As of 1 January 2018, the possibility of refunding witholding tax (WHT) to foreign borrowers of Swiss securities is no longer applicable, irrespective of whether the transaction is a long borrowing transaction or if the shares sourced under a securities lending transaction are sold or delivered to a third party.
The new rules stipulate that a WHT refund in case of long borrowing, including in chain transactions where the last borrower keeps the share, can only be claimed by the original lender. The original lender is, in our view, to be understood as the party that held the long position and that initiated the first transfer of the Swiss securities under a securities lending transaction.
Further to this rule and as only the original lender can claim for a refund, he will receive a compensatory payment of 65% of the income payment subject to WHT. In order to be in the position to claim a refund of WHT under an applicable double tax treaty, the new rules introduce a new requirement, which is that the original lender can prove that the payment received from the borrower is effectively the original dividend.
Although the circular letter that outlines the new rules does not further define this proof, it is the common understanding that this burden of proof can only be fulfilled if the borrower (or, in case of chain transactions, the ultimate borrower) provides the lender with the original dividend payment advice received by the borrower. Under this procedure, the borrower would no longer dispose of the original dividend payment advice enabling him to make a refund claim; instead, only the original lender now holding the original dividend payment advice would have this opportunity. This new procedure also requires the whole chain of the lending transactions to be disclosed, which may be a difficult task.
In transactions where the foreign borrower has sold or delivered the Swiss securities sourced via securities lending to a third party (e.g. to cover a short sale) the rules preclude both the original lender as well as the borrower from filing a claim for a Swiss WHT refund. In such circumstances only the final buyer of the shares shall be seen as entitled to a Swiss WHT refund under the applicable double tax treaty. This new practice may put the lender in a difficult situation, notably in chain transactions where his borrowing counterparty becomes lender to a subsequent securities lending transaction without his knowledge, as the original lender may no longer have control over whether his shares remain in the securities lending chain (resulting in a long borrowing situation for the final borrower) or if the shares are sold by the final borrower to a third party.
In the first case, the lender may file for a refund claim, assuming that he is provided with the original payment advice by the final borrower (or through the chain of borrowers); in the second case no such dividend payment advice should be available, as the third party would have this document and the entitlement to a refund claim. Lenders should therefore review their contractual arrangements to either preclude delivery of lent shares to third parties in order to ensure their own right to file a refund claim.
It is worth noting that the old rules have not changed in cases where the borrower is resident in Switzerland, as the borrower has to levy a second WHT on any manufactured payment he makes to a lender in order to be in the position to claim the WHT levied on the original dividend payment received. In addition, the rules also contain amended rules with regard to the Swiss individual and corporate income tax treatment of the different income flows resulting from securities lending transactions, including a general corporate income tax anti-abuse clause in connection with participation relief.