Fund Management

Swiss Pension Funds Not Subject to US Tax on US Dividends

Tom ODonnell, Baker & McKenzie, Partner, Zurich, March 3, 2005

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In a Competent Authority Agreement (“Agreement”) between the Swiss and United States tax authorities, issued 10 December 2004, the question ...

In a Competent Authority Agreement (“Agreement”) between the Swiss and United States tax authorities, issued 10 December 2004, the question of whether and which Swiss pension funds automatically qualified for zero US withholding tax on dividends under the 1998 tax treaty between the United States and Switzerland (“Treaty”) was resolved.

The Agreement applies also to dividends from Swiss companies to US pension funds and similar arrangements, as is appropriate for a bilateral agreement. However, it has only been the US withholding tax that has been of serious concern. This issue was particularly troublesome for Swiss banks operating as qualified intermediaries (“QI”), as it was unclear whether they could certify Swiss pension funds for zero withholding tax.

The Agreement was made retroactive to 1 February 1998, the date the Treaty was effective for withholding taxes, and thus removes any concern for those Swiss QIs that have certified zero withholding tax on past payments. For those who did not, it should be possible to obtain refunds for withholding tax that was paid at the 15 per cent rate that would have been entitled to the zero percent rate under the Agreement.

Background
The tax treaty between the United States and Switzerland (the “Treaty”) generally reduces the US withholding tax on dividends from 30 per cent to 15 per cent. However, under a special provision of the Treaty, Article 10(3), the US withholding tax is reduced to zero on dividends paid by a US company to a Swiss resident pension or other retirement arrangement, but only if the US Internal Revenue Service (“IRS”) “agreed” that the pension or retirement arrangement “generally corresponded” to a pension or other retirement arrangement recognized for tax purposes in the United States. The IRS has never “agreed” that all or most Swiss pension funds satisfied this standard, and without such a determination it was unclear whether Swiss pension funds were eligible for the zero percent withholding on dividends.

With the inauguration of the QI system in 2001, this question became of paramount concern to Swiss banks operating as QIs and acting as custodians for the investments of Swiss pension funds in US equities. The QI is required to provide US withholding agents paying dividends on US equities direction as to whether zero or 15 per cent would need to be withheld from the dividen d payment. The QI, in turn, is required to ascertain this based upon documentation provided by the client which is valid and which claims the benefits of the Treaty. It was unclear, absent a determination by the IRS, whether a Swiss pension fund could validly claim the benefits of zero withholding tax on dividends.

This problem, and its resolution, has been under discussion between the IRS and the Swiss tax authorities for some time.

Competent Authority Agreement

Swiss Pension Funds and Retirement Arrangements Qualified for Treaty Benefits
Under the Agreement, two types of Swiss pension funds or retirement arrangements are determined to be the beneficial owners of dividends paid to them by US corporations, and thus to qualify for the benefits of zero US withholding tax under Article 10(3) of the Treaty:

a) a Swiss resident pension or other retirement arrangement that has been established in accordance with the Swiss Federal Act on Professional Old-Age, Survivors' and Disabled Persons' Pension Plans (Bundesgesetz über die berufliche Alters-, Hinterlassenen-und Invalidenvorsorge), but not including any form of contributory private savings plans or other individual savings plans; and
b) a Swiss resident investment foundation for pension funds ("Anlagestiftung"), if all of the participants in the investment foundation are pension or other retirement arrangements mentioned under subparagraph (a) above.

The Agreement makes the point that these two categories are not necessarily the only types of Swiss pension funds or retirement arrangements that may qualify for zero withholding tax on dividends. Stated differently, the listing above is not intended to be exclusive. Any type of Swiss pension or other retirement arrangement not mentioned above, including any such arrangement established pursuant to legislation enacted after the date of signature of the Agreement, that considers itself to qualify for benefits under Article 10(3) may qualify as well. However, to do so it must either (i) obtain a ruling from the IRS that it so qualifies, or (ii) seek a bilateral mutual agreement between the US and Swiss tax authorities.

Verification The Agreement provides that the status of any Swiss pension or other retirement arrangement claiming benefits under Article 10(3) is subject to verification by the IRS. The IRS is specifically permitted by the Agreement to request information from the Swiss tax authorities pursuant to the exchange of information provisions of Article 26 of the Treaty.
Methods for Obtaining Treaty Benefits

The United States has two methods for granting benefits under Article 10(3) with respect to dividends paid by US companies to Swiss pension or other retirement arrangements that qualify for benefits under this Agreement. These methods are the "at-source" method and the "refund" method.

At-source method No tax will be withheld from a dividend paid by a US company to a Swiss tax-exempt pension or other retirement arrangement described as qualifying under the Agreement if it provides a properly completed IRS Form W-8BEN to the withholding agent or payer of such dividend before the dividend is paid or credited to the Swiss pension or other retirement arrangement. A Swiss pension or other retirement arrangement filing Form W-8BEN must cite Articles 10(3) and 28(4) on line 10 of Part II of the Form W-8BEN, and state that it is a Swiss pension or other retirement arrangement described in the Agreement that does not control the company paying the dividend and that satisfies the “limitation of benefits” requirement of Article 22(2).

Refund method If the Swiss pension or other retirement arrangement does not provide a properly completed Form W-8BEN before the dividend is paid or credited, the US company or other withholding agent must withhold 30 per cent of the gross dividend payment. Later, upon receiving a valid claim for refund from the Swiss pension or other retirement arrangement, the IRS will refund the full amount of the tax that was withheld. The Swiss pension or other retirement arrangement must file its claim for refund on a Form 1120F US income tax return. The Swiss pension or other retirement arrangement must include with that income tax return adequate proof of payment of the US tax (e.g., IRS Form 1042-S or any other appropriate income statement issued by a bank containing a reference to such payment), and attach to such return an IRS Form 8833 (Treaty Based Return Position) that:

i) cites Articles 10(3) and 28(4);

ii) states that it is a Swiss tax-exempt pension or other retirement arrangement covered under this Agreement; and

iii) states that it satisfies the requirements of Article 22(2).

Where a QI is involved, it may act to recover over-withholding of payments on behalf of multiple Swiss pension or other retirement arrangements entitled to zero withholding tax on dividends under the Agreement by using the refund procedure set forth in Section 9 of its Qualified Intermediary Agreement.

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