A popular way to finance an acquisition (share deal) is the formation of a new company and the subsequent purchase of the target by this new company. If the company raises debt capital from related parties to purchase the investment, the topic of so called hidden equity capital should be taken into account.
According to Swiss practice, a participation can be debt financed by related party loans up to a maximum of 70% of its fair market value. Deviations are only possible if it can be proven that a higher level of debt financing can withstand a third-party comparison.
If more than 70% of the fair market value of the target company is debt financed or if the third-party comparison of a higher debt financing ratio cannot be made, the excess debt financing granted by related parties is qualified as hidden equity.
The qualification as hidden equity can lead to considerable tax consequences. In particular, interest on hidden equity is not tax deductible for income tax purposes and is subject to the Swiss withholding tax of 35% (53.8% if grossed-up respectively) . In addition, hidden equity is added to the taxable capital and is subject to cantonal annual net wealth tax.
As part of an asset deal, the assets of a company and not the shares of the company itself are purchased. The maximum debt capacity of the various asset positions is regulated in a circular letter from the Federal Tax Administration in the sense of a "safe-harbour rule". Therefore, in the case of an asset deal, the debt financing ratio may differ from the 70% applicable to a share deal, depending on the assets involved.