The Swiss Federal Supreme Court recently decided whether a dividend distributed by a Swiss company that participated in a zero balancing 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.
This decision is a leading case which will impact on group internal financing and cash pooling. While the court did not deal with any tax matters, the impact of the decision on tax matters is potentially severe.
The court upheld that up-stream and cross-stream loans within a group may only be granted by a Swiss company if the arm’s length test is satisfied. The Court did not establish clear rules on the conditions for the arm’s length test, but stated that meeting the arm’s length test includes analysing the credit-worthiness of the debtor, potential securities and any required documentation. The court raised the question whether it is at all possible for a Swiss company to enter into a zero balancing cash pooling, however, the court did not provide an answer.
Further, the court stated, that for up-stream or cross-stream loans that do not fulfil the arm’s length requirements, 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 need to be covered by a reserve which reduces distributable equity. It is also important to note that in order to decide whether or not a dividend can be distributed, only the situation as of the relevant date needs to be considered.
While the court did not deal with tax aspects of up-stream and cross-stream loans and cash pooling, it has to be assumed that the Swiss tax authorities will challenge financing arrangements of Swiss companies that do not meet the arm’s length test more often than in the past. In case a company needs to create a reserve for granting financing not at arm’s length, the financing should be expected to be challenged on the tax side. The tax consequences may be severe. The entire loan could be considered a hidden 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 if interest was charged at arm’s length and there was no loan default.
Swiss companies are advised to review their internal financing arrangements having regard to the arm’s length condition, whether they have the required documentation and any potential protective measures that can be taken.