If you are a swiss resident and privately own a company, you probably know its sale will generate a tax-free capital gain. Yet, you may have structured your investments through a holding company as it has the benefit to avoid double taxation of the dividends at the shareholder’s level and allow the reinvestment of these dividends in other projects without any tax impact.
However, if the holding company were to sell one of its investments, the shareholder would have no choice but to proceed to a dividend distribution to get the sale proceeds. This distribution would then trigger income tax for the owner. Thus, some are tempted to split the holding company right before the investment sale, specifically to benefit from this capital gain exemption.
Nevertheless, such demerger operation gets along with major tax issues as numerous consequences may result for both the shareholders and the company.
Taxation of the company
During a demerger, the risk for a company is that its hidden reserves (difference between the market value of an asset and its book value), as well as its other distributable reserves will be taxed as profit upon transfer. Therefore, in order to carry out such restructuring without any tax consequences, the following cumulative conditions should be met:
- The acquiring company must be a swiss tax subject
- The transfer of element from a company to the other must be done at their last value relevant for income tax, i.e. at book value, except hidden reserves.
- The transfer must concern one or more business unit, or part of a business unit. However, a business unit will be admitted only if the company provides services to third parties or to affiliated entities, and is staffed at a cost consistent level compared with practices on the market.
- Furthermore, the entity or entities resulting from the demerger are compelled to pursue the business or part of the business transferred.
These last two criteria constitute a double business requirement, which is of importance as anti-abuse rule regarding demergers. Indeed, without this condition, a company could, by means of such a restructuring, dispose of assets that do not form a business unit as defined above (such as a simple real estate for example). Hence, this company could subsequently generate a tax-free capital gain through a sale, even though this should have been subject to income tax for the company in the first place. This double business requirement was originally introduced to replace a 5-year lock-up period that compelled the shareholders not to sell their shares within 5 years following the demerger.
Consequently, if the conditions set out above are met, the restructuring will be tax neutral.
Special conditions for holding companies
Regarding the holding companies, the situation is a bit more complex. Indeed, the double business requirement cannot be met due to the nature of holding company activities. Thus, to carry out a tax-neutral restructuring, special conditions have been introduced for holding companies.
Therefore, the transferred shares will have to be predominantly from active companies. Also, these shares will have to constitute at least 20% of the share capital of the other companies, alternatively allow a decisive influence on these same companies (through a shareholders' agreement for example). Furthermore, the holding companies resulting from the demerger will have to operate a holding activity by means of their own or mandated personnel and will be obliged to pursue their activity after the restructuring. Finally, according to the Federal Supreme Court (2C_34/2018 para. 4.6), the tax neutrality of a demerger remains, regardless of whether the transfer involves one or more participations.
Taxation of the shareholder
Regarding the shareholder, he is generally taxed on any profit distribution in his favour, whether or not it is a deemed or effective distribution. Indeed, in practice, when an advantage is granted to the shareholder or to one of his relatives, while it would not be granted to a third party in the same circumstances, a deemed distribution of profits exists and is subject to income or withholding tax. However, the capital gain that the shareholder could realize following a sale of shares is tax-free.
As a result of the demerger, the shareholder may be granted new entity's participation rights. Therefore, in order to avoid such taxation, the practice, as confirmed by the Federal Court (2C_34/2018 para. 5.3), states that the tax neutrality of a demerger, and more broadly of a restructuring, implies also tax neutrality at the shareholder level. Therefore, if all the conditions for a tax-neutral demerger are met at the corporate level, the shareholder will not be taxed on the related benefits obtained.
In practice, this leads to eliminating any subjective concept of abuse during a demerger. Provided that the conditions for tax-neutral restructuring are complied with, amongst which the demerger of an active company, as well as the percentage of shareholdings for holding companies, no abuse can be asserted. It is therefore conceivable to operate a sale transaction with the aim of realising an exempted capital gain immediately after such a demerger. However, despite the abolition of the lock-up period prohibiting any sales of shareholdings during the five years period following a demerger, some cantons, such as the Canton of Vaud, upheld this practice at the level of the shareholder’s taxation. Thus, if such a sale occurred within five years following the restructuring, the tax neutrality of the demerger remained unquestioned at company level. However, the Canton reserved the right to tax the hidden reserves existing at the time of the demerger at the shareholder’s level. Such a practice should henceforth disappear considering the Federal Court's decision. One should remain careful though, to the type of the foreseen demerger and the canton of location.
RSM at your service
To prevent any undesirable tax consequences regarding corporate restructurings, we recommend the preparation of rulings prior to the implementation of your project. Such rulings allow to obtain confirmation of the applicable tax treatment by the tax authorities. We are at your entire disposal to guide you further in this process and will be pleased to carry out any communication and request to the tax authorities. RSM can help you identify the tax risks related to your project as well as to define and implement the most optimal structure.
If you would like us to assist you regarding the numerous tax measures related to corporate restructuring, please do not hesitate to contact us at the following addresses: [email protected] (French/English) or [email protected] (German/English)
M. Daniel Spitz, Certified tax expert, Head of tax Switzerland.