“PPL AG” had been set up as a limited liability company and in addition to the ordinary share capital, “PPL AG” had issued non-voting shares (participation certificates) to its German parent company and to three German individual investors in an aggregate amount of CHF 1.82 million.
“PPL AG” was later converted into a joint stock corporation and on that occasion the participation certificates were converted into Profit Participating Loans (PPL), with an annual interest rate of 7%.
In 2015, the Swiss tax administration carried out a tax audit of “PPL AG” for the years 2010-2014 and issued an assessment claiming payment of CHF 94,000 in withholding taxes on constructive dividends. According to the tax administration “PPL AG” had paid excessive amounts of interest to its lenders under the PPLs, exceeding the safe harbour interest rates published by the Swiss tax administration for the years under review. According to the tax administration, the portion of the interest payments exceeding the published safe harbour interest rates constituted constructive dividends.
“PPL AG” brought the case to the Federal Administrative Court claiming an annulment of the tax assessment.
The Federal Administrative Court ruled in favour of the tax administration and thus rejected the argument put forward by “PPL AG” – that PPLs under the arm’s length principle had to be treated differently than ordinary shareholder loans.
All shareholder loans – whether profit participating or not – are subject to the same arm’s-length standard. There is a possibility for the taxpayer to prove that a higher interest rate than the safe harbour rates published by the tax administration i a specific situation is at arm’s length, but “PPL AG” had failed to do so.
The Court concluded that the interest rate of 7% paid by “PPL AG” was excessive, and that the same amount of interest would not have been paid to an independent third-party lender.
Judgement of the Federal Supreme Court
The Supreme Court upheld the decision of the Federal Administrative Court and thus dismissed the appeal of “PPL AG”.
The Court stated that “PPL AG” had failed to specify any valid special circumstances to justify its entry into PPLs with a higher interest compensation. The specific circumstances of the case – in particular the fact that the lenders had previously been equity participants of PPL AG – suggested that the choice of the PPLs and the setting of the high interest rate were a result of shareholder relation, rather than commercial considerations.