Switzerland - Market Insights

Anti-avoidance doctrine in Swiss tax controversies—introduction

Switzerland’s legal system is rooted in the civil law tradition. Yet, in tax matters, both case law and administrative practice play significant roles, especially with respect to anti-avoidance rules. Such rules are most commonly developed by Swiss tax authorities, are quite often not even published, are occasionally validated by judicial courts when a courageous taxpayer dares to challenge them and are only rarely codified by the legislator. While administrative practice may offer clarity, visibility, and equality, it can also create rigidity, legal uncertainty, or even arbitrary outcomes when applied mechanically rather than with due regard to the specific facts and circumstances of each individual case. This is particularly true when anti-avoidance rules are objectivised.

Anti-avoidance doctrine

Swiss tax authorities have developed over the years a myriad of theories to curb taxpayers’ ingenuity in attempting to evade taxes. These theories are continuously evolving along with taxpayers’ creativity. They are all grounded on the same basis: the general anti-avoidance doctrine. As per case law, this doctrine entitles tax authorities to recharacterise a transaction when it appears unusual or artificial, is primarily aimed at saving taxes, and effectively provides a tax benefit. In practice, substantial weight is given to the objective, artificial character of the arrangement, with the subjective tax-saving motive being often assumed. Where the tax authorities successfully apply the anti-avoidance doctrine, tax consequences are determined as if the transaction had been structured more ordinarily. Taxpayers may hence be denied tax benefits.

The doctrine may apply in all situations, even where not explicitly stated, as a general legal principle. There is no need for any specific legal basis. This is not only true in domestic matters, but also in the context of international conventions. Interestingly, the Federal Tribunal held that all double tax treaties entered into by Switzerland contain an unwritten prohibition of treaty abuse, even where no explicit anti-abuse provision is included.

When challenged by taxpayers, most theories invented by the tax authorities have so far been confirmed by the courts. In two historical matters, however, the Federal Parliament decided to intervene and to limit the scope of case law, as it felt that anti-avoidance rules confirmed by the Federal Tribunal went too far. It ultimately codified such rules with narrower and clearer boundaries.

To tackle tax-avoidance schemes, Swiss tax authorities tend to set out strict conditions and to objectify the concept of abuse. As an example, a reorganisation may be deemed abusive under certain circumstances and subject to a blocking period—typically five years—during which a sale of the company would be deemed abusive. If the company is sold within such a blocking period, the sale automatically triggers adverse tax consequences. It leaves no chance for the taxpayer to prove that it was not tax driven and that economic motives prevailed.

Old reserves theory

An excellent illustration of unwritten anti-avoidance rules in an international context is the so-called old reserves theory. It essentially aims to prevent previously accumulated profits (the “old reserves”), that arose during a time when dividends were subject to a higher withholding tax rate, from being distributed at a later time at a reduced tax rate after a change in shareholding structure.

Under domestic tax law, dividends paid by a Swiss company are subject to a 35% withholding tax. Its foreign recipient may be entitled to a full or partial refund based on the applicable double tax treaty, if any. Whereas individuals can generally claim a 20% refund and bear a 15% residual tax, corporate shareholders can sometimes seek a full refund.

Taxpayers may therefore be tempted to reorganise their shareholding structure to enhance their tax refund rights. For individuals, this could typically imply a transfer of shares to a company. For corporate shareholders, classic options include changing ownership with another company located in a jurisdiction that has concluded a more favourable double tax treaty with Switzerland. For instance, a Brazilian company—which could apply for a partial refund and effectively reduce Swiss withholding tax up to 10%—may wish to bring down Swiss withholding tax to 0% and transfer its shares to a Luxembourg company, which could claim a full refund if the specific conditions are met.

To fight against abusive tax-driven restructuring, tax authorities have developed the old reserves theory. Its objective is to ensure that previously accumulated distributable profits will be taxed at the historical (higher) withholding tax rate, even if the distribution took place after the restructuring that would otherwise reduce the applicable rate. In practice, this translates into a denial of the new shareholder’s refund application. The purchaser is treated as if he was in the position of the seller. In other words, the new shareholder steps into the shoes of the former as regards withholding tax refund rights on old reserves. Upon later dividend distributions of the old reserves, the pre-restructuring withholding tax rate continues to apply, up to the amount of such reserves existing at the time of shareholding change.

The theory is most often applied where a sale or restructuring has improved refund entitlements without any concrete economic justification. Historically, tax authorities challenged only internal reorganisations within a group or among related parties, unless non-tax motives could justify the transaction. Third-party transactions were simply considered to fall outside the scope of the theory, as the authorities assumed that abusive behaviour was de facto excluded. This requirement eventually disappeared, and the relationship between the parties to the transaction ceased to be relevant to the authorities. Although inherently grounded in the anti-avoidance doctrine, the old reserves theory progressively distanced itself from its origins and, according to administrative practice, no longer required the existence of actual abusive conduct.

The tax authorities have now developed a whole body of cases determining when (or not) to apply the old reserves theory, leaving little to no room for interpretation or for assessing the specificities of each case.

The 2021 landmark decision

In a pivotal 2021 case (TF 2C_80/2021), the Federal Tribunal held that the old reserves theory cannot rely upon completely objective criteria. Our highest court emphasised that the conditions for tax avoidance must be fulfilled and assessed on a case-by-case basis.

This matter involved a Swiss company that had transferred its shares, previously held by a foreign shareholder not benefitting from withholding tax refund privileges, to another shareholder with better treaty benefits. Following the transfer, a dividend was distributed out of reserves accumulated prior to the change in shareholding. A refund of Swiss withholding tax was subsequently claimed on the basis of the new shareholder’s improved treaty position. The federal tax authorities denied the refund, relying on the old reserves theory.

In its decision, the Federal Tribunal first confirmed, as a principle, the old reserves theory as prevailing practice. Yet more importantly, it criticised the tax authorities for not having properly considered whether the situation was abusive and if there were prevailing economic motivations. It reminded that anti-abuse theories cannot be applied in every case that meets certain conditions predefined. It recognised that the administrative practice on the old reserves theory constitutes a strong indication of the existence of potential tax avoidance, but in no way replaces the thorough and concrete examination of the conditions that case law requires in order to establish the existence of such avoidance. Thus, one may not simply objectify the conditions for such tax avoidance but must examine the concrete facts of each case.

The Federal Tribunal subsequently proceeded with a comprehensive analysis of the facts at hand. It noted that the acquired company was no longer engaged in economic activities shortly after the transaction. It thus considered that these facts corresponded to the hypothesis, already described in case law on tax evasion, in which a person domiciled abroad, for whom withholding tax represents a definitive tax burden, sells its participation in a Swiss company with a view to the forthcoming liquidation to a Swiss resident who can obtain a full refund of the withholding tax. The Federal Tribunal hence found that there was abusive behaviour and confirmed the application of the old reserves theory.

Development of anti-avoidance theories and role of case law

Theories based on the anti-avoidance doctrine are numerous and constantly evolving. The best known to date in Switzerland include, inter alia, international transposition, proxy liquidation, old reserves theory, as well as extended international transposition. Other theories will undoubtedly continue to emerge in the coming years, while existing ones will further develop.

The constant evolution can be illustrated by the old reserves theory, which initially applied only to restructurings but was later extended to sales between third parties. To date, the old reserves theory does not apply to minority shareholders as they are generally unable to exert any influence over dividend distribution policy; however, recent developments suggest that situations may arise in which minority shareholders could also be affected.

Many administrative practices, such as the old reserves theory, remain unpublished. As a result, it is difficult for taxpayers—and sometimes even for practitioners—to anticipate the tax consequences of a transaction, even more so when its anti-avoidance rules rely on objective conditions. This is where case law becomes increasingly essential. Courts are regularly called upon to validate, repeal or simply better define various theories developed by the authorities.

While taxpayers and tax attorneys should not hesitate to seize the courts when the opportunity arises, since this positively participates in clarifying the legal landscape, many tax controversies are nevertheless settled or avoided beforehand through tax rulings. That said, the role of tax advisers and tax litigators remain essential not only to fight against the over-objectification of anti-abuse theories, but also to challenge them in court when the tax administrations use them robotically.

Conclusion

 “It’s a game. We tax lawyers teach the rich how to play it so they can stay rich — and the IRS keeps changing the rules so we can keep getting rich teaching them.” (John Grisham, The Firm).

In Grisham’s eyes, Switzerland would offer a unique playground. Rules are sometimes only known to tax lawyers and are constantly evolving; a dynamic landscape requiring continuous attention and adaptation by both practitioners and taxpayers.

Fortunately for taxpayers, Swiss tax authorities are publishing a growing number of circulars and—more importantly—are always available to discuss their practice or any specific case. The tax consequences of transactions are regularly secured in advance by way of tax rulings, which offer binding guarantees from the authorities.

As for the objectivisation of the notion of abuse, it also provides a silver lining: it offers safe‑haven rules when conditions are met. That said, anti-abuse theories will surely continue to evolve, along with the imagination of taxpayers, and will continue to be the subject of challenging discussions with both the tax authorities and the courts.