PLEASE NOTE: THIS ARTICLE WAS ORIGINALLY SUBMITTED BY REVISUISSE PRICE WATERHOUSE, SWITZERLAND

The new derivative benefits test provides for new attractive tax planning opportunities for EU- and NAFTA- owned multinationals. Switzerland is currently only one of two countries which have this test, where the treaty is already in effect. This test makes Switzerland an even more attractive location for group financing, leasing, commissionaire, etc companies.

IMPORTANT NOTICE

The new Swiss-U.S. income tax treaty contains a so-called grandfather clause. This clause provides that a person claiming treaty benefits may elect to have the old 1951 treaty apply until the end of 1998 in lieu of the new treaty.

The exact procedure of the election is not clearly regulated yet. However, the election must be stated in writing and sent to the Tax Authority in the country of residence, who will then forward it to the other Tax Authority.

If it is elected that the old 1951 treaty should apply, then the 1951 treaty applies in its entirety until the end of 1998 and the new treaty will apply from 1 January 1999 on and to taxes withheld at source from 1 February 1999 on.

REVISED INDIRECT STOCK EXCHANGE TEST

Under the indirect stock exchange test a company is entitled to treaty benefits if the ultimate beneficial owners of a predominant interest in that particular company are companies who whose principal class of shares is primarily and regularly traded on a recognised stock exchange.

The U.S. Tax Authorities limited the scope of this provision to publicly traded companies which are resident in either the U.S. or Switzerland, while the Swiss Tax Authorities extended the provision to all companies listed on a recognized stock exchange irrespective of their residence.

The revision follows the U.S. Tax Authorities' interpretation. Therefore, a company resident in Switzerland is entitled to treaty benefits if the ultimate beneficial owners of a predominant interest in that particular company are companies who are resident in either the United States or Switzerland and whose principal class of shares is primarily and regularly traded on a recognised stock exchange.

NEW DERIVATIVE BENEFITS PROVISION (EURO- OR NAFTA-HOLDING TEST)

A derivative benefits provision entitles a company which is resident in a contracting state to certain treaty benefits even though the majority of its shares is controlled by persons who are not residents of either contracting state.

The original derivative benefits provision of the Swiss-U.S. income tax treaty (article 22 paragraph (3)) namely required a 30% ownership by residents in Switzerland. Since the new treaties with both Ireland (in force) and Luxembourg (not yet in force) impose no local ownership requirements, the Swiss Tax Authorities renegotiated the derivative benefits test resulting in a revision of the Memorandum of Understanding and a new derivative benefits provision. The new provision does not require local ownership anymore.

According to article 22 paragraph (6) and the revised Memorandum of Understanding, a company resident in either Switzerland or the U.S. qualifies for treaty benefits, if:

1. the ultimate beneficial owners of 95% or more of the aggregate vote and value of all of its shares are seven or fewer persons that are residents of a member state of the European Union (EU) or of the European Economic Area (EEA) or a party to the North American Free Trade Agreement (NAFTA); and

2. if the remaining 5% of the value of the company do not consist of a class of stock that paid dividends determined ba reference to the income derived from the U.S. company (sometimes known as tracking or alphabet stock) and 50% or more of the value of the class of stock are not held by residents of a third country that does not have a double tax treaty with the source country (Switzerland or the U.S.); and

3. if such ultimate beneficial owners would have been entitled to the same or better treaty benefits had they derived the treaty protected income directly from the source country; and

4. if such ultimate beneficial owners would have been entitled to treaty benefits under the Swiss-U.S. income tax treaty if they were resident in the company's country of residence and if they had derived the treaty protected income directly from the source country; and

5. if less than 50% of the company's gross income is paid as deductible expense to persons that are neither U.S. citizens nor residents of a EU, EEA or NAFTA member state.

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.