Tax In Distressed Situations Switzerland

GENERAL

1. Does debt have a specific meaning for tax purposes?

Debt does not have a specific definition for Swiss tax purposes, which would differ from its interpretation under Swiss commercial law. However, due to the various forms of debt, different Swiss tax implications can arise depending on the specific type of debt, such as loans, bonds, or term notes, including, for instance whether or not the debt and respective interest payments could potentially lead to Swiss stamp duty and withholding tax consequences.

In addition, recent developments indicate that the Swiss tax authorities are increasingly scrutinizing whether intra-group debt qualifies as a loan from an economic perspective, which must be interest bearing. This is particularly relevant for debt receivables at the level of a Swiss entity, as interest income must be recognized in the P&L.

Moreover, detailed regulations and case law exist regarding the reclassification of intra-group debt as equity for Swiss tax purposes (hidden equity as per Swiss thin capitalization rules). Additionally, there are comprehensive rules and guidelines governing the treatment of interest payments on debt involving related parties and debt guaranteed by related parties; see also more under 3.

In addition, a debt can be classified as taxable bond or term note with respective Swiss tax consequences; see in detail under debt refinancing 3.

2. Do derivatives have a specific meaning for tax purposes?

There are established guidelines concerning the taxation of derivatives under Swiss tax law. However, there are no specific interpretations of derivatives for Swiss tax purposes.

3. Generally, are intra-group debts treated differently to external debt for tax purposes?

Under Swiss tax law, it is essential to distinguish between external debt and intra-group debt, i.e., debt provided by, or to, related parties. It should be noted that, there is no legal definition for the classification of a related party under Swiss tax law; thus, this qualification must be made on a case-by-case basis, considering factors such as ownership, involved individuals, and contractual structures.

Intra-group debts must generally comply with the Swiss thin capitalization rules as outlined in Circular Letter No. 6/1997. The maximum allowable debt financing of a Swiss company is calculated based on the fair market value (“FMV”) of the assets. According to the Circular Letter No. 6/1997, a company’s debt may be reclassified as hidden equity to the extent that the debt consists of related-party debt and cannot be justified with economic arguments or an arm’s length test. To determine the arm’s length nature of intra-group transactions, the Swiss tax authorities generally rely on the OECD transfer pricing rules.

In addition, intra-group debt must have an arm’s length nature, which includes, taking into account, inter alia (i) proper documentation, (ii) arm’s length interest rates, (iii) amount of loan (no cluster risk for lender regarding borrower), (iv) term of loan, (v) borrower’s will and capacity to repay the loan, (vi) repayment mechanism, (vii) solvency of borrower, (viii) events of default, and (ix) security. Where no evidenced arm’s length interest rates can be provided, the so called safe harbour interest rates as annually published by the Swiss Federal Tax Administration on loans receivable and payables from related parties should be applied.

4. Does it make a difference if debt is owed by a partnership or other pass through entity in distress to third parties versus to its partners?

As a general rule, and given that partnerships and limited partnerships are not taxable as companies, the income and gains will be allocated to the general and limited partners. There are specific rules applicable to partnerships or other pass-through entities. These rules also include provisions relating to debt positions of partnerships or pass-through entities and the liability for corporate debts of the partnerships.

DEBT IMPAIRMENT

1. What are the key tax considerations on a debt impairment for the creditor?

Under Swiss tax law, a debt impairment for the creditor must be commercially justified and thus at arm’s length, particularly when the debtor is a related party. If a debt impairment is commercially justified, it should be fully deductible for Swiss corporate income tax purposes for the creditor, [especially if the amount is fully taxable at the level of the debtor]. In general, an impairment should not give rise to taxable income at the level of the debtor as long as the impairment can be reversed and would not constitute a debt waiver.

Further key Swiss tax considerations include, in particular, whether the debt impairment will be made by a direct or indirect shareholder, by a sister company or by a subsidiary and whether a debt impairment constitutes a debt waiver / release. If this is the case, the following should be considered:

Shareholder: If a direct or indirect shareholder is performing the debt impairment, special attention should be given to the recognition of the debt impairment in the balance sheet and profit and loss statement (P&L), since Swiss tax law generally follows accounting principles, as there may be a circumstance where a debt impairment would be considered as a contribution of the debt into the subsidiary, followed by a potential impairment thereof rather than just an impairment of the debt.

When a debt impairment is made towards a subsidiary or other group companies, the following considerations are essential to determine whether the debt impairment would constitute an asset swap followed by a potential impairment for Swiss corporate income tax purposes:

• whether the loan the subject of the debt impairment was reclassified as hidden equity prior to the financial restructuring;
• whether the loan the subject of the debt impairment was initially granted, or additionally provided, due to deficient business performance, and whether it would have been granted by independent third parties under the same circumstances.

Sister company: If a sister company is performing a debt impairment, the question is whether the impairment is made on arm’s length terms or due to group relationship, i.e., upon request of the common shareholder. In the former case the impairment would be fully corporate income tax effective, i.e., fully deductible, while in the latter case, there may be an upward adjustment for corporate income tax purposes, i.e., the impairment will be added-back to the taxable profit due to the requalification as a deemed dividend, which may have also an impact on the tax book values and initial investment costs at the level of the common shareholder. In addition, deemed dividends are subject to Swiss withholding tax of 35%. Generally, the refund of Swiss withholding tax may be requested by the direct beneficiary, which would be the sister company. The notification of Swiss withholding tax instead of a payment and refund may only be applicable in limited circumstance e.g. if the debtor and creditor have the same direct parent entity and, additionally, if the debt impairment is performed as part of a financial restructuring as in this case the beneficiary of the deemed dividend is the shareholder of the financially distressed entity.

In an international context, the (partial) refund and the applicability of the notification procedure depend on the relevant double tax treaty, previously confirmed treaty clearance, and whether the entities have the same direct parent entity.

Subsidiary: Similar to the impairment of debt by a sister company, it is necessary to assess whether the impairment is at arm’s length. If it is, the impairment is fully effective for corporate income tax purposes. Otherwise, an upward adjustment will be made for corporate income tax purposes due to its classification as a deemed dividend. This deemed dividend will also trigger Swiss withholding tax consequences. However, in this case, the process should be more straightforward compared to a sister company, as the direct beneficiary would be the shareholder. This generally means that the domestic notification procedure is applicable. In an international context, if a confirmed treaty clearance is applicable, the notification procedure applies; otherwise, Swiss withholding tax must be paid and a (partial) refund needs to be requested.

2. What are the key tax considerations on a debt impairment for the debtor?

The impairment of the debt at the level of the creditor should, in principle, not have any adverse Swiss tax consequences at the level of the debtor unless it constitutes a debt waiver or debt release. In this case, and provided the debt release/waiver is at arm’s length, it will generally be recognized as income in the P&L, which is fully corporate income tax effective and thus, deductible for corporate income tax purposes.

However, in certain situations, debt releases by shareholders are deemed not to have occurred for corporate income tax purposes at the level of the debtor, particularly in the first two cases described above, i.e.:

• where the underlying loan of the debt impairment was reclassified as hidden equity;
• where the loan the subject of the debt impairment was initially granted or additionally provided due to deficient business performance, and whether it would have been granted by independent third parties under the same circumstances.

In those cases, there should be no taxable income as it is treated as a mere contribution by the shareholder.

In addition, if a debt release is made by a sister company, it needs to be reviewed whether such debt impairment withstands a third party comparison or not. In the first case, i.e., if it’s at arm’s length, the debt impairment is fully subject to corporate income tax, while in the latter case it is merely a so called non-genuine restructuring income, which can be recognised in other reserves and which should not be effective for corporate income tax purposes and thus, not subject to corporate income tax.

DEBT AMENDMENT, REFINANCING AND NOVATION

1. What are the key tax considerations on a debt amendment?

A debt amendment generally needs to comply with arm’s length terms, (i.e., market conditions) as otherwise adverse Swiss tax consequences may be triggered. This is particularly relevant if the creditor agrees to a debt amendment of a related party in a situation where a third party would not have agreed to a debt amendment.

2. Does the deferral of any payments of interest or repayments of principal trigger tax consequences?

In general, the deferral of any payments of interest or repayments of principal needs to comply with the arm’s length terms , as otherwise adverse Swiss tax consequences may occur. Swiss tax law generally follows the accounting treatment; thus, a deferral of any interest accrual may, in addition, have an impact on the timing of recognition of any interest income and expenses.

3. What are the key tax considerations on a debt refinancing?

A debt refinancing, whether in a distressed scenario or otherwise, generally has the same key Swiss tax considerations:

• Withholding tax. In principle, Switzerland does not levy withholding tax (“WHT”) on interest payments, provided that the 10/20 non-bank lenders rules and thin capitalization rules are complied with, and that interest payments are in line with arm’s length terms. Non-arm’s length interest payments will be requalified as a deemed dividend, which is generally subject to 35% Swiss withholding tax. This tax can be reclaimed if a double tax treaty is applicable. Swiss 10/20 non-bank lender rules: Withholding tax of 35% applies on certain debt instruments involving a Swiss resident company as borrower/issuer or security provider and notably applies in the following scenarios:
  • Swiss borrower has issued debt to more than 10 non-bank lenders or more than 20 non-bank lenders (“Swiss Non-Bank Rules”):
    • 10 non-bank lender rule: A Swiss resident borrower borrows funds from more than 10 non-bank lenders on identical terms against written acknowledgment of debt and the total borrowed sum is at least CHF 500,000 (taxable bond; 10 Non- Bank Rule).
    • 20 non-bank lender rule: A Swiss borrower borrows funds from more than 20 non-bank lenders on variable terms against written acknowledgment of debt and the total borrowed sum is at least CHF 500,000 (taxable note; 20 Non-Bank Rule). For the purpose of calculating the relevant number, all interest-bearing instruments are taken into account.
    • Non-bank lenders are persons that do not qualify as (i) banks as defined in the Swiss banking legislation, or (ii) persons or entities which effectively conduct banking activities with their own infrastructure and staff as their principal purpose and which have a banking license in full force and effect issued in accordance with the banking laws in force in their jurisdiction of incorporation (“Qualifying Banks”).
    • Non-Swiss borrower has issued debt to more than 10 non-bank lenders or more than 20 non-bank lenders with guarantee or security provided by a Swiss company (down- stream guarantee/security) and proceeds from such non-Swiss issuance are directly or indirectly remitted to Switzerland in excess of the equity of the non-Swiss issuer calculated as per the closing of the financial year (harmful use of proceeds rule).
    • It is standard market practice to obtain an advance tax ruling confirmation from the Swiss Federal Tax Administration that in case of an upstream security which is limited to the amount of distributable reserves of the Swiss security provider, such guarantee would not be considered as not harmful for Swiss withholding tax purposes.
    • Thin capitalisation rules: Under the rules set forth by the circular letter 6/1997, the maximum debt financing is calculated based on the fair market value of the assets. Debt from related parties exceeding the threshold may be considered as hidden equity, and the quota of interest expenses allocated to the hidden equity will not be deductible for corporate income tax purposes and will be subject to 35% withholding tax (or up to 54% if grossed-up; refund according to applicable double tax treaty possible).
    • In addition, Switzerland also levies a withholding/source tax on interest payments on mortgage-secured loans.
  • Interest deductibility. Interest is generally a deductible expense for Swiss corporate income tax purposes. However, a number of detailed rules should be observed which can impact the deductibility of interest for Swiss corporate income tax purposes, particularly the thin capitalization rules and whether the interest payments correspond to the arm’s length principle.
  • Stamp duty. Generally, no stamp duty is levied on the issue of debt. However, if the debt is requalified into a taxable bond or term note, such a bond can be subject to stamp duty upon transfer by a Swiss securities dealer or involvement of such.

4. Does rolling up interest or satisfying interest through issuing “payment in kind” notes give rise to any tax consequences?

Given that Swiss tax law follows the accounting principle, neither the rolling of interest nor the issuance of PIK notes should have any adverse Swiss corporate income tax consequences for either a Swiss creditor or a Swiss debtor, provided the interest is at arm’s length and commercially justified. However, Swiss withholding tax consequences can be different depending whether there is a roll-up of interest or satisfaction of interest through issue of PIK notes, whereas the latter can also trigger additional Swiss tax implications.

• Roll-up of Interest: If interest is capitalised or booked to a separate account, no Swiss withholding taxes should be due since no payment is made. However, if and when the rolled-up interest is paid, it must be determined whether the interest is at arm’s length. If the interest is not at arm’s length, it may be requalified as a deemed dividend, resulting in Swiss withholding taxes.
• Satisfaction of Interest through PIK Notes: The issuance of PIK notes in satisfaction of interest may be subject to Swiss withholding tax if requalified as a deemed dividend. Additionally, the different settlement of the PIK should be analysed in detail, if e.g., the PIK notes are settled by issuing new shares, stamp duty consequences may also be triggered.

5. Does the novation of debt by a debtor to another group company trigger any adverse tax consequences?

Generally, the novation of debt by a debtor should not have adverse Swiss tax consequences, provided that the underlying 10/20 non-bank lender rules are adhered to and the conditions of the debt, particularly the interest rates, remain unchanged and at arm’s length terms.

6. Are there any specific tax considerations to bear in mind where the security / guarantee package is amended as part of the debt amendment / refinancing?

Generally, if a non-Swiss borrower provides up-stream and cross-stream guarantees, it should be noted that such guarantees must generally be limited to the freely distributable reserves in accordance with Swiss corporate law.

If the guarantee package provided by a non-Swiss borrower changes to a down-stream guarantee, it is important to note that such a downstream guarantee can have adverse Swiss withholding tax consequences, particularly under the 10/20 non-bank lender rules for a non- Swiss borrower, especially if the harmful use of proceeds rule is violated. Therefore, it is essential to analyse whether (i) there will be a change from an up-stream or cross-stream guarantee of a non-Swiss borrower to a downstream guarantee and if such a change occurs, it should be further analysed (ii) whether there is indeed a harmful use of proceeds in Switzerland.

In addition, it is crucial that the guarantee is remunerated at arm’s length as otherwise adverse Swiss corporate income tax and withholding tax consequences can arise.

To view the full article click here

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.