European Directive "Faster" and Reduction of Withholding Tax at Source

The European Directive "Faster" for “faster and safer relief of excess withholding taxes” was adopted by the Council of the European Union (EU) on December 10, 2024. Member States must transpose it into their national legislation by December 31, 2028 for implementation starting on January 1, 2030. This new regulation provides for a simplified process for reducing withholding taxes at source on financial products.

Claire Frerejean Swiss certified tax expert, Senior manager, PwC

Matthias Staubli Director, Financial Services, PwC Switzerland

Most countries have implemented a tax withholding at source on income from financial products, with various rates: for example, it is 25% in Germany on dividends from German companies, 30% in the United States on dividends from US companies, and 35% in Switzerland (“impôt anticipé” or “Verrechnungssteuer”) on dividends from Swiss companies. In general, the financial products concerned are also taxable in the recipient's country of residence, leading to double taxation. Most countries have entered into tax treaties with each other with the aim of minimizing or eliminating double taxation and limiting the withholding tax rates provided by domestic laws. However, the application of these treaties involves a cumbersome process: the recipient of the income must have paper forms certified by the tax authority in their country of residence to certify their tax residence and then send them to the country of origin of the security to obtain a refund of some or all of the initially withheld tax. Within the EU, investors often have to deal with hundreds of different forms, some of which are only available in national languages. It is common for the refund process to take more than a year.

A special regime applies to income from US sources. stemming from the Qualified Intermediary (QI) regimes. Under these rules, financial intermediaries can directly apply the rates provided by the tax treaties concluded by the United States, provided they receive compliant documentation from their clients. For individuals, applying the treaty withholding rate (generally 15% instead of the 30% provided by US domestic law) is relatively simple. For entities, the process requires the recipient to indicate why the limitation of benefits clause of the treaty (LOB clause) does not apply to them.

The "Faster" directive provides for harmonization of the procedures for refunding withholding tax within the EU through the issuance of digital tax residence certificates (DTRCs) valid for one year, using an automated procedure. Unlike the current situation where a residence certificate must be requested for each country of income source, only one tax residence certificate will be required during a calendar year. This will avoid issuing multiple residence certificates for investors with diversified portfolios. Financial intermediaries, if certified and registered in a national register, will be able to request on behalf of their clients a reduction or a quick refund of withholding tax, which will have to be processed within 60 days of the request. Failing the refund in due time, interest for late payment will be owed by the tax authorities. To proceed, financial intermediaries will need to collect the DTRC and a declaration stating that the taxpayer is the beneficial owner of the security.

Regarding Switzerland, there is currently no procedure to simplify the process or to directly apply the rates provided by tax treaties: for taxpayers resident in Switzerland, the withholding tax serves as a guarantee and is easily recoverable provided the recipient is the beneficial owner of the income and declares it. However, in an international context, the 35% withholding tax is a final tax burden for a recipient residing abroad, which can only be reduced under a tax treaty to avoid double taxation, after making a request within three years from the end of the calendar year in which the income was paid.

The Swiss Federal Tax Authorities (SFTA) are particularly careful in verifying that the conditions for refund are met. Among these conditions, the recipient of the income must be the beneficial owner and there should be no abuse of rights under domestic or treaty law. The status of beneficial owner was recently examined in a landmark decision of the Federal Supreme Court concerning derivative financial transactions (9C_635/2023 of October 3, 2024). In this decision, a Danish financial institution had subscribed to loans from the Swiss Confederation and, to hedge against exchange rate risk, had entered into swaps that led to transferring Swiss franc interest payments to its counterparties. The Federal Court, by overturning the SFTA's position, ruled that the Danish credit institution was indeed the beneficial owner of the interest despite the swap arrangement, as it bore the investment risk: it would have had to make payments according to the swaps even in case of default by the Confederation on the interest from federal loans.

This decision highlights the uncertainty surrounding the refund of Swiss withholding tax in certain complex transactions. Depending on the situation, it is recommended to seek a ruling in advance to secure the benefit of the reduced rate provided by tax treaties signed by Switzerland.

Biography

Claire Frerejean is a Swiss certified tax expert and senior manager at PwC, based in Geneva. Claire provides guidance to businesses and their owners on various tax matters, such as tax compliance and restructuring within an international framework. With over ten years of experience in the private banking industry, she has served as a tax and wealth planner, as well as a specialist in tax compliance and tax operations. Beginning her career as a tax attorney in France during more than twelve years, she later held the position of tax director in the luxury goods industry. 

Matthias Staubli is Director in Tax at PwC Switzerland. Matthias studied Law and Economics at University of St.Gallen and did a CAS in Tax Compliance Management at Lucerne University of Applies Science. He leads the Operational Tax Practice of PwC Switzerland and Liechtenstein. He supports Financial Institutions in FATCA, CRS/AEoI, QI and other new withholding or reporting regimes like CARF or FASTER since more than 10 years.