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Withholding tax reform - subject of the vote
On 25 September 2022, Swiss citizens will be asked to vote on the withholding tax reform. The aim of the reform is to make Switzerland more competitive in the domain of bond issuance. However, as tax laws are becoming more and more technical, we would like to give you a brief overview of the implications of such a reform.
Function of withholding tax
As a reminder, withholding tax (hereafter : "WHT") fulfils two functions for the Confederation:
- On the one hand, it has a guarantee function for Swiss residents. It is a withholding tax which combats tax evasion by encouraging Swiss taxpayers to declare their income subject to withholding tax ;
- On the other hand, it has a fiscal function for foreign residents, by subjecting them to tax when certain benefits are paid from Swiss sources.
The changes of the WHT reform
Switzerland is currently not competitive in bond issuance. This is the observation of the Federal Council and, with this referendum, it wishes to remedy this. Indeed, the issuance of bonds in Switzerland is subject to two major disadvantages which are :
- The 35% WHT
- The 0.15% stamp duty (hereinafter : "STD") for Swiss securities - the stamp duty having already been abolished in respect of bonds.
The underlying idea of this reform is to enable Switzerland to be a major financial center for bond issuance. Therefore, the Federal Council wants to abolish the WHT and the STD.
This has a collateral effect on collective investment schemes (hereinafter : "CIS") which in case of investment in Swiss bonds would be at a disadvantage compared to a foreign CIS which would not have an equivalent to the Swiss WHT in its country (e.g. Luxembourg). Although this was discussed in the parliamentary debates, no legislative change will be made in this respect. The competitive distortion for a Swiss individual due to the collection of the WHT after a coupon distribution by the Swiss CIS will remain.
Finally, two further changes are foreseen through this reform :
- The taxation of manufactured dividends: the idea is to subject to WHT certain compex financial transactions (e.g. securities lending) where the borrower of a security (generally a bank in Switzerland) benefits from the reimbursement of WHT on a subject benefit (e.g. a dividend) in order to pay back the said benefit to an investor (note that there could still be other intermediaries before arriving at the reimbursement to the initial investor).
From now on, WHT will be levied on all compensation payments, not only on the initial payment. However, this new purpose of WHT will be difficult to implement in practice, since if a beneficiary was the debtor of a compensation payment and was domiciled abroad, this would mean that he would be subject to WHT in Switzerland. The implementation, respectively the monitoring of these flows and the payment of WHT by a beneficiary domiciled abroad would be complex for the Federal Tax Administration.
- WHT on interest on client assets: it should be recalled as a preamble that tax law has a broader definition (rule of 100 creditors and 5 million debts) to qualify a company as a bank, and therefore de facto subject to WHT, than that of the Federal Banking Act. If the reform is accepted, this specific tax law definition would disappear.
In addition, the WHT on interest on client assets would be reduced in scope. The WHT would only continue to be levied on natural persons resident in Switzerland. Legal entities would therefore no longer be affected by the WHT in this respect. The idea is that the keeping of accounts in compliance with the accounting provisions by the legal entity in question provides the Confederation with sufficient guarantees against possible fraud. Therefore, the guarantee function of the WHT is no longer necessary.
Furthermore, the WHT would no longer be due for foreign natural persons holding assets with banks. This is a logical consequence of the recent legislation on automatic exchange of information (hereinafter : "AEOI”). The Confederation taxed benefits received from Swiss sources by foreign individuals in order to avoid tax evasion. Thanks to the AEOI, Switzerland now has this information. Therefore, as for legal entities, the guarantee function of the WHT is no longer necessary.
Collateral effect : Start-ups
The regulation proposed in this referendum has advantages in a broad sense. Indeed, the definition of obligations is much broader in the sense of tax law than in the sense of capital markets law.
The notion of obligation depends on various additional factors that currently subject certain companies, including start-ups, to WHT :
- Definition of a cash bond: a company borrows from 20 creditors, against an acknowledgement of debt (IOU) on variable terms, an amount exceeding CHF 500,000.
- Definition of the loan obligation: a company borrows from 10 creditors, against acknowledgement of debt (IOU) on similar terms, an amount exceeding CHF 500,000.
As soon as these conditions are met, a company no longer borrows capital but issues bonds in the sense of tax law.
Currently, many start-ups are issued bonds without intending to do so and are therefore, according to their own financing plan, subject to WHT when paying interest to lenders. As these lenders/investors are not necessarily domiciled in Switzerland, the perception of AI may have negative consequences for the attractiveness of Swiss start-ups abroad.
The interesting collateral effect of this new proposed law is that these start-ups would fall outside the scope of WHT. The reform would greatly simplify fundraising for them.
Transitional provision
If accepted, the law would come into force on 1st of January 2023 or 2024. In any case, bonds issued in Switzerland before the entry into force of the reform, but whose interest matures thereafter, will not be subject to the WHT.
