The Swiss Federal Supreme Court recently considered whether a dividend distributed by a Swiss company that participated in a zero balancing financing arrangement had been distributed lawfully. The case refers back to 2001 when Swisscargo AG distributed a dividend. At the time, Swisscargo AG belonged to Swissair, the Swiss airline, which later went bankrupt.
While the court did not deal with any tax matters, the decision will impact on group financing arrangements of retail groups with Swiss financial or cash pooling arrangements.
The court held that up-stream and cross-stream loans within a corporate group may only be granted by a Swiss company if on arm’s length terms. The Court did not establish clear rules on what this requires, but stated that meeting the arm’s length test includes analysing the credit-worthiness of the debtor, the security provided and any required documentation. Indeed the court raised the question whether it is at all possible for a Swiss company to enter into zero balancing cash pooling arrangements, however, the court did not provide an answer.
The court did however state that for up-stream or cross-stream loans that do not satisfy the arm’s length test, a Swiss company needs to create a corresponding reserve which is not available for distribution. As a result, there is a limitation on dividend distributions as up-stream and cross-stream loans that are not at arm’s length consequently reduce distributable reserves.
While the court did not deal with tax aspects of up-stream and cross-stream loans and cash pooling, there is a real risk that the Swiss tax authorities may challenge financing arrangements of retail groups with Swiss financing and cash pooling arrangements that are not on arm’s length terms. The tax consequences may be severe. The entire loan could be considered a dividend distribution subject to 35% withholding tax (or even 54%, if grossed-up). Until now Swiss tax authorities did not often challenge intra-group financing arrangements if interest was charged at arm’s length and loans are not in default.
Retail companies with Swiss financing and cash pooling arrangements are advised to review their internal financing arrangements having regard to the arm’s length requirements, whether they have the required documentation and whether any further potential protective measures that can be taken.