PLEASE NOTE: THIS ARTICLE WAS ORIGINALLY SUBMITTED BY REVISUISSE PRICE WATERHOUSE, SWITZERLAND
The new Swiss-US income tax treaty entered into force on January 1, 1998. In respect of withholding tax on dividends, interest and royalties the new treaty enters into force on February 1, 1998. The new treaty contains a "grandfather clause" which grants the taxpayer the choice between the new and the old treaty during the whole of 1998.
The most important provisions in the new Swiss-US income tax treaty from a Swiss viewpoint are:
Dividends will be subject to a 5% US withholding tax if the beneficial owner is a corporate entity, holding directly at least 10% of the US company. In all other cases (i.e. for US portfolio investments of corporate shareholders as well as all US investments held by individual shareholders) the unrecoverable US withholding tax is 15%. Special provisions apply to distributions of US Regulated Investment Companies, as well as Real Estate Investment Trusts.
Branch profits tax
For the purpose of equal treatment of branches and subsidiaries there is a 5% US branch profits tax levied on the amount of the "transferable branch profit" (dividend equivalent amount).
In principle there is no US withholding tax on interest payments.
This exemption shall not apply to:
- interest from US sources if the amount of such interest is determined by reference of receipts, sales, income, profits etc. to the extent the interest does not qualify as portfolio interest under US law
- an excess inclusion with respect to a residual interest in an entity that is treated as a real estate mortgage investment conduit under US law.
Royalty and licence payments are exempt from US withholding tax.
Capital gains from the sale of movable property may only be taxed by the country of residence of the seller.
Capital gains from the sale of US real property may be taxed by the US. The term "real property" includes shares in US companies whose assets mainly consist of US real property or an interest in a partnership, trust or estate, to the extent attributable to US real property. In the US the term includes a "US real property interest" as defined by the Internal Revenue Code.
Limitation of Benefits (LOB)
There are some specific provisions which limit the application of treaty benefits to certain Swiss residents. However, it appears that the LOB provisions of the Swiss treaty are somewhat less stringent than in treaties of the US with other European countries.
1. There is basically no limitation of benefits for:
a) Swiss resident individuals;
b) Switzerland, its political subdivisions and other qualified subdivisions;
2. Corporations and other corporate bodies resident in Switzerland may claim treaty benefits only, if one or more specifically defined criteria are met. In summary Swiss resident companies meeting the following criteria may claim treaty benefits:
a) Companies being engaged in the active conduct of a trade or business in Switzerland and the income derived from the US must be in connection to that trade or business. Managing or simply holding of investments for the company's own account is not considered to be an active trade or business, unless it is performed by a bank, insurance company or registered securities dealer. - Contrary to the treaties with Austria, France, Germany, Luxembourg, and the Netherlands there are no safe haven rules based on objective tests. This is considered to be more beneficial and above all more flexible, because all factual circumstances have to be taken into consideration.
b) Companies of a multinational corporate group being Swiss headquarters may claim the treaty benefits if they are recognised as such. This is for a Swiss resident headquarters company, amongst other conditions, the case, if:
i) the headquarters company provides a substantial portion of the overall supervision and administration of a group of companies;
ii) the group companies are engaged in an active trade or business in at least five other countries (or group of countries) and in each of these (group of) countries they generate at least 10 percent but (with the exception of Switzerland) not more than 50% of the gross income of the group;
iii) not more than 25 percent of the Swiss headquarters company's gross income is derived from the US;
iv) the Swiss headquarters company has, and exercises, independent discretionary authority to carry out the headquarters functions as described in paragraph 1 above
v) the Swiss headquarters company is subject to generally applicable rules of taxation in Switzerland.
c) Companies whose shares are primarily and regularly traded on a recognised stock exchange. This criteria is also met, if the Swiss entity is beneficially owned by one or more other companies meeting this stock exchange requirement. Recognised stock exchanges for this purpose are: any Swiss stock exchange, the NASDAQ system and any US stock exchange registered with the SEC, the stock exchanges of Amsterdam, Frankfurt, London, Milan, Madrid, Paris, Tokyo and Vienna and any other stock exchange agreed upon by the competent authorities.
d) Companies, trusts or estates, provided the ultimate beneficial owners of a predominant interest in the form of a participation or otherwise are entitled to the treaty benefits by themselves. This includes, amongst others, all ultimately Swiss owned companies.
e) Swiss family foundations, unless the founder or the majority of the beneficiaries are not Swiss resident individuals or 50% or more of the income of the foundation could benefit persons which are not Swiss resident individuals.
f) If, based on the above rules, a Swiss resident company does not qualify for treaty benefits, it may nevertheless claim a relief from US withholding tax on dividends, interest and royalties, provided that certain requirements relating to the ultimate beneficial ownership are met. These requirements are:
i) the ultimate beneficial owners of more than 30% are Swiss residents qualifying for benefits under paragraph 1 a) and b), or paragraph 2 b), c) d) or e) above; and
ii) the ultimate beneficial owners of more than 70% are held by persons that are resident in Switzerland, the U.S. or a member state of the EU, EWR or NAFTA; and
iii) less than 50 percent of the companies gross income is paid as deductible expense to persons not qualifying for treaty benefits.
g) Based on a memorandum of understanding, foreign owned Swiss companies may also claim relief from US withholding tax on dividends, interest and royalties, if the ultimate beneficial owners of 95% or more of the Swiss resident company are seven or fewer persons resident in the EU, EEA or in a country being party of the Nafta and less than 50 percent of the companies' gross income is paid as deductible expense to persons that are neither US citizens or nor resident in a EU, EEA or Nafta State.
3. Swiss pension funds and any other Swiss organisation maintained exclusively to administer or provide pensions, retirement or employee benefits established or sponsored by a Swiss resident person and Swiss not-for profit organisations established and maintained for religious, charitable, educational, scientific, cultural or other public purposes may claim the treaty benefits, provided that more than half of the beneficiaries, members or participants, if any, are persons that are entitled under the LOB provisions to the treaty benefits.
All of the income tax treaties which the US concluded in the past years contain a LOB provision. Compared to the treaties concluded by other European countries with the US, the LOB provision in the Swiss-US treaty may generally be considered more flexible and less stringent. Therefore, the LOB provision in the new Swiss-US treaty certainly is not a reason for a US person to transfer its investment into another European country.
US investments in Swiss resident companies which enjoy tax privileges in Switzerland should be critically examined. Although such tax privileged companies are not automatically excluded from treaty benefits, they usually would not meet activity test or the headquarters company test. However, Swiss resident companies which meet either the stock exchange test or the ultimate beneficial ownership test, could qualify for treaty benefits despite being tax privileged in Switzerland. Due to the grandfather clause in the new treaty, a structure using a Swiss tax privileged company which does not meet the LOB provisions, can still be left in place until the end of 1998, since in such cases one would elect the old treaty.
The content of this article is intended to provide a general guideline to the subject matter. Specialist advice should be sought about your specific circumstances.