Indirect Partial Liquidation

Preliminary remarks

The indirect partial liquidation provision of Art. 20a (1)(a) FITA prevents a tax free capital gain for a Swiss resident individual shareholders. The indirect partial liquidation had been introduced with the Federal Law on 23 June 2006  (Art. 20a para. 1 lit. a FITA, respectively Art. 7a para. 1 lit. a CCITHA). The classification of a sale of shares as taxable income according to the concept of indirect partial liquidation can occur if the following criteria are fulfilled (cf. Circular No. 14 of the FTA, dated 6.11.2007, paras. 3.1 et seq)
  1. A transfer of shares takes place;
  2. Sale of at least 20% of the nominal or authorized capital of a share corporation or a cooperative ("target company") by seller or a group of sellers;
  3. System change: transfer of shares from an individual's private wealth to an individual's business asset or to a legal entity's asset (change from nominal value regime to book value regime);
  4. target has assets not required for business activity (e.g. cash, securities, real estate held for investment purposes, etc.) that are commercially and legally distributable at the time of sale;
  5. Withdrawals occur within five years after the sale; and
  6. Cooperation: seller knows or must have known that non necessary and distributable reserves are used to finance the acquisition and are transferred to the seller as part of the price (Art. 20a para. 2 FITA).
1 A system change occurs even if the purchaser declares its participation rights as part of business asset at the time of the acquisition pursuant to Art. 18 para. 2 FITA (see also Circular No. 14 of the FTA, dated 6.11.2007, para. 4.3).

Legal Materials

Please refer to the German version.

Jurisprudence

Please refer to the German version.

Practice of Tax Authorities

Please refer to the German version.

Literature

Please refer to the German version.

Q&A

What are the tax consequences for the seller in an indirect partial liquidation case?

A Swiss resident individual sellers is in general subject to income tax at a rate of about 20% to 40% (rate depending on the tax domicile / taxable income of the seller). However, depending on the tax domicile of the seller, income from qualifying holdings (like the target shares) might benefit from a reduced tax rate or a reduced tax base. This income from a qualifying holding in that case is subject to income tax at an effective rate of around 10% to 20%

What is the tax base in an indirect partial liquidation case?

The tax base (relative to the percentage of shares sold), is the smallest amount of:

• purchase price (including deferred payments); or
• withdrawals from the target; or
• amounts of reserves available under commercial law in the last financials before the sale; or
• amounts of asset not required for business activity at point of sale

Is the buyer faced with restrictions for the post deal integration in case of an agreed indirect partial liquidation clause in the purchase agreement?

Yes, as a result of an agreed indirect partial liquidation clause a number of post acquisition actions are not possible without substantial indemnification risks for the buyer. This applies for 5 years after closing. Such risk exists provided the target upon sale had non-operational distributable asset that are withdrawn from the target with the following actions:
  • Open or hidden dividend distributions 
  • a capital reduction of the target
  • an up-stream merger of the target with the acquisition vehicle
  • the liquidation of the target

Why does a seller ask for an indemnity in the SPA?

An individual resident Switzerland wishes to realise an income tax free capital gain. Such seller therefore has a strong interest to avoid an indirect partial liquidation taxation and if well advised will ask for a clause like the one below under which not required substance of the target is not distributed for five years after the completion of the transaction. 

Miscellaneous

Example: Tax consequences of indirect partial liquidation

 

Balance sheet of A AG

 

Current assets

6'000

200

Nominal share capital

Fixed assets

2'000

7'800

Distributable reserves

Total

8'000

8'000

Total

 

Tax consequences of a dividend payment of CHF 5 mio. to the Swiss resident private shareholder A of A AG:
A sells its shares in A AG to B AG. A AG distributes CHF 5 mio. as dividends to B AG. This has the following tax consequences:
  • A realizes a capital gain in accordance with Art. 16 para. 3 FITA subject to the below. 
  • At the level of B AG, the book value principle applies from an income tax perspective. The dividend distribution impoverished A AG. B AG books the dividend as income, but B AG's book must be depreciated by the same amount of the impairment of the A AG shares.
  • According to Art. 69 f. FITA B AG may benefit from the participation relief, unless no impairment is booked. 
  • Hence, no income tax will be payable. 
  • Withholding tax is levied on A AG but may possibly only be reported.    

B AG does not have sufficient financial resources and immediately after acquisition partially finances the purchase of A AG with the dividend of A AG to the amount of CHF 5 mio. In such a situation, the following tax consequences result (if there is an indirect partial situation):

Provisions in share purchase agreement (SPA)

Swiss resident sellers being individuals in a share purchase agreement often require on a non-distribution of assets to prevent an indirect partial liquidation.

Below you will find an example of such a Swiss indirect partial liquidation clause in favour of the vendor:


8.1 Indirect partial liquidation clause

8.1.1 Purchaser has been made aware of Seller's intention to derive a tax-free capital gain from the sale of Shares under this Agreement, as well as the Swiss income tax provisions and / or administrative guidelines regarding direct or indirect total or partial liquidation ("direkte oder indirekte Teil- oder Totalliquidation"), as set out in art. 20a of the Federal Act on Direct Federal Tax (DFT), Article 7a Federal Tax Harmonization Act, corresponding provisions of cantonal tax laws and Circular No. 14 of the Swiss Federal Tax Administration, dated 6 November 2007 ("Circular No. 14"), which concern Sellers who are Swiss resident individuals and own Shares as private property.

8.1.2 The Purchaser undertakes and assures, during a period of five years from Closing, not to take nor that the Company will take any measures after the Closing which a tax authority in Switzerland could qualify as direct or indirect total or partial liquidation  in accordance with the aforementioned tax laws and / or Circular No. 14 and thus would lead to a re-classification of the Seller's private capital gain into taxable investment income.

8.1.3 In case of a violation of any obligations of this Section 8, Purchaser shall be liable to Seller for any tax consequences ( Swiss federal tax, cantonal tax, municipal tax, church tax including any related interest, penalties, costs and expenses, court and reasonable attorney’s fees) on the Seller and shall fully indemnify the Seller, irrespective of any fault and without any limitations by this Agreement or the CO. Purchaser's obligation to indemnify the Seller survives even if Purchaser disposes of the Shares during the five year-period which is relevant for purposes of the direct or indirect partial or total liquidation set forth above. Purchaser undertakes to use all efforts and assures that Company uses all efforts (at their costs) to assist Seller in the defense of any negative tax consequences.

8.1.4 The Purchaser shall in the case of a subsequent transfers of share interest in the Company include the same restrictions as set forth in this Section 8 and the obligation to include such clause in any subsequent share purchase agreement, transfer or contribution agreement during the five year blocking period counted as per Closing.

8.1.5 The Seller agrees to fully cooperate with the Purchaser in order to obtain any ruling which the Purchaser requests at its sole discretion and at the Purchaser's costs. Without prejudice to the generality of the foregoing, the Seller agrees to promptly provide the Purchaser with a power of attorney to file the ruling on behalf of the Seller at the Purchaser’s first request, it being understood that the Purchaser will keep the Seller informed.



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