Private equity or real estate investments in the US and Swiss tax law

I have been dealing with the Swiss tax aspects of US files for over 15 years.

Whilst this was a highly confidential matter at the outset, it is now becoming increasingly significant, particularly given the investment opportunities in private equity or real estate within the US.

But which tax rules apply in Switzerland for investors who are Swiss tax residents?

Let’s start with the structuring.

In my experience, such investments are never made through direct ownership. Generally, they are made via local structures such as partnerships (rarely as a general partnerships, more often as a limited partnerships) or LLCs.

There are various reasons for this type of structuring. It would appear that, for local legal reasons relating to personal liability, the corporate veil offers significant advantages. The aim, however, is to keep the tax advantages offered by direct ownership, hence pass through structures in the US, such as partnerships and C-corp LLCs (check-the-box).

A tax-efficient structure in the investment country in no way prejudices the tax treatment of said structures in the investor’s country of residence.

Which is the situation in Switzerland regarding these US pass throug structures?

Among the two models described by international tax law to eliminate (or mitigate) double taxation – namely the credit method and the exemption method – Switzerland largely favours the exemption method.

Consequently, the taxation of partnerships does not raise a lot of issues, because they are either treated for tax purposes in Switzerland as passive SPVs holding real estate, or they are treated for tax purposes in Switzerland as US located businesses. In both cases, income and wealth items are tax exempt in Switzerland — for both income and wealth tax issues — and are taken into account solely for the rate.

It may also be the case that the partnership is merely a passive SPV holding US securities. In that event, the Swiss tax authorities could merely treat the vehicle as a financial investment fund – fully taxable in Switzerland for both the basis and the rate, with tax credits applied for US sourced dividends/ distributions if any.

The tax treatment of pass through LLCs, namely C-Corps, has long been the subject of considerable debate – and this debate is certainly not over yet.

The debate really has taken off following a 2011 publication containing highly one-sided conclusions by the Swiss Tax Conference (CSI), the association comprising the 26 cantonal tax authorities and the Swiss Federal Tax Administration (SFTA). The most critical observers have viewed this as a highly incomplete overview of the matter, exclusively favouring the tax authorities, when the CSI described these structures as fiscally opaque under Swiss tax law – opaque means that both income and wealth are subject to taxation in Switzerland as long as the US-Switzerland Double Taxation Agreement (US-DTA) does not exempt the income. Many tax experts, including the undersigned, have taken the view that C-Corps were also merely pass through in Switzerland.

The issue was partially clarified in a 2015 case law ruled by the Swiss Federal Supreme Court, which concluded that – in the case brought before it – the US LCC treated in the US as a C-Corp is a pass through either in Switzerland. The issue has been partially clarified because the CSI website has not removed the analysis stating the contrary yet, even though civil servants from the SFTA admit off the records that it is no longer up to date; however, due to a lack of time and resources, a new analysis of the legal and tax situation has not yet been published. There appears to be a severe lack of time and resources, given that simply removing the analysis from the website would go some way towards clarifying the situation.

Are there any limits to this pass through tax treatment?

Pass through tax treatment may be based on the US-DTA. If this is the legal basis for pass through, as the US-DTA covers only income, investment as an asset is therefore not covered by the US-DTA and, as a result, the asset would be taxable in Switzerland for both the basis and the rate for wealth tax purposes.

Pass through tax treatment may be based on Swiss domestic international tax law. If this is the case, both income and wealth are covered by these legal provisions, meaning that the exemption applies to both income and wealth.

An investment must be understood on a net-of-tax basis, taking into account the underlying economic risks, including currency risk for investments in foreign currencies. If tax treatment is not taken into account at the time of investment and this accounts for 50 per cent of the return, the impressive figures presented on glossy paper melt away like snow in the sun under the scrutiny of tax law. Ultimately, the expected return fails to materialise and the investor is left feeling frustrated.

When calculating your return – regardless of whether it is before or after fees – do you calculate it before or after tax?