In its decision of 3 October 2024 (BGer 9C_635/2023), the Federal Supreme Court shifted the focus for the examination of the withholding tax refund requirements in connection with financial products from a beneficial ownership test to an abuse test, thus initiating a paradigm shift that the financial industry has long awaited and that we have always called for.

1. Facts

The Federal Supreme Court ruling is based on the following facts: A Danish credit institution acquired several packages of fixed-interest Swiss federal bonds in the secondary market over the counter. At the same time, the credit institution entered into cross-currency interest rate swaps with terms exactly matching the maturity of the federal bonds. Under the swaps, the credit institution received the nominal value of the federal bonds plus a premium consisting of the difference between the market and nominal value of the federal bonds and the accrued interest. The CHF received under the swap bore interest at the same rate as the federal bonds. In return, the credit institution paid the USD equivalent of the nominal value of the federal bonds under the swap, after which it received a variable USD Libor interest rate plus a spread. Ultimately, the credit institution was fully hedged against currency fluctuations of the CHF against the USD and against interest rate changes. The credit institution only bore the default risk on the federal bonds.

The credit institution's application for a withholding tax refund on the interest payments on the federal bonds was rejected. The FTA argued that the arrangement described resulted in harmful forwarding of the interest payments on the federal bonds to the swap counterparties. This view was confirmed by the Federal Administrative Court. It was argued in particular that the credit institution did not bear any significant risks, since the default risk is of a merely theoretical nature due to the creditworthiness of the Swiss Confederation. Accordingly, the second dependency to be examined under the concept of double dependency was affirmed due to the lacking risk exposure, and thus ultimately the beneficial ownership was denied.

2. Federal Supreme Court Ruling

The Federal Administrative Court's judgment has now been corrected by the Federal Supreme Court. Of relevance are the following aspects:

The concept of double interdependency was (finally) laid to rest. Only the second dependency is now relevant when assessing beneficial ownership. A harmful forwarding can only be assumed if the amount of the payment to be forwarded depends on whether the income subject to withholding tax is generated. This means that the focus is on risk-bearing. Even if the significant interest rate, currency, exchange rate and other market risks are fully hedged and (due to the creditworthiness) only a theoretical default and credit risk is borne, it is sufficient to deny harmful forwarding and thus affirm beneficial ownership. In other words, if risks are borne, beneficial ownership is to be affirmed.

If beneficial ownership is established, any treaty abuse must be examined. The Federal Supreme Court has ruled that treaty abuse may only be assumed with caution. In addition, the party claiming treaty abuse must prove the conditions for it. Finally, an examination for treaty abuse in an international relationship is subject to the principle of good faith and must therefore be carried out according to the same standards as a domestic or national anti-abuse test. Therefore, tax avoidance must be examined. This is the case if, cumulatively, (i) an unusual, inappropriate or strange arrangement is chosen that appears completely inappropriate under the economic circumstances; (ii) this arrangement can only be explained by the intention of saving taxes; and (iii) the unusual arrangement would actually lead to a tax saving.

3. Consequences

When examining the withholding tax refund requirements in connection with financial products, the focus – provided that risks have been borne and thus beneficial ownership exists – is now on the unusual nature of the arrangement and the intention to avoid taxes. According to the Federal Supreme Court, these characteristics are to be evaluated with the help of a financial expert and thus from the perspective of the financial industry. Hence, if it turns out that the transaction has an economic purpose, tax avoidance is no longer possible and the withholding tax must be refunded. For the same reason, refunds in connection with retail products should no longer be an issue from a tax avoidance perspective.

The Federal Supreme Court's decision is also to be applied to dividend-bearing securities, since the withholding tax refund requirements are identical in international relationships, regardless of the type of income on which the withholding tax was levied. This practice must also be applied to national relationships, since the analogous withholding tax refund requirements apply.

Despite the clear ruling of the Federal Supreme Court, it is to be expected that applications for withholding tax refunds will continue to be approved only hesitantly or not at all. Therefore, pending refund requests are to be reassessed under the latest Federal Supreme Court ruling and, if necessary, appropriate measures are to be taken.