the background to this is above all the high availability of comparable foreign interest-bearing securities without any withholding taxes. The purpose of the reform is to reduce these disadvantages and thus attract significant issuing activities from abroad to Switzerland.

Furthermore, the current system has a loophole, as only interest received from Swiss debtors is subject to Swiss withholding tax. Swiss investors can collect interest on foreign bonds largely without incurring any withholding tax. The reform aims to close this loophole.

Finally, the transfer stamp duty on bond trading constitutes a competitive disadvantage for Switzerland as a business location. The abolition of the stamp duty on domestic bonds aims to eliminate this disadvantage.

Elements of the reform

The presentation of the consultation process is largely in line with the key points of the reform, which the Swiss government set out in summer and autumn of 2019.

  • Interest income should be subject to paying agent tax and not withholding tax.
  • Domestic legal entities and all foreign persons should be exempt from withholding tax on interest.
  • The Swiss withholding tax (as paying agent tax) is to be extended to interest on foreign bonds and indirect interest.
  • The new Swiss withholding tax is limited to paying agents in Switzerland. Interest payments via foreign paying agents will be secured by the automatic exchange of information.
  • Swiss paying agent tax will be applicable to structured products
  • Statutory regulation of manufactured payments for interest and dividends
  • Abolishment of the transfer stamp duty on domestic bonds

Differences from the previous proposals

The proposal does not contain any elementary differences compared with the Swiss government's previously established benchmarks. In the key figures, the Swiss government had already announced that indirect interest should also be subject to Swiss withholding tax under the new model. However, the draft now shows how ambitious this plan is in its implementation. Indirect interest, for example, concerns collective capital investments and structured products. The proposal covers both domestic and foreign products.

Domestic products

For Swiss collective investment schemes and issuers of structured products, the introduction of this system will require additional settlement data. Whereas today, a distinction is only necessary between capital gains and taxable income for these products, interest income will also have to be reported so that Swiss paying agents can apply the tax. In return, foreign investors (and legal entities) are then exempt from any tax on this income. Swiss providers will most likely provide this data to enable paying agents to make correct statements.

Foreign products

The new Swiss paying agent tax also applies if individuals domiciled in Switzerland hold foreign collective investment schemes or structured products with a Swiss paying agent. The paying agent requires the interest components of the income on these investments to settle the Swiss paying agent tax. Since most likely this settlement data will not be made available for all investments, the proposal provides for a catch-all provision.

According to the proposal, if the necessary data on the fund or structured product is not available, paying agent tax is to be levied on the total amount. In this case foreign investment income (dividends) received by the fund will be subject to paying agent tax on interest. The explanatory report considers the disadvantages of this catch-all solution to be less serious because the dividends are also subject to Swiss income tax and the paying agent tax is fully refundable.

Beneficiary is decisive

The paying agent tax does not solely refer to the account/custody account holder, i.e. the contracting party of the paying agent, in order to determine whether a domestic individual is present. The decisive factor for the application of the paying agent tax is whether "the recipient of the benefit is a domestic individual" (Art. 5b, marginal note c., para. 1, lit. e) of the submission).

The explanatory report of the proposal already contains a draft of central provisions for the Regulation in the Annex. These provisions also include a specification of the beneficiary. This clarifies, for example, that in the case of a usufruct relationship known to the bank, the usufructuary is deemed to be beneficiary. Reference is also made to the paying agent's knowledge based on the regulations in the area of money laundering and automatic exchange of information.

These issues are likely to remain controversial, as Swiss paying agents have an overriding interest in keeping the applicable rules clear and as simple as possible.

Settlement and liability risks of paying agents

Since paying agents are the taxpayers in this system, they have to bear considerable settlement risks. For example, the necessary settlement data for various securities, especially foreign securities, are not always available in time. Furthermore, the question of the beneficiary is still unclear and potentially subject to error.

The Swiss government has proposed several measures to reduce these settlement risks. For example, criminal liability in the event of negligence is excluded and quarterly settlement is envisaged so that any corrections can still be processed. Likewise, the paying agents should receive compensation for the implementation costs. Furthermore, SMEs and Swiss collective investment schemes will be able to choose between the old and the new withholding tax.

No adjustments of the profit tax in the area of the participation deduction

The proposal does not contain any changes to the rules on participation deduction for profit tax. The Swiss government had instructed the Federal Department of Finance (FDF) to examine these. The FDF has now come to the conclusion that the effects of the extensive changes under the STAF should first be reviewed before any further changes are considered.

Legal regulation for compensation payments

Manufactured payments reflect dividends or interest in securities transactions and are not paid by the company or the bond debtor.

Article 4 (1) (h) of the proposal subjects income from structured products to Swiss withholding tax, provided that these products replicate capital assets subject to Swiss withholding tax.

This Swiss paying agent tax is explicitly not limited to indirect interest alone. This regulation also covers dividends on Swiss shares, which are the reference value for the manufactured payment. Contrary to the basic concept, this Swiss paying agent tax is not limited to individuals in Switzerland, but, like the Swiss withholding tax on dividends, applies to all investors.

This regulation addresses open questions regarding the refund of Swiss withholding tax on the original dividends that the issuer of the structured product may have received.

Art. 4 para. 1 lit. j) of the proposal now legally regulates the so-called "second withholding tax" in the area of securities lending. This second withholding tax had previously been levied on the basis of a circular letter from the Federal tax administration (FTA), which the Federal Supreme Court, however, did not consider to be a sufficient legal basis.

Proposal of the Contact Group Domestic Banks (KIB)

The explanatory report also comments on the proposals of the contact group on domestic banks. The KIB has proposed to outsource the settlement of the new Swiss paying agent tax to a central custodian, such as the SIX, in order to avoid the costly introduction for the banks. According to the FDF, this outsourcing is already possible under current law and would remain in place with the planned changes. However, just as today, liability would remain with the paying agent and cannot be transferred to the custodian.

KIB's second concern was the restriction of the Swiss paying agent tax to direct interest and Swiss bonds. In particular, for collective capital investments, the current system, which leaves foreign funds without Swiss withholding tax, should be retained. The Swiss government did not accept this proposal, as the equal treatment of direct and indirect interest is a central element of the security purpose, which should be strengthened by the proposal.

Outlook

The consultation period will be open until 10 July 2020 and it will no longer be possible to bring the directive into force on 1 January 2022.

The tax team will be happy to answer any questions and provide further information.

Author: Marc-Antoine Bree

Categories: Tax

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