An SPA or a dividend with extra steps

Risks of partial indirect liquidation in Swiss tax law


For Swiss residents, a capital gain realised on the sale of privately held shares in a Swiss or foreign limited liability company is generally exempt from income tax, while dividends and liquidation bonuses constitute taxable income. However, as some creative minds have devised complex structures to receive a dividend from their company disguised as an exempt gain, tax legislation and practice is developing accordingly to tackle these artificial arrangements. One such case is that of partial indirect liquidation.

This occurs when a shareholder sells shares in a target company to a company or an independent entrepreneur with a surplus, while the target company sold contains substantial accumulated profits that are not needed for continued operation. These profits are quickly distributed to the buyer without any tax because he can immediately write off the value of these acquired shares at a price that has been determined, in part, on the basis of the target’s substantial retained earnings. There is a suspicion of abuse when the buyer uses this profit distribution to finance the acquisition, because overall these dividends are then returned to the seller, but in the form of a capital gain, so it is a dividend, just with extra steps.

However, there are some reasonable limits to this recharacterisation. First of all, the seller must cooperate with the buyer, otherwise it is illegitimate to tax the seller who has no idea how the buyer will finance the acquisition. Nevertheless, it is sufficient that the seller has a reasonable suspicion of such an intention of the buyer.

Secondly, the sale must involve at least 20% of the share capital, although subsequent sales of packages and concerted sales by several shareholders are also relevant, provided that this threshold is reached in aggregate within 5 years. The distribution of the target’s profits to the acquirer must also occur within 5 years, but may take various forms, including an upstream merger.

If the conditions for an indirect partial liquidation are met, the taxable income logically amounts to the sale price. However, the seller cannot reasonably be expected to empty the company completely before the sale, because on the one hand some accumulated profits are still needed for the continuation of the business, and on the other hand Swiss law provides for strict rules on the distribution of dividends, since some profits have to be kept as legal reserves. As such, the taxable income is therefore reduced to the funds that could be distributed as dividends according to Swiss or foreign law governing the target company. Furthermore, we cannot reasonably object to the fact that even this disposable profit relates to significant assets of the company, as opposed to mere cash, otherwise the distribution of the disposable profit would require the liquidation of these assets and would hinder the continuation of the business. Finally, as the important criterion concerns the possible distribution of profits to the buyer to cover the purchase price, the taxable income can only be assessed up to this amount.

It is important to note that the moment of realisation of this taxable income occurs when the seller acquires a legal and certain claim for the purchase price against the buyer. Since the conditions for partial indirect liquidation may sometimes be fulfilled in subsequent years, especially in the case of successive transfers of shares, the tax authorities have to resort to reassessing the taxes of previous years.