On 3 October 2024, the Swiss Federal Supreme Court handed down a decision on beneficial ownership in a hedged bonds constellation (refund of Swiss interest withholding tax). The claimant, a Danish financial institution, held Swiss Government bonds and received interest income subject to 35% Swiss interest withholding tax. It hedged its CHF fx and interest rate exposure on the Swiss bonds by entering into corresponding cross currency swaps with non-Swiss financial institutions (CHF fixed into USD floating). The Swiss federal tax administration (SFTA) denied the withholding tax refund, in particular, due to lack of beneficial ownership as a result of the cross currency swaps.
Unlike previous Swiss Federal Supreme Court decisions, the court ruled that the Danish financial institution was the beneficial owner of the interest payments on the Swiss bonds. According to the court, the key factor in determining a harmful forwarding obligation is whether the respective payment depends on the actual receipt of the income that is subject to withholding tax. In the case at hand, the Danish financial institution would have been obliged to make payments under the cross currency swaps to the counterparties even if it had not received interest payments on the Swiss bonds. The court held that if the recipient of an interest payment bears at least this specific credit risk (i.e., default risk), the hedging of the interest rate risk, currency risk, fx risk and other market risk does result in a harmful forwarding obligation. Notably, the high credit rating of the Swiss Confederation does not change this analysis. The court also held that there is a significant difference between the cross currency swaps in the case at hand and other derivative financial instruments, e.g., total return swaps, where the respective payment depends on the actual receipt of a payment on the underlying.
However, the Swiss Federal Supreme Court noted that the case may still be qualified as treaty abuse or tax avoidance which would result in a denial of the Swiss withholding tax refund. To assess these aspects, the court remitted the case to the Swiss Federal Administrative Court. Additionally, it remains unclear how the claimant’s possible violation of its duty to cooperate, especially regarding the disclosure of counterparties, will affect the final outcome in the specific case. Therefore, despite the welcome clarification on beneficial ownership, it will remain to be very difficult for financial institutions with pending Swiss withholding tax refund claims associated with supposed arbitrage transactions to receive refunds.
