On 26 June 2019, the Federal Council approved the objectives and key figures for a withholding tax reform. The Federal Council wants to strengthen the Swiss debt capital market and to extend the safeguard purpose for Swiss individuals. Interest payments to Swiss entities and foreign investors shall be exempt from withholding tax. For Swiss resident individuals, withholding tax shall also be applied on interest from foreign investments if held through a Swiss paying agent. The consultation draft is expected in autumn 2019.
By Alexandra Hirt (Reference: CapLaw-2019-29)
1) Current Swiss Withholding Tax System
At present, withholding tax is levied on interest, participation income, lottery winnings and certain insurance benefits. The legal basis is the Withholding Tax Code of 13 October 1965. The applicable tax rate is 35%. The tax is levied independently of the person of the investor. It affects both individual and institutional investors, as well as foreign investors.
A differentiation is made at the refund level. Swiss-resident investors can normally obtain a full refund of the withholding tax if they declare to the authorities responsible their income subject to withholding tax. In Switzerland, the withholding tax thus has a safeguard purpose. Foreign investors are entitled to a full or partial refund of withholding tax, depending on the applicable double taxation agreement between Switzerland and their country of residence. With regard to foreign investors, the tax is partly intended for fiscal purposes.
The withholding tax on domestic bonds is a disadvantage of the Swiss capital market. Foreign investors might reclaim the withholding tax, but the procedure is cumbersome and, depending on the recipient state, the reclaimability is limited. Swiss bonds are therefore unattractive for foreign investors. Withholding tax often prevents Swiss groups from raising capital in Switzerland. They prefer to issue bonds through a foreign subsidiary.
There are various other reasons for reforming the current system. Gaps in the safeguard purpose for Swiss resident individuals shall be reduced. Further, the international automatic exchange of information helps to ensure taxation in the country of residence of the respective investor and is, therefore, an additional safeguard measure to ensure taxation in the participating countries.
2) Developments to Date
The reform of the withholding tax has been in political discussion for about 10 years. The Federal Council had launched a first reform of the withholding tax in 2010 in order to strengthen the Swiss debt capital market. The Federal Council wanted to replace the existing debtor-based regime by a paying agent-based regime. Parliament, however, rejected this proposal in 2012.
At the end of 2014, the Federal Council launched the consultation on a new proposal. Again, the Federal Council suggested a system change from the debtor principle to the paying agent principle. Due to the negative feedback in the consultation process from Swiss official and private bodies, the Federal Council decided in June 2015 to postpone the reform until further notice.
On 26 June 2019, the Federal Council decided to reactivate the suspended reform of the withholding tax. The Federal Council approved the objectives and key figures for the withholding tax reform. The Federal Finance Department shall prepare a consultation draft by autumn 2019.
3) Strategic Directions for the Consultation Draft 2019
The Federal Council formulated the following objectives for the preparation of the consultation draft, combined with a total of eight parameters for the implementation:
a) Strengthening Switzerland’s Debt Capital Market
One core element of the reform proposal is the exemption of Swiss legal entities and foreign investors from withholding tax on interest investments (Parameter 1). The Federal Council expects this to significantly strengthen the Swiss bond market. Swiss groups shall be able to issue their bonds at competitive rates.
b) Extension of the Safeguard Purpose of Withholding Tax in Switzerland
The second core element of the reform is the extension of the safeguard purpose for Swiss resident individuals in order to combat tax evasion. Swiss resident individuals shall in the future also be affected by a withholding tax on foreign interest payments if such investments are held through a Swiss paying agent; net income from foreign equities remain out of scope (Parameter 2).
c) Ensuring Legal Certainty and Stability of the Financial Centre
A transitional regulation shall be provided for existing too-big-to-fail instruments (CoCos, bail-in and write-off-bonds) (Parameter 3). These instruments are currently exempt from withholding tax.
Further, a legal basis shall be established for structured products. It should be stipulated in the law that payments which are used to replicate or pass on bond interest, dividends or the like are subject to withholding tax (Parameter 4).
d) Consideration of Additional Costs and Liability Risks
The banks are facing new responsibilities due to the planned reform. The Federal Council is aware that this will increase their liability risk and that implementation will lead to costs. Paying agents shall receive an adequate compensation, possibly for a limited period (Parameter 5). The withholding tax is to be levied on an ongoing basis (Parameter 6). Criminal liability shall be limited to intent (Parameter 7). In addition, it shall still be possible to outsource the processing of the withholding tax in order to simplify administration; this shall not lead to a transfer of liability (Parameter 8).
e) Further Considerations of the Federal Council
With regard to the financial consequences of the reform proposal, the Federal Council assumes an estimated loss of CHF 200 million per year. At the same time, it expects dynamic additional revenues from the strengthening of the capital market. The strengthening of the safeguard purpose of the withholding tax shall also lead to more tax revenue. The Federal Council therefore assesses the cost-benefit ratio of this reform to be beneficial.
In its decision, the Federal Council considered two studies, which had been commissioned by the Federal Department of Finance. KPMG had analysed the financial effects of a reform of withholding tax and BaK Economics the economic effects of a reform of stamp duties and withholding tax.
The Federal Council refused pursuing a more comprehensive reform for cost reasons. Such a reform would have included the complete abolition of the transfer stamp tax and/or a reduction of the withholding tax rate on dividends. However, the Federal Council does not rule out the possibility that the reform may be supplemented by additional measures. The Department of Finance will examine this as part of the preparations for the consultation process (in particular profit tax in the area of participation deduction, abolition of transfer stamp tax on Swiss debt securities, equal treatment for indirect and direct interest investments).
4) Appraisal
The Federal Council’s decision of 26 June 2019 is a concept paper with few details. The new proposal will be concretized for the planned consultation. The project seems positive, with good chances of implementation. It is less complex than previous concepts. In doing so, the Federal Council takes the negative feedback in the consultation process 2014/2015 into account. The financial sector was concerned about the administrative burden and liability risks from the replacement of the existing debtor-based regime by a paying agent-based regime.
No change is expected for Swiss companies’ dividends, as there is no need for action in that respect from a capital market view or in terms of safeguarding tax receipts. In particular, the tax rate will probably remain at 35% for both interest and dividends.
From a Swiss capital market perspective, the proposed changes are highly welcome. It can be assumed that the planned reform of the withholding tax will have a positive effect on the development of the Swiss capital market.
Alexandra Hirt (alexandra.hirt@lenzstaehelin.com)