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1. Introduction

Switzerland

Branch Reporter Oliver Untersander*

This report will describe new tendencies in cross-border debt financing from a Swiss point of view, particularly focusing on effective interest taxation. To do this, first, the status quo will be described, including rules currently applicable in international cross-border debt financing and their respective limitations/restric- tions. This allows, secondly, demonstration of emerging trends and/or new meas- ures taken by the authorities or legislature ascertaining effective taxation of cross-border interest. As will be seen, no specific anti-avoidance or specific anti-tax arbitrage meas- ures are currently in force, nor are such measures planned for this field. This sharply contrasts with the situation for individuals. As of 1 July 2005, the agree- ment on interest savings between Switzerland and the EU is in effect forcing Swiss custodians, mainly banks, holding bonds on behalf of individuals resident in the EU to withhold taxes on interest they collect on their behalf. This is a highly effective measure against tax avoidance. However, even though similar measures do not exist for corporations, the general rules applicable in the inter- national setting nevertheless prevent corporations from gaining tax benefits through excessive debt financing.

2. Key tax principles in Switzerland

In Swiss tax law, interest payments are considered ordinary business expenses. No definition of deductible interest expenses is provided by the tax laws or regu- lations. Where characterization/determination of an item of expense is neces- sary, particularly in a cross-border situation, Swiss tax laws solely refer to statutory book-keeping and domestic corporate law rules without taking into account how the payment is treated in the foreign jurisdiction of the lender (bal- ance-sheet approach). Nor does the characterization for domestic tax purposes change where a treaty defining interest differently applies. Thus, under Swiss tax law, characterization of interest expenses and the respective tax consequences (i.e. granting a deduction) fully follow a “capital import neutrality” approach. Deduction is allowed even if there is no inclusion, only deferred inclusion (tim- ing mismatch), or any other beneficial treatment (e.g. as dividend) in the foreign jurisdiction.

* Dr. iur., LL.M. (International Taxation, NYU), tax lawyer, Tappolet & Partner, Zurich

IFA © 2008

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There are no specific rules targeted at limiting or reducing deductible interest expenses. Also, no specific anti-avoidance rules exist and nor is there a (strict) administrative practice combating tax avoidance schemes involving (any kind of) debt financing. The first set of general “restriction” rules is the general alloca- tion rules with respect to tax-exempt income. Where an item of income is tax exempt under Swiss law, attributable expenses (including interest) must be alloc- ated. This allocation occurs essentially in two cases: first, where a corporation has a permanent establishment or real estate abroad, the allocable interest expenses are not deductible from the Swiss tax base (exemption method in inter- national settings). Additionally, dividends and capital gains from substantial par- ticipations (domestic and foreign corporations) are also (unconditionally) tax exempt, and foreign source income of auxiliary companies is taxed at privileged rates. These situations, too, require respective interest allocation. The second set of “restrictions” consists of those rules applicable in related party settings. From a borrower’s perspective, this means that interest rates on loans between related parties must be at arm’s length, whereas tax authorities provide for safe harbour rules (maximum rates). Additionally, taxpayers must comply with thin capitaliza- tion rules, for which safe harbour rules also exist. From a Swiss borrower’s view, the distinction between deductible interest expense and a non-deductible dividend is quite clear. Since tax rules refer to statutory book-keeping and corporate law rules, payments for loans of any kind are also recognized as deductible interest expenses for tax purposes, even if the loan has elements of equity financing. Thus, interest on subordinated, profit par- ticipating, and convertible loans is deductible (although the restrictions for inter- est on loans in a related party setting will apply). With respect to withholding taxes, Switzerland levies such a tax on (gross) interest only on interest paid for publicly issued bonds and similar debt instru- ments, on interest on bank deposits, and on interest for loans secured by a real estate located in Switzerland. On interest on “ordinary” loans, there is no with- holding tax due. Most treaties concluded by Switzerland follow the OECD model and split the taxing rights between the jurisdictions involved. Some allocate the taxing right solely to the residence state. Also, as opposed to the OECD model, some treaties state that for qualification purposes the source country’s tax rules are relevant. A few treaties contain a list of examples absent from the OECD model. Finally, as of 1 July 2005, Switzerland has had access to the EU Directive on Interest and Royalties allocating the exclusive taxing right for interest paid between related parties to the resident state, meaning that the source state must waive its taxing right (withholding tax) if withholding taxes could be levied based on the source state’s domestic tax laws. From a lender’s perspective interest income is ordinarily taxable income. As to effective interest taxation, the main “restrictions” here are the general rules applicable in related party settings, particularly with respect to minimum rates for which the federal tax authority yearly issues safe harbour rules. Also, due to the general rules against treaty abuse and due to the general rules governing the foreign tax credit system, credit for foreign tax withheld on interest can be denied or limited. Finally, interest income does not benefit from the participation exemption system, which defines the term dividend narrowly (in distinguishing it from interest income). On the other hand, Switzerland actually provides measures

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to shift interest income from high-tax countries to low-tax jurisdictions due to privileged tax regimes (holding and auxiliary companies) provided by Swiss tax laws. Additionally, the participation exemption applies unconditionally to divi- dends from substantial shareholdings in domestic and foreign corporations (an essential ingredient to set up finance corporation structures). In sum, effective taxation of interest income for Switzerland is mainly accom- plished by the general rules applicable in related party settings and the general rules against treaty abuse. Along with the fact that there is no withholding tax on interest, Switzerland is a suitable borrower country for hybrid instruments, since tax deductions are mostly granted regardless of the treatment in the foreign juris- diction. On the lender side, the rules are slightly less “relaxed”, and it even seems that interest taxation will become even more effective in the future because the preferential tax regimes for certain companies are under massive attack by the EU. No other reforms are being undertaken nor are any changes in legislation planned.

3. Deduction of interest expense with the borrower

3.1. Definition of deductible interest expense

3.1.1. Qualification in domestic tax laws

For the taxation of corporations, 1 Swiss tax law follows the so-called balance- sheet approach, i.e. tax accounting follows the statutory commercial accounting rules unless otherwise stated by an explicit tax provision. The implementation of this approach is mainly the reason that neither tax laws nor regulations nor any circulars by the tax authorities provide a description or definition of what con- stitutes (deductible) interest expenses. Case law, on the other hand, defines inter- est as “remuneration for providing funds”. However, this definition is too general to be of any help to resolve issues that can arise with respect to interest and its treatment in Swiss corporate tax laws. 2

1 Generally, all legal entities incorporated under Swiss laws are subject to corporate income tax. This includes stock companies (Aktiengesellschaft (AG)), companies limited by shares (Gesell- schaft mit beschränkter Haftung (GmbH)), stock companies with a partner with unlimited lia- bility (Kommanditaktiengesellschaft (KAG)), and cooperatives (Genossenschaft). Associations (Verein), foundations (Stiftung) and all other remaining legal entities incorporated under domes- tic law are also subject to corporate income tax whereas the rules are slightly different from those that apply to companies and cooperatives, particularly with respect to tax rates. This report only focuses on the tax rules for companies and cooperatives.

2 At the federal level, corporate income taxation is mainly governed by arts. 49–82 of the Fed- eral Act on Direct Income Tax from 14 December 1990 (FADIT; Bundesgesetz über die direkte Bundessteuer (German abbreviation: DBG)). There is also the Federal Harmonization Tax Act from 14 December 1990 (FHTA; Bundesgesetz über die Harmonisierung der direkten Steuern der Kantone und Gemeinden (German abbreviation: StHG)) setting forth, among other things, the rules to be adhered to by the cantonal legislatures in determining taxable income. Due to this Act, the federal and cantonal rules with respect to the tax base of corporations are harmonized and, with few exceptions, identical (tax rates are still within the authorities

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From a domestic borrower’s view, the distinction between deductible interest and non-deductible dividends is quite clear. The character of an “outflow” (inter- est, dividend, repayment of funds) is answered under Swiss tax law by referring to statutory accounting principles and corporate law due to the balance-sheet approach. More specifically, characterization takes place by solely referring to the afore-mentioned rules regardless of what law is applicable to the loan agree- ment or what the tax treatment in the lender country is. Thus, payments are rec- ognized as deductible interest expenses if for statutory accounting reasons the loan is to be treated as debt and the interest thereon as expenses.

3.1.2. Examples

Profit participation loans and the interest thereon are recognized as debts or deductible interest, respectively, even if the interest payments are contingent on profits earned by the borrower. Interest on convertible loans is also deductible, as long as the loan has not been transferred into equity. Subordinated loans keep their character as debt-financing regardless of who lends them (related/non- related party) and under what conditions. As to hybrid instruments in general, statutory book-keeping rules always make clear whether a payment is a dividend or interest. Hybrid instruments are debt for tax purposes if treated as loans/inter- est for book-keeping purposes, even though such loans may have elements of equity in terms of risk and the like. Finally, if interest is paid not in cash but in kind, it is nevertheless deductible.

3.1.3. Tax treaties

Most tax treaties concluded by Switzerland follow the OECD model and thus enumerate different kinds of interest payments without providing a general def- inition. 3 In addition, some treaties expressly state that payments are considered interest if they are equated to interest by the tax laws of the source country. 4 To be emphasized is the treaty with Germany setting forth that – contrary to Swiss domestic tax law – interest for profit participating loans is considered a dividend distribution; 5 however, based on this provision, deduction for a domes- tic borrower cannot be denied since it is established practice in Switzerland that treaty provisions only allocate the taxing rights among the jurisdictions involved (negative effect of treaties). Thus, it is not considered a valid legal basis on which to deny the deduction.

cont.

of the cantons). In this report, references to legal provisions are only made to those of the Fed- eral Income Tax Act (FADIT) and the Harmonization Tax Act (FHTA). If cantonal provisions/rules are different it will be indicated.

3 All that is said in the OECD model is that the term interest means “income from debt-claims of any kind” (art. 10, al. 3).

4 E.g. art. 11 al. 2 treaty with Germany, art. 11 al. 3; treaty with Italy, art. 11 al. 2; treaty with Ire- land.

5 Art. 10 al. 4 last sentence treaty with Germany.

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3.2. Limitations of deductible interest expense

3.2.1. Identity of the borrower/lender, specific contractual terms

Under Swiss tax law, interest is considered an ordinary business expense. There are no restrictions on interest expenses based on the identity of the borrower: the borrowing corporation may be foreign owned, a private equity corporation, or a non-resident corporation. If the borrower has a privileged tax status (e.g. dom- iciliary/auxiliary company) the allocation rules explained below apply. Also, there are no restrictions for deductibility of interest expenses based on the ident- ity of the lender (foreign/domestic lender, lender in an offshore or low-tax juris- diction; for related parties see below). As to finance corporations, the only particularity consists of different rules with respect to thin capitalization (defini- tion of deemed equity). In a third party transaction, the tax authorities cannot deny interest deductions based on the contractual terms of the loan (e.g. if the loan has elements of equity financing such as subordination). If it is treated as debt by statutory book-keep- ing and corporate law, deductions are granted. The only means to challenge such interest would be by arguing there is a so-called Steuerumgehung (fraus legis). 6 This is also true in a related party setting: if the rates are at arm’s length and the corporation is capitalized appropriately (under the thin capitalization rules), there is generally no legal basis for recharacterization or, more generally, for denying the deduction.

3.2.2. Limitation due to allocation rules in connection with tax- exempt income

There are essentially two sets of rules to be taken into account that can eventually reduce the amount of deductible interest expenses for a borrowing company. The first set of rules consists of the general allocation rules in connection with tax- exempt income. These allocation rules can be categorized into two main groups. The first group consists of the allocation rules of domestic international tax law. Swiss international tax law follows the exemption method almost exclusively. How- ever, only net income is exempted from tax which makes it necessary to allocate generally deductible expenses between taxable and tax-exempt income. Most importantly, such allocation takes place in situations involving foreign perman- ent establishments and foreign real estate (not amounting to a permanent estab- lishment). Dividends from foreign corporations, however, are foreign source income; income from (non-substantial) shares is not tax exempt according to Swiss international tax law.

6 Case law assumes a Steuerumgehung or a fraus legis, respectively, if the transaction is eco- nomically unusual, results in a tax saving, and this tax saving is deliberately planned by the tax- payer (subjective requirement). If these requirements are met, tax authorities can assume those facts to the transaction that are economically appropriate and apply the tax rules accordingly (i.e. as if these facts had actually happened). As to back-to-back-loans, see below section 3.2.4.

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The second group relates to income that is tax exempt for reasons other than domestic international tax law, but controlled by the same logic. Dividends and capital gains from substantial participations in domestic and foreign corporations are exempt from tax (participation exemption); 7 thus, besides other costs, interest expenses have to be attributed to such income. For the allocation rules, see below. Similar rules apply to domiciliary/auxiliary companies for which cantonal legislatures provide a privileged tax regime, particularly with respect to foreign source income. 8 Under these regimes, dividends and capital gains from substan- tial participations are tax free, foreign source income is taxed ordinarily “in accordance to the importance of the domiciliary company” (in practice, often only 10 per cent to 20 per cent of foreign source income is to be included in the Swiss tax base), and Swiss source income is ordinarily taxed. As with the parti- cipation exemption, interest must be allocated between these three categories of income. To summarize: no restrictions apply based on the criterion of whether the funds are used for an active business or passive investments. If funds are invested in a foreign business, limitations of interest expense occur based on the general allocation rules of domestic international tax law (real estate, permanent estab- lishment). Investments in shares of foreign and domestic corporations also reduce the amount of deductible interest expense if they qualify as substantial participation and if the corporation receives dividend/capital gain income from those participations.

3.2.3. Related party settings

The second set of “restriction” rules bear on related party settings. Loans and their conditions have to be at arm’s length, which essentially means that interest rates must meet the “business expense” test. These rules do not distinguish whether the related party is a foreign or a domestic person. If the rates exceed what would have been paid to a third party, the excess amount is not deductible and is treated as a deemed/constructive dividend which triggers federal with- holding tax of 35 per cent. Related parties are parent companies and any other companies within a corporate group. There are no strict rules governing when lending and borrowing corporations are related. This is ultimately determined under all the facts and circumstances. However, case law concerning deemed

7 Technically seen, income from such participation is not tax exempt but the tax is reduced by a fraction the numerator of which is tax-exempt (net) profits and the denominator of which is total profits. Eventually, the result is equivalent to exempting this income. Substantial partici- pations comprise interests in a corporation with a fair market of at least CHF 2 million or inter- ests of more than 20 per cent of the voting stock. As to the tax exemption for capital gains, only gains derived by a sale of an interest of 20 per cent in the voting stock benefit from this regime; see art. 69 FADIT (for full reference see n. 2). This is the system at the federal level; concerning cantonal tax laws, cantonal legislatures are only obliged to exempt dividends from substantial participations from tax; they are free to also extend the participation regime to cap- ital gains (no full harmonization as to capital gains; see art. 28 FHTA (for full reference see n.

2)).

8 See art. 28 al. 3 FHTA (for full reference see n. 2).

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dividends suggests that the (corporate) interest(s) concerned must be so as to allow influence in the companies involved. 9 There are no provisions in the tax law or in regulations giving guidance as to what conditions meet the arm’s length test. The allowable rate is subject to a facts and circumstances test. However, the federal tax authority issues a circular annu- ally 10 in which it fixes the allowable maximum interest rates for loans granted by related parties. The rates for 2007 range from 3 per cent to 5 per cent, depending on what business the funds are used for (operational/active business, loans to purchase real estate). For loans in foreign currencies, the federal tax authority also issues a yearly circular with tables fixing allowable interest rates; those are slightly higher. Technically, both these circulars of allowable maximal rates are safe harbour rules (that is expressly stated in the circular concerning rates on loans in foreign currencies). However, the latter circular also expressly states that tax authorities can nevertheless require that the corporation give evidence that a loan in foreign currency is commercially justified. If the corporation fails to do so, only lower rates for loans in Swiss francs are recognized. For thin capitalization rules, see section 3.3 below.

3.2.4. Other restrictions

For back-to-back loans, the tax consequences seem to be clear even though there is no case law on them. Such transactions are considered a Steuerumgehung (fraus legis) 11 and the loans are treated as loans from a related party with respect to rates (at arm’s length) and thin capitalization rules. If a loan granted by a third party is guaranteed by a related party, the loan and interest nevertheless qualify as debt or deductible interest expense, respectively. 12

3.2.5. Procedural requirements

There are no specific procedural requirements, but tax authorities can require the taxpayer to show proof of interest payments and/or proof of the identity of the

9 See Peter Brühlisauer and Stephan Kuhn, “Kommentar zum schweizerischen Steuerrecht”, I/2a, Bundesgesetz über die direkte Bundessteuer, Basel, 2000, art. 65 fig. 21.

10 Circulars are addressed to the cantonal tax authorities, which, besides their own cantonal income tax, also enforce and collect the federal income tax. Circulars are instructions by the federal tax authority to the cantonal tax authorities as to how apply federal income tax law. In most cases, cantonal authorities apply their own provisions identically.

11 See n. 6.

12 There is a single case from a cantonal tax court holding that a loan granted by a bank and guar- anteed by the main individual shareholder should be treated as a loan from a related party with respect to the application of the thin capitalization rules. However, there is general consensus among scholars that only if the requirements of a Steuerumgehung are met can a loan guaran- teed by a related party be recharacterized as a loan from a related party. Within a corporate group, if a loan granted by a bank is guaranteed by a member of the group, according to some scholars (there is no case law on this point) this loan shall qualify as a loan from a related party if the bank has legally enforceable claims against the guarantor when repayment is outstanding; see Brühlisauer and Kuhn, op. cit., art. 65 figs. 23–25.

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lender. No advance tax procedure exists. However, rulings can be obtained which are similarly legally binding on the authorities.

3.2.6. Tracing/allocation methods

If a corporation has tax-exempt income due to the participation exemption or due to its status as a domiciliary company, interest related to such exempt income is allocated based on the (book) value of the assets, which is economically appro- priate due to the principle “money is fungible”. If income is exempt due to inter- national tax laws (permanent establishment, foreign real estate), the allocation of interest for permanent establishments is eventually based on where the assets are located, estimated at book value or fair market value if the latter reflects the eco- nomic situation of the corporation more appropriately (apportioning overall (third party) interest based on the assets in the countries involved, following the so-called capital mirror theory). 13

3.3. Thin capitalization rules in particular

The legal basis for the Swiss thin capitalization rules is article 65 FADIT 14 stat- ing that interest paid for debts that economically have the character of equity (deemed/constructive equity) are not deductible for corporate income tax pur- poses. All cantonal tax laws have similar provisions. In 1997, the federal tax authorities issued a directive on how it would apply the thin capitalization pro- visions. 15 There are essentially four steps for recharacterizing debt as “deemed” equity. First step: thin capitalization rules only apply if there are debts from related parties. If all debts are granted by third parties, the question of deemed equity cannot arise. 16 The second step consists of hypothetically determining the overall debt that could have been raised by the corporation from third party lenders (hypothetical debt). The directive calculates these hypothetical debts in relation to the assets owned by the corporation (e.g. “debt raising force” of sub- stantial participations: 70 per cent of the fair market value); there is no specific ratio between equity and debt required. For financial corporations (mainly banks), the hypothetical debt is calculated differently; for them, debt must not exceed 6/7ths of their balance sheet (assets also estimated at fair market values). In the third step, all interest bearing debt from third parties is deducted from the hypothetical debt; if the difference is positive, this constitutes the amount of debt that is also recognized for tax purposes if lent by related parties. If loans from related parties exceed this amount, this excess amount is treated as deemed equity, and the interest deduction is denied. If third party debt exceeds

13 See Peter Brühlisauer, The attribution of profits to permanent establishments, branch report for Switzerland, IFA Congress 2006, p. 660; also, interest can be allocated based on auxiliary fac- tors if the permanent establishment is not relatively independent.

14 For full reference see n. 2.

15 Directive by the federal tax authority from 6 June 1997, as to deemed equity; similarly to circu- lars (see n. 10), directives are addressed to the cantonal tax authorities prescribing to them how to apply federal tax law; cantonal tax authorities also follow theses rules when applying their own tax laws.

16 As to who is considered a related party, see section 3.2.3.

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the hypothetical debt, all loans from related parties constitute deemed equity. In the last step, the amount of interest attributable to the deemed equity must be calculated. As mentioned above, interest payments attributable to deemed equity are denied the deduction and recharacterized as (deemed) dividends, triggering fed- eral withholding tax of 35 per cent. Such deemed dividends are also treated as dividends with respect to all (Swiss) tax treaties allowing the lender company to claim a (partial or full) refund of the tax collected by withholding.

3.3.1 Specific questions

As expressly stated by the directive, the rules set forth therein to determine deemed equity are considered “safe harbour” rules. Particularly, as to the simpli- fied calculation of the hypothetical debt that could be raised by a corporation, it remains open to the corporation to show that more debt could have been raised in third party transactions. As to the calculation of interest arising from deemed equity: if the loans from related parties are all at the maximum rates set forth in the yearly issued circular by the federal tax authorities, interest payments are allocated proportionately. Where rates on related party loans are below the maximum rates, it is more com- plicated. The question is whether overall interest paid to related parties is also proportionately to be attributed to the deemed equity or whether it has to be taken into account that rates on the related party loans are below what would be allowed due to the safe harbour rules provided by the federal tax authority. The directive gives the answer to this problem according to the relevant case law:

from all interest paid, that amount is recognized for tax purposes that corres- ponds to the amount that would be allowed as interest on the recognized debts; deduction is denied only for that part of the interest that exceeds this hypothetical interest amount. To summarize the mechanisms of thin capitalization and general “arm’s length” rules and their interrelation: interest on recognized debt is fully deduct- ible if the rates are at arm’s length; if they are above, the difference is recharact- erized as a deemed dividend. Deductions for interest on deemed equity are fully denied, even if the rates are at arm’s length.

3.4. Timing of deduction of interest

Due to the authoritativeness of statutory book-keeping rules for tax accounting, statutory book-keeping rules are also decisive as to when interest can be deducted. These rules, generally speaking, consider an expense to be included in the profit and loss statement when the expense accrues. As for deep discount loans or similar loans where funds granted are below what will be due as repay- ment (and thus, interest is economically the difference between funds granted and the amount of repayment), this difference has to be capitalized at the begin- ning of the loan and amortized proportionately over the duration of the loan, the effect being that interest is annually deductible during the term, and not at the repayment (end of the loan). If a loan agreement provides for annual interest and, instead of paying annually, the interest is added to the loan and to be paid

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simultaneously with repayment of the principal, the interest can nevertheless be deducted when accrued (and not when they are due for payment; such terms are often included in mezzanine financing or venture capital lending). Timing mismatch: there are no provisions or any practice denying deductions if there is no simultaneous inclusion for the lender. Such provisions would sub- stantially be subject to tax provisions with respect to timing, which is unknown in Swiss tax laws.

3.5. Effective taxation of interest income from a borrower’s perspective

With respect to effective taxation of interest income, no specific anti-avoidance rules exist in Swiss legislation nor is there a (strict) administrative practice tar- geting tax avoidance schemes involving (any kind of) debt financing. Also, there are no general provisions or practices aimed at curbing international tax arbit- rage, and no changes in legislation are forthcoming. The only rules targeting effective interest taxation from a borrower’s perspective are the general rules applicable to corporations in related corporation settings, i.e. rates must be at arm’s length and interest on deemed equity is not deductible. Additionally, as will be shown in the next section, there is generally no withholding tax on interest payments, even if paid abroad. Hybrid instruments are a good example for international tax arbitrage. They accomplish deduction of interest in the borrower’s country while avoiding inclu- sion (or otherwise receiving preferential treatment) as dividend in the lender’s country. From a Swiss borrower’s perspective, there are no specific provisions denying the deduction when there is no inclusion in the lender’s country, deferred inclusion (timing mismatch), or otherwise beneficial tax treatment (due to qualifi- cation, e.g. as a dividend). The only means to target such a transaction would be under the fraus legis doctrine. However, in case of hybrid instruments, the trans- action is usually not “artificial”; instead, the transaction complies with the rules of both jurisdictions. Thus, at least in a third party transaction, there are rarely grounds for the authorities to deny the deduction for interest paid with respect to a (hybrid) instrument that qualifies as debt based on domestic tax law. This seems also to be true in a related party transaction: if payments to a related corporation qualify as interest, deductions must be granted as long as no (general) restrictions (rates at arm’s length, thin capitalization rules) apply. How payments are treated in the foreign jurisdiction generally does not matter since Swiss tax laws apply a “purely domestic” view: as long as a payment is to be treated as an expense based on domestic tax laws, deduction is granted whatever the treatment abroad may be. This cannot be changed by a treaty either: e.g. the treaty with Germany states that interest on profit participation loans is considered to be a dividend distribu- tion; 17 however, if a domestic borrower pays such interest, it is nevertheless deductible due to domestic tax laws. It cannot be recharacterized as dividend pur- suant to a treaty provision since it is the general consensus in Switzerland that treaties have only negative or restricting effects: denying the deduction, however,

17 See n. 5.

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would eventually result in increasing the tax base even though there was no legal basis for this in domestic tax law. For further examples see section 6.

4. Withholding tax on cross-border interest income

4.1. General

Generally, there is a federal withholding tax of 35 per cent 18 only on interest on bonds, other similar debt instruments, 19 and on deposits with Swiss banks, whether the lender is foreign or domestic. On interest of “ordinary” loans there is no withholding tax, neither in a domestic nor in an international context. There is one exception: on loans secured by mortgages on immovable property located in Switzerland, at the federal level a withholding tax of 3 per cent of the (gross interest) income 20 applies if paid to non-residents; additionally, cantons also levy a withholding tax at rates ranging from 10 per cent to 30 per cent. Even though public bond financing is not of main interest here, one issue – particularly regarding effective interest taxation – has to be mentioned. If a for- eign subsidiary of a domestic parent company issues bonds with a guarantee by its parent company (or another domestic company of the same corporate group), and if the funds are transferred to Switzerland (i.e. not invested abroad), the par- ent company is treated as if it had issued the bonds by itself triggering federal withholding tax of 35 per cent on the interest on the bonds. Thus, loans between corporations of the same group can trigger withholding tax if they are refinanced by public debt instruments that would be subject to withholding tax if they had been issued by a domestic borrower. 21 On dividends distributed by a Swiss corporation there is always a federal withholding tax of 35 per cent, 22 regardless of whether the recipient is foreign or domestic; therefore, distinction between non-taxable interest and taxable divi- dends is crucial. Generally speaking, the rules are identical to those for corporate tax purposes; in particular, with respect to related parties, the same safe harbour rules as to rates (arm’s length test) and deemed equity apply. If withholding tax applies (interest on bonds/secured loans), the withholding tax is the final tax lia- bility for non-resident lenders. There is no possibility for an (optional) filing or for claiming additional expenses whether a treaty exists or not.

18 See art. 4 al. 1 lit. a, b, and d of the Federal Withholding Tax Act from 13 October 1965 (FWTA; German abbreviation: VStG).

19 Bonds and other similar debt instruments in the sense of the FWTA are loans issued to a plural- ity of lenders (usually more than 20) that have all the same conditions; common to all these bond instruments is that they are used to raise funds in the public (bond) market.

20 Art. 94 FADIT (for full reference see n. 2).

21 See Thomas Jaussi and Marco Duss, “Kommentar zum schweizerischen Steuerrecht”, II/2, Bun- desgesetz über die Verrechnungssteuer, Basel, 2006, art. 9, fig. 46 et seq.

22 See art. 4 al. 1 lit. C FWTA (for full reference see n. 18).

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4.2. Double tax treaties

Most Swiss treaties split the taxing rights for interest (5 per cent to 15 per cent residual tax for the source state). There are 15 treaties which allocate the taxing right exclusively to the residence state. Where a Swiss borrower is concerned, withholding tax is reduced at source with respect to interest on secured loans; no advance approval for a reduction at source is necessary. For interest on bonds and the like (and on secured loans if reduction did not take place at source), a refund of the difference between the withholding rate and the residual rate set forth by the applicable treaty is available. The legal basis for the claim of the refund is the treaty itself and the respective domestic implementation provisions. Refund procedure/provisions always require at least a confirmation of residence issued by the respective tax authority. Almost all treaties follow the OECD model; thus, a refund can only be claimed if the recipient is the beneficial owner of the interest. Also, even if the term beneficial owner is not mentioned in a treaty, Swiss practice nevertheless requires the interest be beneficially owned by the recipient. According to Swiss practice, interpretation of this term is essentially con- trolled by its meaning in domestic tax law, even though principles of interna- tional tax law, particularly as reflected in the commentary to the OECD model, are also taken into account. From a Swiss point of view, 23 beneficial ownership is considered an economics term requiring the recipient be the real economic owner of the income concerned. In a tax treaty context, particularly where for- eign corporations are involved, the question of who is deriving the benefits of the income and, especially, whether this person is a resident in the contracting state is relevant. With respect to foreign corporations (often with little sub- stance) there seems to be a tendency for federal tax authorities to apply treaties more restrictively, either by denying beneficial ownership of the recipient or by arguing there is treaty abuse. 24 Besides its treaty network, Switzerland concluded several bilateral agree- ments with the EU on 26 October 2004, one of which concerns the interest tax- ation of individuals resident in the EU. 25 Under article 15 al. 2 of this agree- ment, Switzerland participates in the EC Interest and Royalties Directive. 26 Under those provisions, outbound interest payments must be exempt from any withholding tax if the recipient is a related corporation being resident in the EU. 27

23 The term is used in art. 21 FWTA (for full reference see n. 18) which determines the require- ments for resident taxpayers to be met to claim the tax credit for the tax withheld on dividends and (particularly bond) interest (35 per cent).

24 This is shown by a recent case in the federal court involving a Danish base company claiming a refund for withholding tax levied on dividends (decision from 25 November 2005, 2A.239/2005) where the court held that each treaty, even if not expressly mentioned in the treaty, contains an (implicit) anti-abusive provision.

25 Agreement between the EU and Switzerland providing for measures equivalent to those laid down in the EC Savings Directive; this agreement became effective on 1 July 2005.

26 2003/49/EC.

27 For further details, particularly the requirements to be met for the corporations involved to ben- efit from the withholding tax exemption see Rolf Wüthrich, Taxation of Companies in Europe, IFBD, 8.5.2.1.

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Tax treaty non-discrimination concerns are not much of an issue since with- holding tax is not levied on “ordinary” interest, and if it is levied, it is levied without respect to residence (exception: interest on loans secured by mortgage on Swiss real estate and paid to foreign lenders). To be sure, domestic lenders always receive full refunds for withholding taxes, and ultimately they are taxed on their net income, whereas a foreign lender may pay (withholding) tax even though its net income is negative. However, such a situation can always occur where a treaty allocates taxing rights to both jurisdictions, and where it does so by allowing the source state to tax a percentage of gross income. There are no specific measures (legislation or practice) with respect to effect- ive taxation of interest in the field of withholding tax.

5. Inclusion of interest in taxable income of the creditor

5.1. Interest from a lender’s perspective: qualification and avoidance of double taxation

5.1.1. Definition of interest

Generally, interest income is ordinarily taxable income under Swiss corporate tax laws. There are no rules providing for special or preferential treatment for such income nor is any “basketing” necessary. As has been mentioned, from a bor- rower’s perspective, there is no definition of (deductible or taxable) interest expense in Swiss tax law, which is mainly due to the authoritativeness of statutory accounting for tax accounting. Various provisions of corporate tax laws, however, require income be characterized (e.g. with respect to the participation exemption). Where a characterization is necessary for corporate tax purposes, Swiss tax law determines, based on its own rules, whether income is interest or, e.g. divi- dend income. Particularly, these rules do not refer to the domestic corporate laws or domestic tax laws of the country where the income is sourced, i.e. Swiss tax law does not defer to the qualification of the source country’s (tax or civil law) rules to determine the character of an item of income for domestic tax purposes. For example, where income of a foreign entity is concerned, especially when it comes to the question of whether the income is interest or dividend income, it must first be determined what domestic entity (corporation/partnership) the for- eign entity most resembles legally or factually. 28 Then, characterization takes place by applying the rules applicable to the Swiss entity by analogy. Besides this general characterization mechanism laid down in the federal and cantonal tax laws, the directive of the federal tax authority as to the participation exemption expressly provides for a (non-exclusive) list of what constitutes interest income (and thus does not benefit from the exemption). 29

28 See art. 49 al. 3 FADIT and art. 20 al. 2 FHTA (for full reference see n. 2).

29 Directive no. 9 of the federal tax authority from 9 July 1998, as to the participation exemption, fig. 2.3.2, where it is stated that, e.g. loans within corporate groups and hybrid instruments

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This qualification regime is not changed where a treaty applies. As opposed to the OECD model, some treaties state that, for qualification purposes, the domes- tic tax law of the source country is decisive. Furthermore, the treaty with Ger- many expressly sets forth that income from profit participation loans is treated as dividend income. 30 However, such determination does not affect or change the qualification for domestic tax law purposes. It is established practice in Switzer- land that a treaty provision cannot provide a valid legal basis to claim benefits for an item of income (e.g. participation exemption) that would not be available under domestic tax laws. The characterization or the definition in the treaty, respectively, is only decisive as to what distributive rule applies to the income in question.

5.1.2. Avoidance of double taxation

Basically, domestic international tax laws unconditionally exempt foreign source income from Swiss tax and take foreign source income into account only to determine the tax rate. However, even though interest from foreign borrowers is foreign source income, it is nevertheless taxable for resident lenders. The only relief from double taxation granted by domestic international tax laws (unilateral relief) is deduction from the Swiss tax base of the foreign tax withheld. Where a treaty applies that provides for a foreign tax credit (which is the case in all treaties concluded after 1965), double taxation is avoided by granting a credit for foreign taxes withheld. Besides the treaty itself, legal basis for this tax credit are three federal ordinances 31 determining the requirements for claim- ing the credit and its limitation amount. As to the limitation amount, four fea- tures of the foreign tax credit regime shall be highlighted. (a) Generally, the amount of the credit is limited to the amount of tax that is due in Switzerland. To determine this amount, total federal, cantonal, and communal taxes (not including church taxes) due are to be apportioned to the net interest income for which the credit is claimed. To calculate this net income, general expenses effect- ively connected with the interest income are to be allocated; also, interest paid is allocated based on the book value of the interest bearing assets in relation to the book value of overall assets. 32 (b) For corporations benefiting from a privileged tax status, in particular holding and domiciliary/auxiliary companies, the foreign tax credit is reduced in advance to one-third of the foreign taxes withheld and can be credited only against the federal income tax. 33 (c) Foreign tax credit is not available if a resident company is not entitled to the benefits conferred by a treaty because of specific anti-avoidance provisions in the treaty itself and/or the general anti-avoidance provisions set forth in the decree of the federal gov-

cont.

(profit participating loans, subordinated loans) do not qualify as participation and thus the income thereof does not benefit from the participation exemption.

30 See n. 5.

31 Ordinance of the federal government from 22 August 1967, on the foreign tax credit, and ord- inances no. 1 and 2 of the federal finance department from 6 December 1967 and 12 February

1973.

32 See art. 11 of the ordinance of the federal government (for full reference, see n. 31).

33 See art. 12 al. 3 of the ordinance of the federal government (for full reference, see n. 31).

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ernment on measures against treaty abuse from 14 December 1962. 34 (d) Finally, the Swiss tax credit system eventually follows a “double basket” limitation sys- tem (basket for dividends and interest, basket for royalties) preventing corpora- tions from utilizing excessive tax credits: foreign income (interest/ dividends and royalties), even if derived from a treaty country, is not taken into account for cal- culating the limitation amount if no withholding tax is levied. In other words, only items of income sourced in a treaty country that actually bear withholding tax are taken into account for computing the limitation amount. Items from non- treaty countries and items without withholding tax are not in the baskets.

5.2. Non-inclusions, notional inclusions and other restrictions

5.2.1. Non-inclusions due to privileged tax status and domestic international tax law

As mentioned above, there are generally no specific rules providing for beneficial treatment of interest income. However, non-inclusions (or partial non-inclusions) of interest income eventually occur where a corporation has a privileged tax status or where interest is tax exempt due to domestic international tax laws.

5.2.1.1. Holding companies

If a company has holding status, only federal income taxes are levied (no income taxes at the cantonal and communal level). To qualify as a holding company, either two-thirds of the assets (at fair market values) must consist of substantial participations or, if this “asset-test” is not met, two-thirds of the gross income must derive from dividends from substantial participations. 35 This means that up to one-third of all assets of such a company may consist of loans to (foreign and domestic) subsidiaries; the only tax levied on the interest thereof is the federal income tax at a rate of 7.83 per cent (before tax).

5.2.1.2. Auxiliary/domiciliary companies

If a corporation qualifies as a domiciliary company, foreign source income is partly exempt at the cantonal and communal level. For interest from foreign bor- rowers, the tax status eventually results in taxation of the income that is reason- ably below the tax ordinarily levied on interest income.

5.2.1.3. Domestic international tax law

Interest income is tax exempt if it is attributable to a foreign permanent estab- lishment.

34 See art. 6 of the ordinance of the federal government (for full reference see n. 31).

35 See art. 28 al. 2 FHTA (for full reference see n. 1).

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5.2.2. Notional inclusions in related party settings

With respect to borrowing companies, the federal tax authority yearly issues a circular setting forth the maximum rates for loans granted by related parties. 36 For loans granted to related parties, the federal tax authority also annually issues (in the same circular) the minimum rates to be charged by the lender corporation. For 2007, the minimum rate was 2.75 per cent if there was no refinancing. If a lending corporation refinances its loan, the rate has to cover at least its own costs plus a profit mark-up of 0.25 per cent to 0.5 per cent. 37 Interest rates for loans in foreign currencies are higher, and these rates are also issued annually by the fed- eral tax authority. Technically, these minimum rates are safe harbour rules, and lower rates should be respected if they can be shown to be at they arm’s length. If rates on loans granted to related parties are below these minimum rates (and it cannot be shown that these rates are commercially justified), the difference is included as notional interest in the Swiss tax base; simultaneously, this notional interest is considered a deemed dividend triggering 35 per cent federal withhold- ing tax. The respective amount of withholding tax must be collected from the borrowing company, otherwise the withholding tax is grossed up. These rules on minimum rates apply to all loans within a corporate group, par- ticularly to loans granted to sibling or parent companies. However, there is one interesting point that is not completely resolved under Swiss tax law. This point refers to the question of whether these minimum rates also apply where a parent company grants a loan to its subsidiary. In particular, the question arises whether the parent company (lender) can grant a loan at a zero rate if no refinancing occurs or, if refinancing takes place, at rates covering only the costs incurred by the parent company (no profit mark-up). Until recently, Swiss practice was clear on this point: loans granted at a zero rate or at rates only covering the parent’s own costs (no profit mark-up) were considered capital contributions from the parent company to its subsidiary not resulting in imputed/notional income at the level of the parent company. 38 How- ever, this practice seems to have changed since the participation exemption was extended to capital gains in 1998. Additionally, there are cases known to this reporter where tax authorities tried to force a parent company to include notional interest in its tax base where loans were at zero or “at-cost” rates.

5.2.3. Other restrictions

There are generally no restrictions (or provisions that would tax interest income more heavily) for a lender corporation with respect to the identity of the bor- rower (particularly offshore or low-tax jurisdiction borrowers). The only excep- tion is loans granted to related corporations (minimum rates). With respect to the identity of the lender, again there are no specific rules that would permit treating

36 See above, section 3.2.3.

37 For loans up to CHF 10 million 0.5 per cent; for any amounts above CHF 10 million 0.25 per cent.

38 See Markus Reich, “Verdeckte Vorteilszuwendungen zwischen verbundenen Unternehmen”, ASA 54 (1985/86) 630; Brühlisauer and Kuhn, op. cit., art. 58 fig. 283; differing opinion:

Wüthrich, op. cit., fig. 2.7.5.

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interest differently depending on, e.g. what business the lender was engaged in. Finally, there are no Swiss laws that would take into account that part of the interest received only corresponds to inflation. In Switzerland, issues of inflation are not dealt with at the level of the tax base. There is no controlled foreign company legislation in Switzerland, and there are generally no grounds to impute a foreign subsidiary’s interest income to the tax base of the Swiss parent company. However, there are three caveats. First, a foreign subsidiary can be subjected to unlimited Swiss taxation if effective man- agement is exercised in Switzerland. Second, there is one extraordinary case from the federal tax court holding that, under certain circumstances, income of a subsidiary is to be imputed to its parent if the subsidiary acts only as fiduciary on behalf of the parent company. 39 Third, income of a subsidiary can be imputed to its parent company if its legal personality is denied based on the general argu- ment of Steuerumgehung. 40 However, Switzerland seems to be reluctant to refuse to recognize a foreign subsidiary’s legal personality. 41 The characterization of an item of income is done autonomously by Swiss tax law, which follows the lines explained above. 42 As to the characterization rules of the participation exemption, it is enough to say that not all kinds of debt financ- ing qualify as participations. Only where profits of an entity are distributed to its shareholders (or to persons holding a corporate interest in this entity that is com- parable to a corporate interest in a Swiss corporation) does the participation exemption apply. 43 Thus, Switzerland follows a restrictive approach in interpret- ing what constitutes (foreign) dividend income entitled to the exemption.

5.3. Timing of inclusion of interest

Since tax accounting follows statutory book-keeping rules, interest income is to be included in the tax base when it accrues. This time can differ from payment- time since the so-called “matching principle” (Periodizitätsprinzip) is to be observed. Therefore, e.g. if an annual interest rate is concluded in the loan con- tract but payment is deferred until termination and repayment of the loan, the respective annual interest has nevertheless to be included. Similar timing rules apply to deep discount loans. Here, such interest income is to be included equally over the duration of the loan.

5.4. Effective taxation from a lender’s view

As seen from a borrower’s perspective, Switzerland’s tax laws have only “relaxed” rules to ascertain effective interest taxation. When looking at the lender’s side, this

39 Decision from 9 May 1995 (Panama decision). As mentioned, this is an extraordinary case and it is not completely resolved how far this decision affects cross-border financing within a corporate group.

40 See n. 6.

41 See Georg Lutz, Limits on the use of low-tax regimes by multinational businesses: current measures and emerging trends, IFA Congress 2001, branch report Switzerland, p. 844.

42 See section 5.1.1.

43 As to the non-exclusive list provided by the directive of the federal tax authority of what does not constitute dividend income, see n. 29.

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judgment proves only partly true. Though there is no specific legislation or practice in this field, there are various general rules that aim at effective interest taxation (though they are not specific anti-interest-avoidance rules). Worth men- tioning are: (a) the rules applicable in a related party setting (lender company has to charge interest rates that are at arm’s length (minimum rates)); (b) the limita- tion rules for foreign tax credits (limitations for holding and auxiliary companies, basket system); and (c) the rules against treaty abuse preventing domestic cor- porations from benefiting from double tax treaties (particularly: no tax credit for foreign withholding taxes). Further, even though there are no controlled foreign company rules and even though administrative practice is generally reluctant to deny a foreign subsidiary’s legal personality (at least if they have some economic substance), there is nevertheless a legal basis to subject a foreign subsidiary’s (interest) income to Swiss taxation. On the other hand, due to the preferential tax regime for holding and auxiliary companies, Switzerland actually provides meas- ures to shift interest income from high-tax countries to low-tax jurisdictions. However, these regimes are under massive attack by the EU on the theory they constitute impermissible state subsidies that breach the provisions of the free trade agreement between the EU and Switzerland. 44 The outcome of this dispute is highly uncertain. Even though Swiss scholars argue that the EU’s view cannot be upheld legally, in this reporter’s view, the EU’s position will eventually pre- vail. In this reporter’s view, which is also shared by various scholars, the only successful long-term strategy for Switzerland is to eliminate these regimes and to generally decrease corporate tax rates. 45

6. Effective taxation of interest income

To summarize the applicable rules in general and the recent developments in par- ticular with respect to effective interest taxation, some examples of tax planning structures will be given with comments thereon from a Swiss point of view.

6.1. Interposition of a finance company, whereby interest payments made to the finance company are allowable and dividend payments made by the finance company are exempt

If we address first the borrowing company paying interest to the finance company and assume it is a resident company in Switzerland, deduction for interest expenses are generally recognized. If the ultimate lender is a third party, there are generally no grounds for denying the deduction. Switzerland’s tax laws are almost exclusively controlled by the principle of “capital import neutrality”: as long as such payments are considered business expenses based on domestic tax

44 Particularly art. 23 al. 1(iii) of the free trade agreement from 22 December 1972, between Switzerland and the European Economic Community (former EU) is concerned.

45 As it was indicated by an official of the EU at a conference held in Zurich on 3 July 2007, this would be an acceptable way for the EU even if it took longer to change the current system.

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law, they remain deductible regardless of the tax treatment abroad (particularly, even in the case of no inclusion). If there was a withholding tax on the interest, and if the finance company had low or no substance, treaty benefits would prob- ably be denied according to recent case law that seems to enforce treaties in such settings more restrictively (i.e. where the foreign base company claims a refund for taxes withheld). In a related party setting (i.e. if the ultimate lender and fin- ance corporation are related parties), the same is true. However, in a related party setting, rates must be at arm’s length and thin capitalization rules must be com- plied with. Besides this, there would be legal grounds to subject the finance com- pany to Swiss taxation if it were effectively managed in Switzerland. However, as long as the finance company has some economic substance, it is hard for the authorities to challenge such a structure. If we turn to the ultimate lender com- pany and assume it was a resident company in Switzerland, no restrictions apply; rather, the dividends received by the lender company benefit from the participa- tion exemption.

6.2. Characterization as loan relationship with the borrower and characterization as equity financing with the lender

The tax treatment of hybrid instruments has already been dealt with (see section 3.5). Here, only the main points are highlighted: If the “borrower” is resident in Switzerland, domestic tax laws determine the character of the payment solely by referring to statutory book-keeping and domestic corporate law rules. Here, the capital import neutrality principle is also at work: how the payment is treated abroad (e.g. as dividend) does not matter. Also, a different characterization in an applicable treaty does not change the domestic treatment (i.e. deduction in Switzerland) either. Denying the deduction based on the fraus legis doctrine (Steuerumgehung) is rarely possible since such transactions often do not amount to an “artificial arrangement”. Even in a related party setting, the fraus legis argu- ment also seems unavailable to deny the deduction, since there are other rules combating excessive debt financing. Also from a “lender” perspective, Swiss tax laws decide autonomously what character an item of income has. However, par- ticularly with respect to the preferential tax treatment provided by the participa- tion regime (unconditional tax exemption), the term “dividend” is interpreted narrowly, preventing interest on hybrid loans/instruments from benefiting from the exemption. Thus, with respect to hybrid instruments, Switzerland is a suitable “borrower country” whereas from a lender perspective, if payments are treated as interest in the jurisdiction abroad, it is very probable that they will also be con- sidered interest in Switzerland.

6.3. Granting foreign tax credit exceeding effective withholding tax in the borrower’s country

For a lender company in Switzerland, foreign tax credits are only available if a treaty provides for such relief. The respective provisions in domestic law, how- ever, ensure that this credit does not exceed the tax actually paid abroad. Addi- tionally, further limitations apply under the Swiss “basket system”.

SWITZERLAND

6.4. Immediate interest deduction on zero bond lending with the borrower and inclusion in taxable income of the lender at the time of repayment

Such a scheme does not provide for tax benefits when Swiss corporations are involved since interest expenses are deducted when they accrue. Thus, a borrow- ing company must capitalize the interest (difference between the funds paid out at the beginning of the loan and the amount due at the time of repayment) and amortize it equally over the duration of the loan. The same rules apply, vice versa, for the lender company.

6.5. Repurchase transaction whereby an asset is sold and bought back at a price already fixed in advance, treated in one country as sale and purchase transaction and in the other country as loan relationship

The tax benefit from such an arbitrage scheme particularly lies in the potential beneficial treatment for capital gains in the “lender” country: the lender realizes a capital gain instead of interest income, whereas the “borrower” claims a deduc- tion for interest expenses. This is classic tax arbitrage: the borrower’s country applies its tax laws economically (loan transaction) while the lender’s country follows a more formal approach. From a Swiss perspective, it is uncertain how tax authorities would treat such a transaction, since there is no case law on it. In general, it can be said that transactions that are in accordance with civil law are also to be recognized for tax purposes; only in the case of a Steuerumge- hung 46 are the tax authorities allowed to deviate from what the parties (formally) concluded and to treat a transaction based on its economic substance. This implies that Swiss tax law tends to follow a more formal approach in applying its rules. However, this need not be true for corporations: due to the balance-sheet approach, statutory accounting rules are decisive for tax purposes. And these rules are based on economics. Therefore, in this reporter’s view, it seems that under a correct understanding and interpretation of the statutory accounting rules, such a transaction must be treated in the corporation’s books as a loan transaction (col- lateralized by a movable asset), and that treatment would also be decisive for tax purposes. Bearing this in mind, we can first address the borrower’s side. A Swiss cor- poration entering into such a transaction is allowed and simultaneously obliged by statutory accounting rules to make deductions for interest expenses during the term of the agreement. On its books, it must treat this transaction based on its economic substance and thus as loan transaction. If it did not do so, deduc- tions for deprecation after resale could be denied by the authorities because the matching principle was not observed. The deduction for interest could not be denied, even if the transaction is treated differently in the other jurisdic- tion. Here, the same mechanisms as for hybrid instruments are in play. If it were actually treated differently (i.e. as repurchase), this would not constitute a

46 See n. 6.

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Steuerumgehung: in both jurisdictions the transaction is treated in accordance with the applicable laws. As to a Swiss lender involved in such a transaction, the character (capital gain/interest) does not matter since there is no preferential treatment for capital gains. In addition, following the line of argument shown above, there is no poss- ibility to make use of a potential timing mismatch (capital gain at resale instead of accrued interest over duration). It seems that the tax authorities are allowed to force a corporation to include such income in its tax base equally allocated over the duration of the transaction.

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