Switzerland has concluded tax treaties with well over forty countries. Save for a few exceptions, the majority of the treaties concluded by Switzerland do not contain specific treaty abuse provisions. This fact has long been considered due to the unilateral treaty abuse decree, which the Swiss government passed in 1962.

The main purpose of the Swiss unilateral treaty abuse decree of 1962 is to prevent mere conduit entities from obtaining treaty benefits. Based on the 1962 decree, companies which are resident in Switzerland but foreign owned may claim treaty benefits for foreign source income only if the following conditions are fulfilled:

1. Not more than 50% of the treaty-protected income may be used to satisfy claims of persons resident in third countries. In addition special conditions regarding financing apply: The total amount of interest bearing debt may not exceed six times the equity and the interest rate may not exceed a certain amount set down by the Swiss tax authorities.

2. At least 25% of the treaty protected income must be distributed as a dividend (and thus subject to 35% Swiss withholding);

3. In addition, fiduciary relationships, family trusts and Swiss partnerships without any local commercial activity generally do not qualify for treaty benefits.

During the past years though, voices became loud demanding that the 1962 treaty abuse decree should be abolished. While the supporters of the 1962 treaty abuse decree maintain that Switzerland as a known low tax location could not have concluded as many favorable treaties without the decree, the opponents of the 1962 decree point out that those countries worried about treaty abuse incorporated specific abuse provisions in their treaty which overrule or even exclude the 1962 decree (namely the tax treaties with Germany, France, Italy, Belgium and the USA).

In this situation the Swiss federal tax authorities now issued a draft circular which would significantly revise the 1962 decree and lower the restrictions for active and quoted companies as well as pensions funds and tax exempt foundations.

The Swiss federal tax authorities suggest revising the 1962 decree as follows:

1. Active companies, which do not qualify for special income tax privileges, may use more than 50% of the treaty protected income to satisfy claims of independent third parties. In addition, active companies are not obliged to distribute at least 25% of the treaty protected income as dividends.

2. Quoted companies shall also be excluded from the 50% limitation and the 25% distribution requirement, provided that the majority of their stock is quoted on a recognized Swiss or foreign stock exchange, or that they are directly and majority owned by a Swiss resident quoted company, or directly and 100% owned by a foreign resident quoted company.

3. In addition, the 50% limitation requirement shall not apply to pension funds and to certain income tax exempt foundations.

4. And finally, the conditions regarding the financing shall be abolished. In their stead, the general financing guidelines published by the federal tax authorities apply.

5. In all other cases (for example domiciliary or holding companies, which are not quoted or owned by a quoted company) the 50% limitation and the 25% distribution requirement continues to apply.

Compared to the existing 1962 decree, the suggested revision is certainly an improvement. By dropping the 25% dividend distribution requirement for active or quoted companies, foreign corporate shareholders have more flexibility for their dividend planning - they even can accumulate profits and realize them later as a capital gain upon the sale of their Swiss investment (Please note: Swiss withholding tax risks must be considered when accumulating profits!).

However, the draft revision suggested by the Swiss federal tax authorities could still be improved. For example, if more than 50% of treaty protected income are used to satisfy the claims of related parties, treaty benefits are denied even to active and quoted companies and even if such related party claims are at arm's length. Another flaw of the draft revision is the very limited definition of quoted companies. For example, if a Swiss company is not directly but only indirectly 100% owned by a foreign quoted company, the exemption foreseen in the draft revision would not apply. Rather, the Swiss company would have to fulfill the 50% limitation and the 25% dividend distribution requirement in order to qualify for treaty benefits.

It is therefore to be hoped that the Swiss federal tax authorities will further improve their planned revision of the 1962 decree. Should there be any further improvements of the 1962 decree, they will happen fast, because the revisions are supposed to enter into force on 1 January 1999.

Overall though, in conjunction with the revised Swiss corporate tax law, the planned revision of the 1962 treaty abuse decree certainly will help to make Switzerland an even more attractive location for international businesses.

The content of this article is intended to provide a general guideline to the subject matter. Specialist advice should be sought about your specific circumstances.