IFA 2025 - Subject 2 - Branch Report For Switzerland - Subject B: Improper Use Of Tax Treaties And Source Taxation: Policy, Practice And Beyond

Switzerland

Branch reporter

Matthias Bizzarro¹

Summary and conclusions

Switzerland as a source state levies withholding taxes mainly on profits distributions and interests paid on bonds and banking deposits. There is no general withholding on other interest payments, nor on other payments such as royalties.

The main focus of Swiss anti-abuse practices thus lies on dividend withholding taxation and, to a lesser extent, bond interest withholding taxation.

The Swiss tax authorities have developed a wide anti-abuse arsenal to prevent improper use of tax treaties.

In general, the Federal Tax Administration (FTA) considers an arrangement as abusive for tax treaty purposes if:

• the tested party disposes of insufficient substance;
• there is an improvement in the treaty position;
• there is an abusive intent.

The key element in this analysis is the presence of substance (which is divided between equity, functional, and infrastructural substance). The required elements of substance needed to determine the legitimacy of a structure or arrangement may vary depending on the facts and circumstances of the specific case.

Apart from this, there are a number of specific anti-avoidance practices developed by the FTA based on recurring factual patterns, thin capitalization, minimum or maximum interest rules, practices dealing with surplus stripping cases and similar situations.

According to the jurisprudence of the Swiss Federal Supreme Court (FSC), as recently clarified in a decision of 3 October 2024, the prohibition of treaty abuse is a general principle of international law, which from a Swiss perspective is applicable even in the absence of specific provisions.

According to the FSC case law, treaty benefits may only be denied if, cumulatively, both the conditions under the domestic tax avoidance rules and the conditions of treaty abuse (either based on international law or, arguably, based on a specific treaty provision such as the PPT) occur. This dual requirement arguably ensures that the denial of benefits is in line with both domestic law and international treaty obligations.

According to the longstanding practice of the FSC, from a domestic perspective tax avoidance occurs if:

• the chosen legal arrangement appears unusual, inappropriate, or peculiar, and is completely unreasonable given the economic circumstances (objective element);
• It must be assumed that the chosen legal arrangement was abusively made solely to save taxes that would be owed under proper circumstances (subjective element);
• the chosen approach would actually lead to significant tax savings if accepted by the tax authority (effective element).

Switzerland has been actively participating in the BEPS project and has signed and ratified the MLI. It has implemented the principal purpose test (PPT) with a number of countries and is in the process of revising further double tax treaties with a view of introducing the PPT.

The main question that arises from this development is whether there will be a change in the Swiss approach towards treaty abuse. In light of the recent jurisprudence of the FTA, this does not seem to be the case. The Swiss domestic general anti-avoidance rule is less strict, as regards the subjective element, as it requires the tax savings to be the main goal of an arrangement for it to be considered abusive, whereas under the PPT it is sufficient if one of the main purposes of an arrangement is to obtain treaty benefits. Since under the recent jurisprudence of the FSC both treaty-based and domestic anti-abuse rules must be cumulatively fulfilled to deny benefits, the result would arguably be to maintain the existing domestic standard.

Part I

1. The line between proper and improper use of tax treaties

As regards source taxation, the main concerned tax in Switzerland is the federal withholding tax ("WHT",² see section 2 below).

In order to benefit from tax treaties, according to the practice of the Swiss tax authorities the following elements must be assessed:³

1. the item of income must be attributable to the person claiming treaty benefits;
2. the person requesting the treaty benefit must be a resident of the contracting State pursuant to the applicable treaty;
3. the recipient of the item of income must be its beneficial owner (see section 4.3 below);
4. the request for treaty benefits must not constitute a case of treaty abuse.

Generally speaking, WHT is collected and treaty benefits must be requested by way of reimbursement. For dividends from qualifying participations, a partial or total (depending on the treaty) exemption at source can be obtained via a special notification procedure which is subject to previous authorization by the FTA.⁴

1.1. The decisive factors or elements 

Apart from specific situations, for which the FTA has developed a number of specific antiabuse practices (see section 2.1. below), the general anti-abuse practice of the Swiss tax authority is described hereinafter. It should be underscored that the FTA generally adopts uniform anti-abuse factors and standards when analyzing international cases, irrespective of the specific treaty applicable to the situation.⁵

The relevant elements or indicia for treaty abuse are generally as follows:⁶

1. the structuring seems inadequate/unusual, which generally equates to the recipient of the item of income having insufficient substance;
2. there is an improvement in the treaty position (e.g. a lower residual WHT rate);
3. there is an abusive intent.

It should be noted that the practice described here has been developed mainly for dividend payments, but should also be applicable to other treaty benefit situations.

Of the three treaty abuse elements just described, the improvement in treaty position is generally self-evident and does not require particular comments. It is sufficient that a structure allows the recipient of an item of income to benefit from a lower residual tax rate.

As regards the element of unusual structuring, the FTA generally deems a structure unusual for purposes of treaty abuse if the person claiming treaty benefits does not have sufficient substance. The FTA distinguishes three types of substance:⁷

1. equity substance requires an equity ratio (based on the standalone accounts of the tested party and taking into account the book values, i.e. without considering any hidden reserves);
2. functional substance is generally applicable to holding companies. It is considered fulfilled if the party requesting treaty benefits, in addition to the Swiss company making the payment subject to WHT, holds at least an additional participation in a third country with a value comparable to the Swiss entity, i.e. if the tested party exercises an international holding function;⁸
3. infrastructural substance is considered to be present if the party claiming treaty benefits employs its own personnel and disposes of its own (rented or owned) remises in the State of residence. Infrastructural substance present in other group companies within the same State of residence can generally be considered towards the substance of the party claiming treaty benefits.⁹

As regards the subjective element, the FTA generally presumes the abusive intent from the fulfillment of the other two elements (i.e. insufficient substance and improvement in treaty benefits). However, as also shown in the case of the old reserves practice (see section 2.1.3. below), there may be situations, particularly in case of minority shareholders that may not impose any payments, that could be considered as lacking an abusive intent.¹⁰

1.2. Establishment of the elements of abuse

The decisive question in the application of the FTA's anti-abuse practice is whether the various types of substance mentioned above (section 1.1) must be fulfilled alternatively or cumulatively. 

The substance requirements vary depending on the circumstances of the specific case. In general, in case of group structures of operating groups and of listed companies, if the tested party fulfils one of the three substance criteria alternatively, this is considered sufficient, as long as no intermediate holdings in non-treaty jurisdictions are present in the chain.¹¹

e chain.11 For personal holding companies, the substance required depends on whether the ultimate beneficial owner resides in a State with which Switzerland has agreed on an equivalent residual rate for qualifying participations (e.g. 0%).12 If that is the case (e.g. if the ultimate beneficial owner is resident in the same State as the tested party), the substance criteria can be met alternatively. If the DTA with the State of residence of the ultimate beneficial owner does not provide for an equivalent relief, or if the individual is resident in a non-treaty jurisdiction (or is not counted as a resident under the treaty in application of specific requirements that account for preferential tax regimes), the substance requirements are higher (i.e. infrastructural or functional substance are required in addition to equity substance).¹³

Higher substance requirements apply also for acquisition vehicles of funds (e.g. private equity funds). In these cases, equity substance alone is not considered sufficient and must be complemented by functional or infrastructural substance.¹⁴

As discussed below, treaty abuse situations may also occur to avoid real estate capital gains taxation in Switzerland, i.e. by interposing a holding company in a treaty jurisdiction that does not assign capital gains from indirect real estate transfers to the situs State. The situation in this case is not very clear, as the criteria for treaty abuse would be applied by the Cantonal tax authorities. Nevertheless, on the basis of the case discussed in section 3.2 below, it can be assumed that high substance requirements would be imposed and that the tested company would need to dispose of infrastructural substance.¹⁵

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Footnotes

1. Matthias Bizzarro is a partner with Bär & Karrer AG, Lugano. His practice focuses on domestic and international individual and corporate taxation as well as tax litigation. Matthias Bizzarro is a Swiss attorney-at-law and a certified tax expert. He holds a Master of Laws degree from the University of Lucerne and an LLM in international taxation from Georgetown Law School.

2. Swiss Federal Act of 13 October 1965 on the withholding tax (Bundesgesetz vom 13 Oktober 1965 über die Verrechnungssteuer, Verrechnungssteuergesetz, VStG, "WHT act"), SR [number in the Swiss systematic legislation] 642.21

3. See Oesterhelt in Oesterhelt/Stocker, Internationales Steuerrecht der Schweiz ("IStR"), § 24 N 5-6; Oesterhelt/ Oppliger, Rückerstattung der Verrechnungssteuer ("Oesterhelt/Oppliger"), § 1 N 5-29.

4. See Oesterhelt/Oppliger, § 1 N 26-28 and § 12 N 1-18.

5. Oesterhelt, IStR, § 24 N 15-17

6. See Oesterhelt, IStR, § 24 N 18; Oesterhelt/Oppliger, § 6 N 23-24; Lutz, Abkommensmissbrauch ("Lutz"), 210-211.

7. See generally Oesterhelt, IStR, § 24; Oesterhelt/Oppliger, § 6; Lutz, 210-214.

8. Oesterhelt, IStR, § 24 N 22; Oesterhelt/Oppliger, § 6 N 28.

9. Oesterhelt/Oppliger, § 6 N 209-213.

10. Oesterhelt, IStR, § 24 N 37; Oesterhelt/Oppliger, § 6 N 28

11. Oesterhelt, IStR, § 24 N 30-34; Oesterhelt/Oppliger, § 6 N 39-55 and 111-149; Lutz, 210-211.

12. Oesterhelt, IStR, § 24 N 37-41a; Oesterhelt/Oppliger, § 6 N 64-75.

13. Oesterhelt, IStR, § 24 N 42-49; Oesterhelt/Oppliger, § 6 N 76-110.

14. Oesterhelt, IStR, § 24 N 59-62; Oesterhelt/Oppliger, § 6 N 150-231.

15. Oesterhelt/Opel, IStR, § 22 N 36-38.

Originally Published by IFA Lisbon Congress 2025 Journal

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