On 5 May 2015 the Federal Supreme Court rendered its long awaited decision on a withholding tax (WHT) reimbursement claim related to Total Return Swaps. The case was based on essentially the following facts: a Danish bank entered into swap contracts with clients in England, Germany, France and the US. Pursuant to those agreements the clients undertook to trade the entire return (esp. dividends and capital gain) of a specific underlying asset (in this case a basket of Swiss shares) against a fixed stream of payments. In consideration of this so-called Total Return Swap (TRS) the Danish bank was entitled to a variable interest (Libor) and a margin. That allowed the clients to build up a synthetic stake in an underlying asset (basket of Swiss shares) without having to directly invest into the related basket of shares. The Danish bank hedged its obligations arising under the TRS, i.e. payment of the aggregate return at a particular due date, by purchasing the related basket of Swiss shares. Dividends were paid by the Swiss enterprises to the Danish bank net of WHT

Subsequently, the Danish bank sought reimbursement of WHT from the FTA in an amount close to CHF 50 m. The FTA denied reimbursement arguing (i) lack of beneficial ownership of the dividend on the bank’s part and (ii) abuse of the double tax treaty between Switzerland and Denmark. According to the FTA the entering into TRS on the one hand with simultaneous purchase of related shares on the other hand had resulted in a transfer of all financial opportunities and risks to the clients. The FTA argued that the structure could not be justified on economic grounds and had been purely tax driven.

The FTA decision was appealed against and the Federal Administrative Court (FAC) partly upheld that appeal in March 2012. The FAC held that the appealing bank had remained free in its decision how to hedge its risks. It did not see any interdependence between the TRS and the hedging by the purchase of shares. The FAC confirmed the bank’s beneficial ownership in the dividends and denied treaty abuse.

The Federal Supreme Court now took a different view: it held the relevant question was whether the bank could freely dispose of the dividends which it thought was not the case for the Danish bank. The bank did not qualify as actual recipient of the dividends but merely acted as interposed entity under legal or economic constraint too pass on dividends to the counterparties of the TRS. The Federal Supreme Court’s written motivation of the decision is yet to be rendered.

The decision is of great relevance to the Swiss and international derivatives markets. Underlying values generating returns subject to Swiss WHT will probably no longer be included in TRS structures. Further consequences for the derivatives market remain to be seen.