Introduction
The Swiss tax practice already applied strict substance requirements for the acceptance of international investments or group structures. In particular, the discussion around substance requirements became even more important within the framework of BEPS. In this context, the Swiss tax practice also increased the substance requirements. Therefore, before any investment or group is set up, it should be considered whether the substance requirements can be fulfilled.
Issue
In order to benefit from a double tax treaty, the Swiss tax authorities review whether both parties – i.e. the Swiss entity as well as the foreign counterparty – are entitled to make use of the double tax treaty. Such a review is based on specific substance criteria. If, in this process, the foreign entity is unable to show evidence that sufficient substance is available, then any double tax treaty benefits are denied by the Swiss tax authorities. Given that the Swiss tax practice applies a withholding tax of 35% on open but also hidden dividend payments, it is particularly crucial that a foreign parent entity of a Swiss subsidiary is able to claim double tax treaty benefits.
Substance requirements
The Swiss tax authorities measure whether the level of substance is sufficient as follows:
- Personal substance: this is given if the entity employs (its own) employees in its own premises in the country of residence. The employees may also be employed by an associated company resident in the same country as the entity.
- Functional substance: functional substance is given by an operative business. Alternatively, also the function as a holding company can qualify as functional substance. This is given if the foreign entity holds – in addition to the Swiss company – at least one other substantial participation in a company domiciled in another state. In this context, the affiliates generally must be actively engaged in business activities.
- Financial substance: this is given if the holding company shows an equity ratio of at least 30%. This 30% ratio is determined based on book values of the stand-alone statutory financial statements (i.e. not consolidated financial statements).
For a foreign parent entity of an operational group, at least one of the aforementioned criteria must be fulfilled. In the case of a personal holding company of an individual, financial substance alone is not sufficient under specific circumstances. In the case of a private equity investment structure, at least two of these criteria must be fulfilled. In summary, depending on the company structure, the Swiss tax authorities expect the fulfilment of at least one or two criteria.
Application of double tax treaty
Beside the substance requirements, a foreign parent entity must additionally have the right of use of a dividend payment by the Swiss entity in order to make use of a double tax treaty (i.e. beneficial ownership). This would not be the case if the foreign parent entity would have to pass the dividend contractually or de facto to another party.
To summarise, the Swiss tax practice applies strict requirements, in particular with regard to foreign parent companies, that a double tax treaty can be applied in connection with a Swiss subsidiary. Therefore, it is crucial that a certain extent of substance is available at the level of the foreign entity.
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