Magazine Issues » Dec 2008-Jan 2009

LEGAL EASE: Switzerland of plenty

In November 2008 FE looked at the tax treatment of fund managers in the UK.. Heini Rudishuli, partner at Lenz & Staffelin (Zurich), now focuses on Switzerland, trying to attract more investment professionals ...

The Swiss city of Zurich has ranked first in Mercer’s survey of quality of living for the last three years. Geneva ranked second in 2006 and 2007 and third in 2008. However, it is not only the high quality of living that makes Switzerland an attractive place to live for affluent individuals. The tax environment also attracts such people.

Switzerland wants to attract hedge fund and private equity fund managers. This goes along with the recently introduced new law on collective investment schemes. It is hoped that these fund managers will prove to be creators of high quality and high value-added jobs in Switzerland.

The popular lump-sum taxation is available to residents who do not perform any business activity within Switzerland. Therefore, this tax regime will in most cases not be available to foreign hedge fund and private equity fund managers because they actually want to work in Switzerland. However, the Swiss tax systems offer two other attractive features to individual tax payers. One being the tax exemption for private capital gains and the other being the tax discount of at least 40% on dividends received from qualifying participations.

The Swiss tax system basically distinguishes between capital gains, income from business activity (employed or self-employed) and income from investments. As a general rule, private capital gains are tax-free while income from business activity is fully taxable. Income from investments is basically also fully taxable except for dividends received from qualifying investments. An investment is a qualifying investment if it exceeds 10% of the nominal capital of the underlying company. Here, a discount of at least 40% applies.

Originally it was proposed that the Swiss tax authorities would issue guidelines by the end of this year outlining how these features apply to hedge fund managers. But as a consequence of the general financial crisis the publication of these guidelines is no longer a top priority. However, many cantons are already prepared to grant attractive conditions on an individual ruling basis.

It is generally expected that when published, the new rules will contain a generous interpretation of the conditions to be fulfilled for a tax-free capital gain so as to allow at least a portion of performance fees and carried interest to benefit from this feature. At the same time it is expected that the new rules will allow the routing of management fees, as well as performance fees and carried interest, to a Swiss or foreign fund management company – a company which is viewed as being the beneficial owner of this income.

Provided this company fulfils some minimal substance requirements, and provided that ‘arm’s length’ transfer prices are applied, dividend income derived by the Swiss resident fund manager (being a qualifying shareholder of the fund management company) could then qualify for the discount on dividends. At the federal level this discount amounts to 40% of the dividend and is available also for dividends derived from foreign fund management companies. At the cantonal level the various laws provide for different solutions. Many of the cantonal tax laws provide for discounts of up to 75%, albeit most of them restrict the discount to dividends received from Swiss resident fund management companies.

Lastly, if structured properly, it is expected that gains arising upon sale of the shares of a Swiss or foreign fund management company (including ploughed-back profits) will qualify as tax-free capital gains in the hands of the selling shareholders (being the
fund managers).

In summary, the existing features of the Swiss tax system offer an attractive tax environment to private equity and hedge fund managers in Switzerland. This, of course, depends on the composition of the overall compensation of the manager. If structured properly, and depending on the canton of residence of the manager, the overall tax rate can be very low.

©2008 funds europe