Reimbursement of capital contribution reserves for private individuals: New position of the Federal Tax Administration

Reminder of the decision of the Federal Supreme Court - ATF 149 II 158

The case (ATF 149 II 158) before the court can be summarised as follows: in the course of the liquidation of a company, part of the profit from the sale of real estate was transferred to the shareholder. The shareholder had sold the property to the company years ago at a price below the market value. The benefit received by the shareholder during the liquidation was considered by the tax authorities as an ordinary liquidation dividend and was subject to income tax.

The whole issue of the decision was the qualification of the contribution made when the property was first purchased by the shareholder at the preferential value and whether such a "hidden" contribution could be repaid free of income tax when the company was liquidated.

In fact, Article 20(3) of the LIFD states that the repayment of contributions is treated as a repayment of share capital, i.e. without income tax.

Previous practice of the FTA

Until March 2023, the FTA was of the opinion that only contributions that it recognised as such could be reimbursed without income tax. This means that only proper Capital Contribution Reserves (CCR) as described in the Federal Withholding Tax Act (WTA) and complying with the conditions of the WTA can be refunded tax-free to an individual shareholder.

Such CCR must meet two conditions to be recognised by the FTA: 1) the contribution is made by a direct shareholder, and 2) the contribution must be recorded in a specific account in the company's financial statements.

The second condition excludes any possibility of CCR recognition where hidden contributions are made. From a withholding tax perspective, this condition is explicitly mentioned in the law and cannot be challenged.

However, the Court analysed Article 20(3) LIFD and concluded that such an "accounting" condition was not mentioned in the article exempting from income tax. The Court decided that in the specific situation, the liquidation dividend in question was in fact a repayment of a capital contribution and should be exempt from income tax.

This was an important rejection of the FTA's practice of applying the legal conditions for withholding tax analogously to income tax. It opens the door to a different treatment of hidden contribution repayments from a withholding tax perspective and from an income tax perspective for individuals.

New position of the FTA

Following this decision, the reaction of the FTA was eagerly awaited. On 22 March 2024, the FTA published its position on the Federal Court's decision.

In a nutshell, the Court’s interpretation from an income tax perspective is as follows:

• A tax neutral repayment is only possible in the context of a liquidation.
• Such a neutral repayment cannot result in undertaxation, i.e. if the hidden contribution was made in the context of a tax-neutral reorganisation (such as a conversion, merger, transformation, etc.).
• Theburden of proof for such a contribution lies with the taxpayer.

For the sake of completeness, we refer you to the official statement of the FTA on its website only in French or German.

What will change?

The FTA's statement takes a restrictive approach, limiting itself to the specific case decided by the Federal Court. In particular, it is understandable that the hidden reserves must be realised in the financial statements of the company to be reimbursed, but why in the context of a liquidation process?

In any case, the recognition of such a hidden contribution was not a major challenge at the time. Indeed, the FTA refused to recognise them from a WHT perspective and the Federal Court indirectly confirmed that the accounting condition explicitly written in the law is a condition for such CCR recognition. However, from a purely income tax perspective, when considering a hidden contribution, it could be interesting that the value at the time of the contribution is recognised by the tax authorities. In this way, the hidden contribution (which could be subject to stamp duty) is made official and there is clear evidence of this amount at the time the hidden contribution is recognised in the accounts and reimbursed to the individual shareholder.

This new decision has changed the practice of the FTA and there are still many open questions. The cantonal tax authorities are responsible for levying income tax and, with 26 cantons, their respective practices are not yet known. Will they have the same restrictive interpretation as the FTA? Will they require that the repayment be made to the same shareholder who made the hidden contribution in order to benefit from the income tax exemption or not?

In any case, if a significant hidden contribution is planned or has even been made in the past and the shareholder is an individual, it could be interesting to formally recognise this contribution with a tax ruling or at least to keep all the supporting documentation to prove the value of the contribution in order to be able to invoke it when the time comes.

Article written by Isabelle Bugnon and Dominique Roggo