Financial Restructuring: Mind The Tax Traps

Restructuring measure

Tax consequences in Switzerland

Subordination (Rangrücktritt)

The borrowed capital remains in place. The creditor subordinates its claim behind the other creditors and refrains from enforcing it until the over-indebtedness has been remedied or until further agreed conditions occur.

A sufficient subordination may render notification of the bankruptcy court unnecessary despite over-indebtedness, provided the requirements of the Swiss Code of Obligations are met.

Benefiting company

No immediate corporate income tax, withholding tax or issuance stamp tax consequences.

Creditor subordinating its claim:
A value adjustment or write-down of the claim required as a result of the subordination may, in the case of business assets, in principle be tax-deductible, provided it is commercially justified.

Capital contribution to reserves
(no increase in the statutory capital)

New funds are contributed to the company by means of a cash or “in-kind” contribution, without increasing the statutory capital.

Benefiting company
Corporate income tax:
No corporate income tax consequences provided the contribution is recognized as equity for accounting purposes.

Stamp duty on capital contributions:
Contributions by a direct equity holder
In principle, the contribution is subject to issuance stamp tax at a rate of 1%. In restructurings, however, the restructuring allowance of CHF 10 million or a waiver of the issuance stamp tax may in particular apply, provided the statutory requirements are met.

Contributions by indirect equity holders
No issuance stamp tax, provided the contribution is not attributable to a Swiss intermediate company.

Creation of capital contribution reserves exempt from withholding tax:
A contribution by a direct equity holder may, in principle, qualify as a capital contribution reserve. This requires, in particular, that the contribution is reported as equity in a separate account for accounting purposes and is not offset directly against existing accumulated losses.

For the CHF 10 million restructuring allowance, however, the restructuring contribution must be offset against existing accumulated losses. The Federal Supreme Court has confirmed this requirement. The conditions for a waiver of issuance stamp tax must be assessed separately.

In restructuring situations, there is therefore often a tension between creating capital contribution reserves on the one hand and claiming the restructuring allowance or a remission of issuance stamp tax on the other.

Which option is preferable depends, in particular, on the shareholder structure and the intended future distribution policy and should be assessed on a case-by-case basis.

Shareholder

In the case of business assets, the contribution must, in principle, be capitalized on the participation. In addition, the tax values relevant for the participation deduction change.

Where applicable, the book value of the participation must then be written down again (tax-deductible expense). The tax values relevant for the participation deduction remain unaffected by such a write-down. A subsequent recovery in the value of the participation may give rise to taxable income (no participation deduction).

Debt waiver

The company's liabilities are reduced

A debt waiver is one of the most important restructuring instruments. However, the tax consequences differ considerably depending on who waives the claim and how the debt waiver is recorded for accounting purposes. The new Circular No. 32a clarifies the previous administrative practice, in particular with regard to the P&L-neutral treatment of debt waivers by equity holders and the distinction between a restructuring contribution and a capital contribution.

Benefiting company
Debt waiver by independent third parties:
Corporate income tax:
Debt waivers by independent third parties generally constitute taxable restructuring gains.

Tax loss carryforwards must be offset first. To the extent that tax loss carryforwards are available, the debt waiver can therefore regularly take place without an immediate corporate income tax burden, but it reduces the potential for offsetting losses in the future.

Stamp duty on capital contributions:
None.

Capital contribution reserves:
None.

Debt waiver by a direct shareholder:
Corporate income tax:
In principle, a distinction must be drawn between a debt waiver recorded through profit or loss (P&L-effective) and one recorded directly in equity (P&L-neutral).

If the debt waiver is recognized through the income statement (P&L-effective), a taxable restructuring gain generally arises. As with a restructuring gain from a third party (see above), this must first be offset against available tax loss carryforwards.

If the debt waiver is credited directly to equity for accounting purposes, the new Circular No. 32a treats this, in principle, as a P&L-neutral capital contribution. In this case, no taxable restructuring gain arises.

Irrespective of the accounting treatment, a debt waiver remains P&L-neutral to the extent that the loan already qualified as hidden equity for tax purposes prior to the restructuring. Restructuring loans that were granted exclusively on account of the company's economic difficulties may likewise continue to be treated as tax-neutral, provided the conditions of the circular are met.

Stamp duty on capital contributions:
A debt waiver by a direct equity holder may, in principle, be subject to issuance stamp tax. In restructurings, however, the restructuring allowance of CHF 10 million or a tax remission may in particular be available, provided the statutory requirements are met.

Creation of capital contribution reserves exempt from withholding tax:
A debt waiver by a direct equity holder that is recorded directly in equity (P&L-neutral) may, in principle, lead to the creation of capital contribution reserves.

However, where the restructuring contributions are offset directly against existing accumulated losses, the SFTA takes the position that no capital contribution reserves are created to that extent.

In practice, there is often a conflict of objectives between creating capital contribution reserves and claiming restructuring-related relief from issuance stamp tax. This conflict of objectives should be analyzed before the accounting entries are made.

Debt waiver by other related parties (other than a direct equity holder):
Corporate income tax:
Debt waivers by related individuals or companies are, in principle, recognized in the income statement (P&L-effective) for tax purposes, to the extent they are commercially justified.

If there is no commercial justification, the debt waiver may qualify for tax purposes as a hidden profit distribution from the perspective of the company making it.

Stamp duty on capital contributions:
None.

Creation of capital contribution reserves exempt from withholding tax:
Not possible.

Waiving creditors
Independent third parties:
In the case of business assets, the recorded debt waiver is a tax-deductible expense.

By contrast, the waiver of a claim held as private assets generally qualifies as a capital loss that is not relevant for tax purposes.

Direct shareholders:
In the case of business assets:
Debt waiver recognized in profit or loss (P&L-effective) = in principle tax-deductible.

Debt waiver recognized directly in equity (P&L-neutral) = to be treated for tax purposes like a capital contribution.

In the case of private assets:
Debt waiver = capital loss that is not relevant for tax purposes

Other related parties (other than a direct shareholder / partner):
Corporate income tax:
In the case of business assets, the debt waiver is a tax-deductible expense, provided the debt waiver is recognized in profit or loss (P&L-effective) for the benefiting company.

Otherwise, the debt waiver is treated as a so-called hidden profit distribution for tax purposes. In that case, it does not give rise to a deductible expense.

In the case of private assets, the debt waiver generally qualifies as a capital loss that is not relevant for tax purposes.

Withholding tax:
To the extent the debt waiver qualifies for tax purposes as a hidden profit distribution, withholding tax consequences may arise in addition to the profit tax consequences. These should be examined at an early stage, in particular in the case of intra-group debt waivers.

Practical note on debt waivers:

The new Circular No. 32a makes clear that, for debt waivers, it is not so much the structure under civil law but rather their economic function and accounting treatment that are decisive. The choice of accounting method alone can have a significant impact on profit tax, issuance stamp tax and the creation of capital contribution reserves. The tax analysis should therefore be carried out before the restructuring is implemented and closely coordinated with the financial reporting.

Debt waiver in exchange for recovery certificates or restructuring dividend rights certificates

The creditor waives its claim and receives in return a recovery certificate (Besserungsschein) (the right to reclaim the claim if the financial position improves) or a restructuring dividend rights certificate (Sanierungsgenussschein) (definitive waiver in exchange for a mere profit participation).

Recovery certificate (Besserungsschein)

The creditor waives its claim. If the company's economic situation subsequently improves, the claim revives in whole or in part under the agreed conditions.

Benefiting company
Corporate income tax:
The subsequent revival of the claim, as well as any interest thereon, generally constitutes a commercially justified expense, to the extent the original debt waiver was treated as a genuine restructuring gain.

Payments going beyond this are, in principle, not commercially justified.

To the extent capital contribution reserves were created at the time of the debt waiver, these must be derecognized in the amount of the reviving claim.

Stamp duty on capital contributions:
The issuance of a recovery certificate does not, in itself, trigger issuance stamp tax.

However, the underlying debt waiver may – like a contribution by an equity holder – be subject to issuance stamp tax (subject to the restructuring allowance or a tax remission).

Waiving creditor
Corporate income tax / income tax:
In the case of private assets, the debt waiver generally constitutes a capital loss that is not relevant for tax purposes.

Subsequent repayments of the reviving claim generally remain tax-free, provided that corresponding capital contribution reserves are simultaneously derecognized at the level of the benefiting company.

Interest or payments going beyond this constitute taxable investment income.

In the case of business assets, the debt waiver may, in principle, be written down.

Payments made on the basis of the recovery certificate constitute taxable income.

Withholding tax:
Repayments of the reviving claim are generally not subject to withholding tax, to the extent they correspond to a matching derecognition of capital contribution reserves.

Payments going beyond this may be subject to withholding tax.

Restructuring dividend rights certificate (Sanierungsgenussschein)

With a restructuring dividend rights certificate, the creditor definitively waives its claim and receives in return solely rights of an economic nature (e.g. a profit participation).

Benefiting company
Corporate income tax:
Payments on a restructuring dividend rights certificate do not, in principle, constitute a commercially justified expense.

Stamp duty on capital contributions:
The issuance of a restructuring dividend rights certificate is, in principle, regarded as the creation of a participation right. Accordingly, issuance stamp tax may arise (subject to the restructuring allowance or a tax remission).

Waiving creditor
Corporate income / income tax:
In the case of private assets, the debt waiver results in a capital loss that is not relevant for tax purposes. Distributions on the restructuring dividend rights certificate generally constitute taxable investment income.

In the case of business assets, the debt waiver may, in principle, be written down. Subsequent payments constitute taxable participation income; in the case of legal entities, the participation deduction should, where applicable, be examined.

Withholding tax:
Distributions on restructuring dividend rights certificates are, in principle, subject to withholding tax.

Restructuring merger

Merger of a company in need of restructuring with a financially sound company, whereby the losses of the company in need of restructuring are economically borne by the sound company.

Merging companies
Corporate income tax:
The tax loss carryforwards of the company in need of restructuring may, in principle, pass to the acquiring company, provided the requirements of the Merger Act and of tax law are met.

In particular, no transfer of losses takes place if the loss-making company had already ceased its business activities or if the acquired business is discontinued shortly after the merger.

Withholding tax:
In the SFTA's view, restructuring mergers – in particular between sister companies – may give rise to withholding tax consequences to the extent that reserves are extinguished which do not qualify as capital contribution reserves.

Shareholders of the merging companies
Corporate income tax:
In the case of business assets, the merger is, in principle, tax-neutral. The relevant tax values of the participation are preserved.

Income tax:
Where participations are held as private assets, using the reserves of the sound company to restructure the loss-making company may, in certain circumstances, trigger income tax consequences. The specific effects depend largely on the structure of the merger and the companies involved.

Book revaluation

Book revaluations can, under commercial law, help eliminate an accumulated loss. However, they improve neither the liquidity nor the actual equity of the company.

Benefiting company
Corporate income tax:
The book revaluation is, in principle, taxable and gives rise to taxable profit in the amount of the revaluation.

Available tax loss carryforwards must be offset in accordance with the general rules. To the extent no offsetable loss carryforwards remain, the revaluation may lead to an immediate corporate income tax burden.

Shareholder

No immediate tax consequences.