Swiss tribunal decision on beneficial ownership in connection with total return swaps
Swiss withholding tax developments
28 March 2012
The latest decision (A-6537/2010 of 7 March 2012) of the Swiss Federal Administrative Tribunal on Swiss withholding tax refund entitlement is of great importance to the financial industry. The tribunal concluded on the beneficial ownership of a Danish bank for Swiss dividend payments from equities the bank acquired for the purpose of hedging total return swap positions.
A total return swap is a financial contract that transfers both the credit risk and market risk of an underlying asset. In a total return swap, the party receiving the total return will receive any income generated by the asset as well as the benefit if the price of the asset increases over the life of the swap. In return, the total return receiver must pay to the counterparty the set rate over the life of the swap. If the price of the assets falls over the swap's life, the total return receiver will be required to pay the counterparty the amount by which the asset has fallen in price.
By entering into a total return swap with a non-Swiss counterparty, the party receiving the total return can indirectly participate in Swiss equities. It can therefore receive manufactured dividend payments that are not subject to 35% Swiss withholding tax as would not be possible with a direct investment in the assets.
In the recent case, a Danish bank entered into total return swaps with counterparties in the UK, Germany, France and the US on equity baskets involving Swiss equities. In order to hedge the swap positions the bank acquired the corresponding amount of the underlying Swiss equities.
Over the life of the swaps the bank collected dividend payments on the acquired Swiss equities, which were subject to 35% Swiss withholding tax. The bank asked for a full refund of the Swiss withholding tax based on the double tax treaty between Switzerland and Denmark (the treaty has since been amended and now provides for a residual withholding tax of 15%).
The Swiss Federal Tax Administration denied the refund, arguing that because the bank entered into swap transactions it was obliged to pass on the Swiss dividends received to the swap counterparties. As a consequence the bank does not qualify as the beneficial owner of these dividends, and therefore could not rely on the treaty.
Upon a complaint filed by the bank, the Swiss Federal Administrative Tribunal granted the refund, stating that the bank – despite entering into swap transactions – retained beneficial ownership of the Swiss dividends received. The tribunal argued that entering into the swap transactions did not oblige the bank to acquire the underlying equities. As such, the bank would also have had the obligation to pay the amount of the dividend to the swap counterparties in case the position was not hedged and the bank had not collected Swiss dividends. In addition, the bank could also – independently from the swap contracts – decide to acquire the respective Swiss equities and collect dividends thereof.
Furthermore, lacking an explicit abuse clause in the double tax treaty between Switzerland and Denmark no treaty abuse can be assumed based on the fact that the Danish bank conducts a genuine commercial business activity and disposes over own offices, personnel and infrastructure.
The Swiss Federal Tax Administration have the option to appeal the case until 12 April 2012 to the Swiss Federal Supreme Court.