Refund of Swiss withholding tax on intra-group dividends requires sufficient “substance” at recipient end on the one hand but also beneficial ownership, in the Supreme Court case below meaning economic justification to the transaction.
This post summarises a recent Supreme Court decision that set out criteria applying to beneficial ownership.
The decision confirms the Supreme Court’s tendency to take an increasingly economic view when examining the question of beneficial ownership. Tax payers will not be able to solely rely on their legal, or even factual, obligations. The full set of circumstances, including behavioural patterns, will be taken into account.
When structuring an international group with Swiss affiliates this economic approach needs to be borne in mind.
It is probably fair to say that, although possibly creating a some degree of legal uncertainty, the decision is in line with where the world is headed. Authorities and courts are likely to assume a particular arrangements artificiality rather sooner than later.
- A Danish bank (Bank) entered into swap contracts with clients in England, Germany, France and the US. Pursuant to those agreements the clients undertook to trade the entire return (esp. dividends and capital gain) of a specific underlying asset (in this case a basket of Swiss shares) against a fixed stream of payments. In consideration of this so-called Total Return Swap (TRS) the Bank was entitled to a variable interest (Libor) plus a margin.
- That allowed the clients to build up a synthetic stake in an underlying asset (i.e. the basket of Swiss shares) without having to directly invest into the related basket of shares. The Bank hedged its obligations under the TRS, namely payment of the aggregate return at a particular due date, by purchasing the related basket of Swiss shares. Dividends on the Swiss shares (Swiss Dividends) were paid by the Swiss enterprises to the Bank net of Swiss withholding tax (WHT).
- Subsequently, the Bank sought reimbursement of WHT from the Federal Tax Authority (FTA) in an amount close to CHF 50m. The FTA denied reimbursement arguing (i) lack of beneficial ownership of the dividend on the Bank's part and (ii) abuse of the double tax treaty between Switzerland and Denmark in its pre-2009 version (DTA-CH-DK; amended since).
- According to the FTA, the entering into the TRS on the one hand with simultaneous purchase of related shares on the other hand had resulted in a transfer of all financial opportunities and risks to the clients. The FTA argued that the structure could not be justified on economic grounds and had been purely tax driven.
- While the previous instance, the Federal Administrative Court (Administrative Court) had followed the Bank’s arguments, the Supreme Court sided with the FTA denying the bank’s claim for reimbursement of WHT.
- Essentially, it came down to the question whether the Bank qualified as beneficial owner of the Swiss Dividends and was therefore entitled to reimbursement of WHT under the pre-2009 DTA-CH-DK.
- One of the DTA-CH-DK’s particular features was its dividend related provision under which the right to tax dividends lied solely with the state of the recipient (as distinguished from the taxation rights for both states in the post-2009 version).
2. The decision – summary
The decision may be summarised as follows:
- The issue was whether the Bank qualified as beneficial owner of the Swiss Dividends or whether it had merely been interposed to benefit from the DTA-CH-DK’s dividend provision.
The Bank’s Danish tax residence was unquestioned.
- The Supreme Court primarily relied on the concept of beneficial ownership (literally: effective right of use, effektive Nutzungsberechtigung). The recipient of a dividend qualifies as beneficial owner only if „he is at full liberty as to the use of the dividend and has its unfettered enjoyment without restriction by any statutory or contractual obligation.“
The Supreme Court made a point of interpreting beneficial ownership in an economic light. Merely formal rights of use will not be sufficient.
- Both the Administrative Court and the Supreme Court took the view that the power of disposal (Verfügungsberechtigung) needed to be examined under economic aspects, “substance over form”.
The Administrative Court had concluded that it was irrelevant whether the Bank had kept the Swiss dividends or transferred them onwards. The relevant point in time was payment of the dividend (and not what happened afterwards).
According to the Supreme Court, however, consideration of the full set of circumstances required taking into account any transfers onwards of the Swiss Dividends at a later stage.
Restrictions to beneficial ownership needed not be of a statutory or contractual nature. They might also result from factual circumstances.
- According to the Supreme Court, the stronger the correlation between the realisation of an income and the obligation to transfer it onwards the weaker the beneficial ownership. The fact that a minor part of the Swiss Dividends remained with the recipient (and was not transferred onwards) did not make it a beneficial owner; that remaining part might qualify as the recipient’s remuneration for acting as “transferor”.
- Whereas the Supreme Court did accept that the Bank had not been under any legal or factual obligation to transfer onwards the Swiss Dividends it went on to dismiss that argument as irrelevant.
The Bank had, without exception, fully hedged its transactions with the purchase of underlying Swiss shares. According to the Supreme Court it was in the „utmost interest of the Danish Bank to hedge its risk by purchasing the underlying assets to ensure they would collect the amount at stake under swap“. The Supreme Court also noted that all shares were sold once the Swiss Dividend had become due or the TRS had expired.
The Supreme Court held that despite the absence of any legal or factual obligation the economic setup created a “relevant interdependence”, ultimately resulting in beneficial ownership being denied.
- The Supreme Court also held that the Bank did not bear any risk in the context of these TRS transactions. Any credit risk had been compensated by the interest margin.
- In summary, the Supreme Court came to the conclusion that the Bank’s TRS transactions amounted to a “stepping stone”-scheme aiming at making benefits under the DTA-CH-DK available to parties in jurisdictions with a less favourable treaty.