Podcast

Economic Substance –The Reality and Practical Issues in Switzerland

17 February 2021

IQ-EQ is pleased to share a recording of the second webinar in our new global series that aims to shed light on the reality and practical issues of economic substance in all key investment hubs. 

For this second session, which focused on Switzerland, we were joined by two expert panellists: Olivier Cavadini, Partner at Charles Russell Speechlys SA, and Janet Palmiero, Associate Director at IQ-EQ Switzerland. Serge Richard, Managing Director of IQ-EQ Switzerland, moderated the panel and Q&A session.

During the webinar, Olivier Cavadini provided an overview of the substance requirements in Switzerland, while Janet Palmiero shared her insights and best practice case studies to help companies ensure their local entities achieve compliance.

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Transcript

Spoken content

Pascal:

Good afternoon, everyone. And welcome to this IQ-EQ webinar, which would focus on economic substance in Switzerland. My name is Pascal Rapallino, Group Investment Structuring Leader at IQ-EQ. To briefly introduce IQ-EQ, as you may know, we are an investor services firm employing a global workforce of over 3,500 people located in 23 jurisdictions with assets under administration exceeding 500 billion USD. 

We are pleased to be hosting this second webinar as part of a global series with the objective of bringing some light on the reality on particular issues on economic substance, in all key investment hubs, of course, including Switzerland. To provide a broader context to today's discussion, the economic substance agenda is one which we have become increasingly familiar driven from the highest level of international cooperation at the level of OECD, including the BEPS action plan, ATAD I and ATAD II for the European countries. Against this backdrop, Switzerland has recognized the importance of ensuring economic substance and has been taking a number of steps, which we'll explore in today's webinar. As a brief introduction to these recent developments in the economic substance landscape of Switzerland the implementation of the corporate tax reform, which became effective on January 1st, 2020, has seen the jurisdiction abolish its tax privileged regime.

In particular, the holding company, the mixed company, the principal company and the finance/branch regime, all of which had been considered harmful by the OECD. On this positive note, it's a pleasure to hand over to Serge, to discuss how these historical regimes are being replaced with new and internationally accepted structures., among other aspects of the key measures shaping economic substance into that. That's it for me. And I will pass the baton to Serge.


Serge:

Thank you for this introduction Pascal. It is a great pleasure to be here with you today and to share my insights with the audience on how Switzerland is moving to ensure compliance with globally accepted economic substance requirements. As Pascal briefly mentioned, Switzerland recently reformed its corporate tax system to bring it in line with OECD and EU requirements. It was in 2018 that the Swiss parliament adopted the Tax Reform Act, which was accepted by Swiss voters in a referendum held on 19 May 2019. The Tax Reform Act then entered into force on 1st of January 2020, which is just over a year ago. Most importantly, in response to the Tax Reform Act, many Swiss companies, as well as foreign companies with a Swiss presence, are in the process of reorganizing and restructuring to ensure maximum tax efficiency. As you know, at IQ-EQ, we are very much committed to playing our part in helping companies to meet their current and future substance requirements.

For example, through setting up and administering a Swiss payroll or seconding employees to your Swiss company in line with the company's specific profiles and needs. If you look at the picture in a wider context in the light of this pandemic, we are currently facing travel restrictions, it would also be interesting to consider whether there might be some negative impact on the ability of companies to demonstrate the economic substance as they would normally do in a business as usual scenario. And we might think about how these can be dealt with as the key element of meeting substance requirements on the ground and translating theory into practice. We will surely be looking into some of these issues in greater depth today together with Olivier Cavadini, Partner at Charles Russell Speechlys, and Janet Palmiero, Associate Director, my dear colleague at IQ-EQ, which are looking at the latest updates affecting economic substance and who will be sharing the best practices to ensure economic substance compliance. 

Finally, in terms of housekeeping, the webinar will last for 55 minutes, which includes 15 minutes at the end for a live Q&A session. And if you have any questions during the presentation, please type into the question box in your control panel on your right. And I'd be very happy to raise them at the same point in time. We would also like to assure you that we will definitely have a dedicated slot of time for questions at the end of the webinar, and we will now be happy to get started.

Olivier:

Thank you Serge for the introduction. As mentioned by Serge, I'm going to present to you the situation in Switzerland for the substance requirements. Just as a small introduction, I'm a partner of Charles Russell Speechlys in Switzerland. I'm responsible for the corporate and commercial section here and I'm very pleased to have accepted the invitation of IQ-EQ today. So, I'll start with a general consideration. So, first of all, in Switzerland and unlike in many jurisdictions, there's not really a definition of, substance, whether it is under Swiss private law or tax law. Now you will most frequently find it in a tax environment, where the term substance is frequently encountered and is usually connected with the terms operationally justified or caused by operation, domicile, right of use, etc. And the interpretation of the content will depend on the sector or the industry of the concerned company.

It can be financial, real estate, digital economy, or a lot of other activities as well. And when you consider substance, or when Swiss tax authorities consider substance, the industry specific considerations are of fundamental importance to do that analysis. And the relative nature of the concept of substance also makes it clear that the substance-based approach for the purposes of tax law can also be associated with a significant potential of conflict. At an international level, classification conflicts are more or less inevitable, not only because of the concern that the jurisdiction might have, or will have, different interpretation of same concept. There's also because - these jurisdictions will try to attract the taxes of that company in their own jurisdiction to receive the taxes. So, you will find the term substance or the consideration around the term substance in mainly two different scenarios. The first one here is the incorporation of a new Swiss company.

When we are contacted by a client who asks us to assist them with the incorporation of companies, they frequently asked ‘what's the best jurisdiction to incorporate a company’. And of course, there are various usual suspects like Luxembourg, Malta or Switzerland, and what we recommend the clients is, first of all, to create substance. And also, not to decide merely on tax considerations or only on tax considerations. Of course, Switzerland has a good reputation. It has a stable economy and it has some interesting tax regimes, but what we tell the client is not to choose the jurisdiction just for tax purposes. So, in this discussion that we have with clients, we explained to them that substance is important. In Switzerland, just like in other jurisdictions, it is defined as office or own premises, staff, or effective business activity.

And you also have to consider the distinction between a domestic analysis within Switzerland and the international analysis. From a purely domestic point of view, and that is for the Swiss corporate tax income, a company has its tax residency in Switzerland, if it either has its statutory seat or its effective place of management. This applies both at the cantonal level and federal level and, due to the alternate criteria pertaining to the statutory seat or effective piece of management Switzerland does not really have domestic substance requirements in order to treat the company as incorporated in a certain control rather than another. And in most cases, that is really unlike the other jurisdictions. The tax authorities will consider that the statutory seat is more important than the effective place of management. Therefore, for instance, if some of the employees or many employees, even with key positions, do not work at the place of location of the concerned company, but for instance, from their home, that will not jeopardize the tax residency of that company being the registered office.

And of course, there has been some discussion about COVID-19, where a lot of employees have to work from home. Their home is not necessarily in the same canton as where the company is but that does not jeopardize at all the tax residency of that company. Now, in an international context, Switzerland has a slightly more nuanced approach when it comes to consider the substance of a company. Unlike many European jurisdictions, which emphasize the location where the board meeting has to take place, Switzerland would rather follow an approach of looking at the day-to-day operation, and the management of the company. The place for effective management of a company is viewed as to where the decision and the functions take place for the day-to-day operation and how they are performed, rather than where the board meetings take place. Of course, when you have hesitation or where you have companies with low substance, the question as to where the board meetings are taking place will become more important. Now, moving on to the second scenario, so where you really have to consider substance since where you have a Swiss subsidiary owned by foreign companies, and that discussion takes place when it comes to Swiss withholding tax. As a principle, payments from Swiss subsidiaries to international holdings are subject to a Swiss withholding tax of 35%. Now a specific double tax treaty, or even the EU directive under specific conditions will allow the partial or even the total refund of the withholding tax.

During the refund process, that's where the Swiss tax authorities, and the one that is competent here is the Swiss federal tax authority, will check whether there is enough substance at the place of the international holding before allowing the possible withholding tax reduction or the total refund, which I've just mentioned. Switzerland does not apply substance requirements for domestic corporate taxpayers, but it does apply these substance requirements in order to assess whether a company is entitled to have that possibility to recover parts of all of that withholding tax. When it comes to the EU countries, it's the article 15 of the agreement between the European community and the Swiss Confederation. And that EU directive provides for a 0% rate on dividends for Swiss participation, so, a total refund of the withholding tax to the EU parent company. And that is subject to two conditions. The first one being that the participation is of at least 25% in the Swiss subsidiary and that the parent company owns that Swiss subsidiary for at least, or has owned that Swiss subsidiary for at least, two years.

So, what are the elements that tax authorities consider when they are doing data analysis? There’s no definition to determine whether you have enough substance or not. So, you have to refer to case law. And there are a few court cases in the last few years that have allowed to identify the elements that are necessary to define the substance requirements. And there are mainly three sets of categories, when it comes to that substance analysis. The first one is the infrastructure substance and the tax authorities will determine if there is enough substance, if there are not enough employees for the place where the parent company is, enough infrastructure to fulfill the purpose of the company. And for this exercise, they may request financial statements, bank statements, salary slips.

You can copy invoices of fax or telephones or internet and the rent expenses, if you want to prove that the company has premises in the concerned EU jurisdiction. And it is very important to have qualified staff onsite where the parent company is, because that's really the key element for the tax authorities to consider whether there's substance or not. Of course, this does not apply to holding companies because holding companies are not required to have any employees due to the nature of the purpose of their activities. But rather they will look at the functional substance, which also applies for the other operational companies, not only for the holding, but for holding companies, functional substance will be the most important element. And what we mean by functional substance is whether the company has sufficient resources to have their activities or how they are organized and whether it is justified or not.

And when you are considering a holding kind of company, the Swiss authorities will consider it very important that that holding company does not have only one participation in one Swiss company, but have many participations in many companies. And the third element which is analysed by the Swiss tax authorities is the financial substance of that Swiss subsidiary with the parent company. So, holding companies have to have a balanced financing structure and, in the view of the Swiss tax authorities, the book value of the subsidiary’s assets must at least be 30% equity financed. With BEPS, we are witnessing a period of change in the tax world and transparency and substance are really the key words. It is therefore really recommended, it is advisable to review the current structure that one might have and build a new, more sophisticated structure to make sure that you comply with this substance requirements.

So now I'm going to move on with some more examples and Janet will talk about some real life cases that IQ-EQ has faced. I'm just going to go through two very simple examples to show how this works in Switzerland. So here you have a Swiss subsidiary, which is owned by a hundred percent by the holding company in Luxembourg, which is ultimately owned by a French resident individual. So, the principle is that if the Swiss company distributes a dividend to the holding company, this is subject to a 35% of withholding tax. Now, if you apply the double tax treaty between Switzerland and Luxembourg, the applicable rates have to be, or should be, 0% under some certain specific conditions. Now, if the Swiss federal tax authorities determined that the holding company does not have any substance, the double tax treaty treatment will not be applicable. And there you can see that the functional substance is lacking in some way because the holding company has only one asset, which is the participation in a Swiss company.

Now, in the present case with this very simple structure, you can see that the holding company will not meet the substance requirements, as they are applied by the Swiss tax authorities, because the holding company will only have one participation which is the one in the Swiss subsidiary and not enough of any other participation. So, they will apply the look through principle and consider that the holding co does not exist. And that the dividend is paid to Mr. X, the French resident individual. And there, you will have to determine how to apply the double tax treaty between Switzerland and France. And in this case, the double tax treaty between Switzerland and France will allow Mr. X to recover part of the withholding tax, in this case 20% and the remaining withholding tax that will not be reimbursed or refunded will be 15%. I move on to another example, which is the other way where the individual is based in Switzerland, the Swiss resident.

So, Mr. X has, in this case, a BVI holding co whose only assets are a jet and some cash in a bank account, and Mr. X, in his tax return declares the shares of the holding for the wealth tax purposes. The tax authorities will likely consider that there is no substance in the holding co and they will apply the look through principle and, Mr. X will be taxed in Switzerland on the assets directly owned by the holding co, so on the jet and the cash, and Mr. X will be considered to have to declare in his tax return, this jet and, the cash held by the BVI company.

I'm going to finish with a recommendation. So, in the two scenarios when you're incorporating a NewCo in Switzerland, bear in mind the need to give substance to the company, again, this is premises, the staff business activity, accounting tax providers in Switzerland. You usually find this types of questions about the local resident director that is required in Switzerland. And what we recommend is not only to have a resident director in Switzerland in general, but really in the canton where the company will have its statutory seats. When you talk about the Swiss Co owned by international holdings, you have to be careful and check that the holding co abroad, be it in the European Union or elsewhere, means the substance requirement in particular, if you want to recover part or all of the withholding tax applied on any dividend which is distributed by the Swiss company. And for those Swiss tax residents that hold offshore companies, they have to be aware that they may be taxed on the assets of that offshore company. So that does not really change much in terms of wealth taxes, but when it comes to income taxes that can sometimes create bad surprises. So, whenever you are considering having these kinds of structures, make sure there's enough substance in these BVIs or elsewhere offshore companies. So that's all for as far as I'm concerned, and I'm going to pass the floor to Janet, who's going to present some case studies that she faced in her work. Thank you.

 

Janet:

Thanks Olivier. And hello everyone, again, many thanks for taking the time today. My name is Janet, I'm based in Zurich, and I head the IQ-EQ corporate service offering in Switzerland. Well, as Olivier mentioned, there is as yet no definition of substance in Swiss law, its presence is increasingly a requirement from both a local and a global business perspective. This is shown by precedent set in various cases as noted by Olivier and by international developments. It is therefore important to anticipate the future direction that the Swiss authorities will take when developing laws surrounding economic substance. IQ-EQ is in a position to provide all the services that are necessary to support this compliance. Two case studies illustrate best how this is achieved.

The first structure contains Swiss holding companies with central Asian underlying’s. Management and control has to remain in Switzerland. And to this end, we provide domiciliation for the Swiss holding companies, furnished office facilities, including signage, telephone lines, and importantly, a server located in Switzerland, a Swiss resident director as the sole board member and an IQ-EQ employee on a split payroll. We provide payroll services for all the other employees, and we have one hundred percent control of all the bank accounts. We prepare all the accounting and group reporting packs and prepare and submit all statutory returns. We liaise with the tax advisors and prepare and submit value added tax returns and corporate tax returns. The second case study is a trading structure where the European subsidiary of a US listed company has incorporated an entity in Switzerland. The Swiss company holds the license rights to sports events and TV sales.

In this case, IQ-EQ provides registered office services and actual office facilities complete with signage and a dedicated and manned phone line. An IQ-EQ employee with a split percentage employment contract is employed to be a single point of contact for all administrative queries from the global group. We prepare monthly accounting and reporting packs in both local and US GAAR and report to the European financial controller. We attend board meetings, take the minutes and provide assistance to the payroll service provider. We liaise with all regulatory and tax authorities.  

As has been illustrated in the two case studies above, substance is the degree to which companies have economic nexus in a country. The more local infrastructure, transactions, reporting and legal presence that a company has the greater its economic substance. Over the years, IQ-EQ has developed a set of services to support our clients to be compliant with economic substance requirements. We can help you meet all necessary operational elements, including, but not limited to, registered office services, the provision of Swiss resident directors, provision of office space, all accounting and reporting, treasury oversight, corporate secretarial and human resource and payroll services. It has been a pleasure sharing my insights with you today, and we would be happy now to take any questions you may have.

 

Serge:

So, we have a series of questions. I think we will start with one for Janet. Does a Swiss company need to have a Swiss bank account?

 

Janet:

No. The short answer is no, there is no requirement for a Swiss registered company to have a Swiss bank account with a bank residence in Switzerland.

 

Serge: 

Thank you, Janet.Second one. Is it necessary for the Swiss resident director to be based in the Canton in which the business has its registered office, maybe one for you Olivier? 

 

Olivier:

Well it is, I would say the short answer would be its better. Is it required? I wouldn't say so. But it is often recommended that you have the same location, so where the director is located should be the same place as the company.  Generally, the tax authorities will pay attention to that, not so much because it's at a domestic level, but, it might be an argument for the foreign jurisdiction to say, look, this is a completely abusive structure because the director is not in the same place as the company. Now from a domestic perspective, let's say that the tax authorities will kind of accept or tolerate that the director is domiciled in Vals for a Geneva based company or in Zug for a Zurich based company. But again, it's recommended to have at least a very close location or that the domicile of the director should be very close to the company’s because that's for today, but we know also that in the future, the tendency will be stricter and stricter. So, you also have to provide for the future.

 

Serge:

So there is still a bit of flexibility. A third question, even though economic substance is a requirement, what are the tax advantages to having economic substance in Switzerland? Probably one for Olivier as well.

 

Olivier:

Well I would say it's mainly to give ammunition to the Swiss authorities or to the company itself, when you have a scenario or a structure where, for instance, with France or with Germany, the border countries, and France would be very aggressive saying the structure in Switzerland is abusive, and it should be taxed and the company should be taxed in France. Then the fact that there is the economic substance in Switzerland will provide an argument to dispute that assessment by the French authorities, for instance.

 

Serge: 

Another question, are there different tax regimes in different cantons? I think Olivier you can enlighten us on this one.

 

Olivier:

I mentioned that there are favorable tax regimes before in my presentation, but rather than regimes, it's more different tax rates. I mean, for regimes as you mentioned, and I think Pascal also mentioned, there's no more the status holding or the various regimes that Switzerland had before. So it's more one regime for everybody in Switzerland or every company in Switzerland but with various tax rates and that's where you have the difference between Zurich, Geneva and for the main attractive cantons.

 

Serge: 

Okay. That's interesting. So, it's uniformity without uniformity. Then I think a last one, maybe for Janet actually, does a Swiss company need to have a Swiss resident director and what does resident mean?

 

Janet: 

Yes. A Swiss company is required to have a Swiss resident director and residence is based on the Von Sits, which is the actual residence given to an individual by the Canton, and that comes either as, of course, as a Swiss national or as a foreign national that you're required to apply for a Swiss residence permit

 

Olivier

To add to that Serge, it can be the director and it can also be an executive officer. So, a director, not necessarily a member of the board of directors, just to complete what Janet said. And if you want to avoid giving the single signatory power to the director, you can give the joint signatory power to the Swiss resident director.

 

Serge:

Okay, thanks for this precision. I have one for you Olivier, in the case study, was the Swiss Co paying up to the Lux HoldCo? Are there any material substance benefits from the Lux Co, having an employee given the nature of it being a hold co?

 

Olivier:

Let's say it's an additional argument that might help you to recover part of the withholding tax. Will it be sufficient to convince the authorities in Switzerland? Well, I am not so sure, but it's basically an analysis on a case by case basis by the tax authorities. The more you give substance to the Lux co, and one employee is of course enough, if you consider that it is a holding, but on the other hand, if you have, let's say one employee, but just one subsidiary, which was the case of my example, I mentioned that there it is more like the functional substance, so Swiss authorities will look at the structure and they'll see that that the Lux hold co is called hold co, but it only has one participation. So, I think more important than having one employee is to give more participation to the Lux co give it more substance.

 

Serge:

Ok. Thank you very much. There's no further question at this stage. Well, I think that's it then. Thank you very much, everyone for attending this webinar, it was a pleasure to be here with you. I hope you enjoyed it. And we hope we see you soon, one way or the other. Thank you very much. Cheers. Thank you.