Landmark decision ATF 149 II 158: tax exemption for repayment of hidden capital contributions

On March 17, 2023, the Swiss Federal Court issued a landmark decision [ATF 149 II 158] which ended a long-standing administrative practice concerning the taxation of hidden capital contributions. By interpreting article 20, paragraph 3 of the Federal Law on Direct Federal Taxation (LIFD), the Court determined that the repayment of these hidden contributions should be exempt from income tax, even if they are not recorded in separate accounts. However, withholding tax practice remains unchanged.

As a reminder and according to article 20, paragraph 3 of the LIFD, the repayment of additional contribution made by shareholders is exempt from income tax, as is the repayment of share capital. Historically, this exemption applied only to contributions booked in a separate account. As a result, under previous administrative practice, hidden capital contributions were not eligible for this exemption. This accounting requirement stemmed from Circular no. 29c issued by the Swiss Federal Tax Administration (SFTA).

What was the context?

In 2003, B SA, a Swiss-based company, acquired a hotel property abroad. Part of the purchase price included a building right owned by the company's shareholder A, as well as acquisition costs which A had covered. B SA booked the property below its acquisition cost.

In the following years, B SA carried out various revaluations on the property. Additionally, shareholder A took over the property’s mortgage debts without charging B SA. Upon B SA’s liquidation in 2015, the sale of the building generated a book profit of CHF 2.2 million. The cantonal tax authorities considered that this profit constituted a liquidation profit, subject to income tax for shareholder A.

The Federal Court's decision

The Federal Court accepted the shareholder A’s appeal, confirming that the liquidation profit arose from hidden contributions made by shareholder A (made at the time of the purchase of the property and during subsequent years). The Federal Court ruled that hidden capital contributions can benefit from the exemption provided by article 20 of the LIFD, irrespective of the accounting requirements outlined in Circular 29c. As a result, the liquidation profit arising from the hidden contributions was not subject to income tax.

However, the same does not apply to withholding tax, for which the accounting requirement is maintained. The payment of a liquidation profit from an hidden contribution remains subject to withholding tax, which the company is responsible to levy.

Scope of application?

Nothing in the decision suggests the scope of this new practice. The SFTA has thus clarified its scope by limiting this exemption to the distribution of hidden contribution in the event of a company’s liquidation. Shareholders must also provide evidence of such hidden contributions.

This decision raises important questions, particularly regarding hidden contributions made in past transactions (such as during corporate restructuring) and the need to declare both past and future hidden contributions. The tax exemption also raises question on how to declare such income and recover withholding tax for shareholders.

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