The Swiss Federal Supreme Court has delivered two judgements regarding Swiss withholding tax refund cases for two Danish banks involved in derivative transactions over the dividend ex-date with Swiss equities.
In both cases, the Swiss Federal Supreme Court ruled in favour of the Federal Tax Authority (FTA) and overruled the previous decisions taken by the Federal Administrative Court.
The cases under scrutiny
In the first case, a Danish bank entered into various total return swap transactions with counterparties in the EU and the US relating to Swiss equities. To hedge the exposure from the total return swaps, the Danish bank bought the necessary Swiss equities from various parties. Upon the maturity of the total return swaps, the shares were sold to different parties than those from whom the bank had previously sourced the shares. Under the swaps the Danish bank had to pay to the counterpart an amount equivalent to the dividend received.
The second case relates to a subsidiary of a Danish bank that had entered into derivative transactions by selling (OTC) SMI futures through Eurex and a broker and that had hedged this short position by buying the necessary Swiss equities from a different platform/broker. Upon the maturity of the SMI futures, the derivative positions were either closed (and the Swiss equities sold) or rolled into further SMI future contracts.
In both cases, dividends received during the maturity of the trade were subject to 35% Swiss withholding tax for which a full refund was claimed under the former Swiss-Danish double tax treaty (the current amended treaty only provides for a partial refund on portfolio holdings). In both cases, the FTA had denied the refund of Swiss withholding tax and was then overruled in the Federal Administrative Court.
Decisions of the Swiss Supreme Court
In its public hearing of 5 May 2015, the Swiss Supreme Court overruled the decisions taken by the Federal Administrative Court and decided in favour of the FTA.
Regarding the first case, the court was of the opinion that the Danish bank should not be regarded as being the beneficial owner of the dividends. This ownership was given up at the moment in time where the funds received as dividends were paid out to the counterparty of the swap agreement as there was, in the view of the Swiss Supreme Court, an on-payment obligation under the total return swap agreements entered into by the Danish bank. Further to this obligation, the bank was no longer in a position to freely dispose of the dividend proceeds received and, in addition, the total return swap entered into put the bank in a position of being fully relieved of any risk associated to the underlying long position in Swiss equities. Hence, the bank had given up its beneficial ownership of the underlying Swiss equities.
In the second case, the underlying facts were more abstract and, in the view of some judges, insufficiently established by the FTA. Nevertheless, the Swiss Supreme Court was of the opinion that it would have been the Danish claimant´s call to assist the FTA in establishing the right facts and circumstances. Hence, the majority of the judges were of the view that the volumes of SMI futures traded and the fact that only a limited number of parties were involved in the transaction were sufficient evidence to conclude that the bank had given up its beneficial ownership and had to forward the dividend proceeds, the prices for which had been partially pre-determined in the sold (OTC) SMI futures.
Appraisal of the decisions
The Swiss Supreme Court has now issued two leading decisions with regard to the question of beneficial ownership which will have an important impact on the numerous other cases pending with the Swiss courts and the FTA. Although the Swiss Supreme Court´s exact line of argumentation will only be available in a couple of weeks, after the entire decisions including the motivation have been published, these decisions are effectively increasing the hurdles for a refund of Swiss withholding tax for derivative transactions with underlying Swiss equities – not only in an international but also in a domestic context.
It is now clear that the Swiss Supreme Court is of the view that anyone transferring a received dividend to a counterpart of a derivative instrument while not being in a risk-taking position will most likely have relinquished their beneficial ownership to the underlying Swiss equity and with this their right to claim Swiss withholding tax.
Pending claims as well as new derivative transactions that may give rise to a Swiss withholding tax refund claim should carefully be evaluated on the basis of the recent decisions of the Swiss Supreme Court once the written decision is available.