Swiss pension funds: taxes on alternative investments?

The tax implications and obligations for Swiss pension funds of making such alternative investments can be complex. Furthermore, these issues are often not on the radar of Swiss pension funds. Common matters that should be considered include:

1. Alternative investments in the US

The US tax system is notoriously complex, and alternative investments into the US market may give rise to the following key risks for Swiss pension funds:

• If the Swiss pension fund is allocated an amount of ‘Effectively Connected Income’ (“ECI”) from the US investment, this will trigger a US tax return filing obligation for the Swiss pension fund, plus potential US tax liabilities that must be settled.
• If the US investment includes exposure to US real estate assets (so-called ‘FIRPTA assets’), US withholding taxes and US tax return filing obligations may arise for the Swiss pension fund. These can, however, be mitigated if the pension fund fulfills the criteria to be a “Qualified Foreign Pension Fund”.

Failure to comply with a US tax return filing obligation, and late or non-payment of US tax liabilities, can result in penalties and a painful audit by the IRS. 

Before making any alternative investments into the US, a proper tax due diligence is strongly recommended, in order to proactively identify if any such US tax risks are likely to arise. If the risks are identified upfront, options exist to mitigate the impact (e.g. structuring the investment via a ‘blocker’ vehicle for US tax purposes).

2. Direct investment or investment via a Swiss single-investor fund?

For traditional equity and bond investments, Swiss pension funds usually hold such investments via a Swiss single-investor fund (e.g. a Swiss FCP), primarily due to the Swiss stamp transfer tax savings that this provides (Swiss funds are exempt counterparties for Swiss stamp transfer tax purposes).

Regulatory restrictions usually prevent Swiss pension funds from using such existing single-investor funds also for alternative assets, with the result that many Swiss pension funds have made until now their alternative investments directly on the balance sheet of the pension fund, and borne the Swiss stamp transfer tax leakage (typically 15bps) both on acquisition and on disposal. 

However, we are seeing now a significant number of Swiss pension funds considering establishing a separate Swiss single-investor fund solely for their alternative investments (e.g. Swiss FCP, or Swiss LP). This option is worth exploring in greater detail for those that have not considered it until now. The new Swiss ‘L-QIF’ regulatory form may also open up new opportunities which should be considered.

3. Double tax treaty access for relief from foreign withholding taxes

Swiss pension funds typically benefit from favourable withholding tax rates (often 0% on dividends and interest) under most Swiss double tax treaties. However, the administrative process to obtain such treaty benefits has become more burdensome in recent years, especially in cases where the investment is held through a single-investor fund structure. 

Many jurisdictions apply very formal requirements in relation to the documentary evidence required to prove the entitlement to treaty benefits, and this often means that custodians do not apply the reduced treaty rates at source (where possible) or do not proactively seek a reclaim of the over-withheld taxes. This means that Swiss pension funds can end up suffering excessive withholding tax leakages, which are often completely unknown to the pension fund. Regular health-checks can help to identify any such cases and lead to unexpected tax refunds. We had recent experience with exactly this scenario.

KPMG has a dedicated team to support Swiss pension funds manage its tax risks and obligations. Please do not hesitate to contact us directly if we can provide you with assistance.