Within the realm of international bond markets, investors generally do not accept a deduction in withholding taxes (WHTs) on interest. Bond issuers in jurisdictions where a WHT applies may therefore suffer a competitive disadvantage, as they may either have to increase interest rates in order to guarantee an attractive yield (net of WHT), or face limited demand for their offering due to its reduced attractiveness. Both situations lead to an increase in the issuer's costs.
While many industrialised countries have abolished WHTs on bonds issued to international investors (ultimately maintaining the competitiveness of their domestic issuers), Switzerland still levies a 35% federal interest WHT on certain types of collective debt issues.
Withholding taxes in Switzerland
Unlike many other countries, no WHT is levied in Switzerland on interest paid on private and commercial bilateral loans. However, since the WHT definition of 'bond' and 'debenture' is broader than the definition used by Swiss civil law or in financial markets, certain bilateral loans (particularly if syndicated), may fall under the definition of a bond or debenture, triggering WHT.
Due to the WHT on interest, Swiss-based borrowers tend to raise debt capital through foreign subsidiaries that are established in jurisdictions where no WHT applies to such debt instruments. Generally, these issues need to be guaranteed by the Swiss parent companies in order to benefit from the parent's issuer credit rating.
While there are sound commercial reasons for foreign issues with a Swiss parental guarantee, the Swiss Federal Tax Administration (SFTA) has defined criteria under which it considers the use of a foreign issuer as abusive, and assimilates the debt instrument as a Swiss issue, potentially subject to WHT. A recent change of the SFTA's practice has brought a welcome relaxation of the conditions under which this assimilation takes place.
The definitions of bond, debenture and bank, as well as the conditions under which a bond is issued by a foreign issuer under a Swiss parental guarantee are critical in order to determine whether the raising of debt capital is subject to WHT.
Bond and debenture definitions
Swiss withholding tax practice defines bonds or debentures as written debt acknowledgments for fixed amounts that are issued in multiple tranches for the purpose of collective financing, and which allow the investor to evidence, reclaim or transfer its receivable claim.
A bond is defined as the issue of written debt acknowledgments over a fixed amount to more than 10 non-bank lenders at identical conditions (in terms of interest rate, lending period, repayment conditions, etc.), provided that the total amount of issued debt amounts to at least CHF 500,000 ($496,000).
A debenture is defined as the issue of written debt acknowledgments over fixed amounts to more than 20 nonbank lenders at variable conditions, provided that the total amount of issued debt amounts to at least CHF 500,000.
As the above definitions suggest, Swiss and foreign banks (as defined by the Swiss Federal Banking Act or comparable foreign banking legislation at the place of establishment of the lender) are not counted as lenders, unless the debt acknowledgements are securitised (e.g. in the form of bearer bonds, so that the issuer would not know whether the bond is held by a bank or a non-bank).
Furthermore, following a legal amendment a few years ago, companies under common consolidation with the issuer are no longer counted as lenders under the aforementioned definitions. However, as bond issues are rarely subscribed by group companies of the issuer, this amendment is of minor relevance in the context of international bond issues.
In order to avoid WHT applying to the borrower, Swiss issuers who raise debt capital from international investors therefore seek to observe the number of lenders specified under any debt issue. This is done by introducing contractual transfer restrictions in the credit agreements, which aim to restrict the transferability of the debt instruments.
The transfer restrictions can disallow any transfer, or transfers to non-bank lenders. It is also common to seek consent from the issuer for any transfer. The transfer can then be denied by the issuer if the number of lenders exceed 10 or 20.
Since lenders generally want to be able to transfer their receivables to third parties, such contractual transfer restrictions may make the offering less attractive to investors. Swiss issuers therefore regularly issue debt instruments through their foreign subsidiaries.
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