When does the CH-US tax treaty apply to US citizens? When does the CH-US tax treaty apply to US citizens?

As US nationals are subject to US tax due to their citizenship, they may need to rely on US tax treaties. In a case brought in front of the Swiss Supreme Court, the Swiss court imposed higher restrictions on the application of the CH-US tax treaty. A critical analysis and its take aways.

In 2011, 2012 and 2015, a US citizen residing in the UK filed requests with the Swiss Federal Tax Administration (SFTA) for a refund of Swiss withholding tax (WHT) levied on dividends received from Swiss entities.

The SFTA accepted the 2011 refund request, but scrutinized the subsequent ones, requesting him to prove qualification as a US tax resident as per the Switzerland – US Double Tax Treaty (DTT CH-US). In short, Article 4(1) (a) 2^nd sentence reads that a US citizen (who is not a Swiss resident) shall be considered as a US resident "only if such person has a substantial presence, permanent home or habitual abode in the United States."

The taxpayer claimed to have a permanent home in the US and therefore argued that he had met one of the three – in his opinion, alternative – criteria above. The SFTA disagreed, rejected the 2012 & 2015 WHT claims for refund and demanded that he repay the WHT 2011 refund.

The case was then brought in front of the FAC, which confirmed the SFTA’s decision by arguing that Article 4(1)(a) DTT CH-US called for the three criteria to be applied as a tie breaker rule with a view to arbitrating a conflict of residence with a third country. The FAC considered that the permanent home test was not satisfied and that the plaintiff was thus not a US resident as per the DTT CH-US. In its ruling, the FAC also stated that lowering the bar for a US person to be regarded as a US resident for the purposes of applying DTT CH-US could lead to taxpayers claiming WHT refunds on the basis of two different DTTs, which could result in Switzerland having to pay out a double refund. The plaintiff then took the case a step further, to the Swiss Supreme Court.

In terms of the outcome, the SSC agreed with the SFTA and the FAC. As the taxpayer did not argue that either of the other two criteria were met, the only question addressed by the SSC was whether he had a permanent home in the US, which the SSC found was not the case. However, contrarily to the FAC, the SSC did not take any position as to the alternative or cumulative nature of the criteria provided for by Article 4(1)(a), 2^nd phrase DTT CH-US.

First, preventing a taxpayer from benefiting from the DTT CH-US results in an effective increase of the taxpayer’s final tax burden. Indeed, considering that the US income tax rate on dividends can go up to 20%, the 35% Swiss withholding tax would put the individual recipient in an excess foreign tax credit situation (because no credit is given for the remaining 15%).

The text of an international agreement is of primary importance when it comes to its interpretation. An interpretation of the DTT (taking into consideration its context and purpose) should remain compatible with the ordinary meaning of words used. Considering the clear wording of Article 4(1)(a), 2^nd phrase DTT CH-US, there is no doubt that the three criteria are of an alternative nature.

Furthermore, the function of the "residence" concept is to entitle the taxpayer to treaty benefits. In the US Model Convention, US citizenship alone is sufficient to establish tax residence. Thus, subjecting treaty benefits for US citizens residing in third country to the condition that they have either a “substantial presence” or a "permanent home" or a "habitual abode" in the US is a very substantial restriction. Also, the functioning of a DTT implies that the taxpayer is a resident of one of the contracting States only. If an individual is regarded as a resident of both countries, an arbitration needs to be made in favor of the country with whom the taxpayer has the strongest ties (by applying the so-called "tie breaker rule"). Thus, the fact that these criteria should be met cumulatively when going through the said injunctions relates to their specific purpose and should not be used as a sine qua non condition to determine tax residence upon DTT CH-US.

Finally, other arguments mentioned by the FAC raise concerns with respect to the very nature of the DTTs. Such treaties are strictly bilateral and hence, the purpose of Article 4(1)(a), 2^nd phrase DTT CH-US cannot be to arbitrate a residence conflict with a third country, in this case the UK. In addition, the aim of a DTT is to avoid double taxation by requesting the treaty parties to reduce their taxing rights. Should claims for a refund indeed be filed based on two different DTTs, Switzerland would comply with its international commitments if the refund corresponded to the amount set by the DTT requiring the highest reduction of Switzerland’s taxing rights. The risk of a double refund raised by the FAC therefore does not exist.

This decision is unfortunate: because of it, US citizens could be deprived of claiming the application of the DTT CH-US in bona fide situations. We hope that the Swiss tax authorities and courts will soon have an opportunity to revisit their position on this. In the meantime, we recommend that US individuals with significant investments in Switzerland (i) review their current connection to the US; (ii) assess the risks of denial of the benefits provided for by DTT CH-US in light of their personal circumstances and (iii) in the case where another DTT could apply, determine with which of the countries involved they have the strongest ties.