Switzerland-United States International Income Tax Treaty Explained

US Switzerland Tax Treaty

US Switzerland Tax Treaty: International Agreements “US Tax Treaties” between the United States and foreign countries have existed for many years — and the US Switzerland Tax Treaty is no different. An Income Tax Treaty like the income tax treaty between Switzerland and the United States is designed to minimize inconsistent and double taxation — although a tax treaty cannot (unfortunately) shield certain tax implications. Switzerland and the United States have been engaged in treaty relations for many years. The treaty was updated in part, in 2011. The purpose of the US/Switzerland Tax Treaty is to help Taxpayers determine what their tax liability is for certain sources of taxable income involving parties to the treaty. While the US Switzerland Tax treaty is not the final word on how items of income will be taxed — it does help Taxpayers better understand how either the US Government and/or Switzerland will tax certain sources of income; what the IRS reporting requirements are — and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US Switzerland Income Tax Treaty – and which income is taxable:

Saving Clause in US Switzerland Tax Treaty

As we work through the treaty, one important thing to keep in mind is the saving clause. The saving clause (essentially) provides that, despite any information provided in the treaty — both countries reserve the right to tax certain citizens and residents as they would otherwise tax them under the general tax principles of their respective countries.

What does the Saving Clause Say?

• • • Notwithstanding any provision of this Convention except paragraph 3 of this Article, the United States may tax a person who is treated as a resident under its taxation laws (except where such person is determined to be a resident of Switzerland under the provisions of paragraphs 3 or 4 of Article 4 (Resident)) and its citizens (including its former citizens) as if this Convention had not come into effect.

Despite any limitation created by the saving clause, certain portions of the tax treaty are immune from the saving clause — which means the tax treaty will stand despite the Savings Clause:

• • • The provisions of paragraph 2 shall not affect: a) the benefits conferred by the United States under paragraph 2 of Article 9 (Associated Enterprises), paragraphs 6 and 7 of Article 13 (Gains), Articles 23 (Relief from Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement procedure); and

    • b) the benefits conferred by the United States under paragraphs 1 and 2 of Article 19 (Government Service and Social Security), and under Articles 20 (Students and Trainees) and 27 (Members of Diplomatic Missions and Consular Posts) and paragraph 4 of Article 28 (Miscellaneous), upon individuals who are neither citizens of, nor have immigrant status in, the United States.

Resident Defined in the Switzerland & US Tax Treaty

• • • For the purposes of this convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that

      • a) this term does not include any person who is liable to tax in that State in respect only of income from sources in that State; and

      • b) in the case of a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries.

    • A United States citizen or an alien lawfully admitted for permanent residence is a resident of the United States, but only if such person has a substantial presence, permanent home, or habitual abode in the United States. If such person is also a resident of Switzerland under this paragraph, such person will also be treated as a United States resident under this paragraph and such person’s status shall be determined under paragraph 2.

An individual who is a resident of one of the States under the law of that State, or who is a citizen of the United States, and who is not a resident of the other State under its law, will, for the purposes of this paragraph, be treated as a resident of the State of which he is a resident or citizen only if (i) he would be a resident of that State and not a third State, under the principles of subparagraphs (a) and (b) of paragraph 2 of this Article, if that third State is one with which the first-mentioned State does not have a comprehensive income tax Convention, or (ii) he is a resident of that State and not a third State, if that third State is one with which the first-mentioned State does have a comprehensive income tax Convention, under the provisions of that Convention.

What does this Mean?

It means that for purposes of the tax treaty, a resident is essentially a person who intends on being a resident of that country by way of domicile, place of management or incorporation — or any other situation when considering the totality of the circumstance, would tend to show that the person intended on being treated as a resident of that country.

Permanent Establishment in the Switzerland & US Tax Treaty

• • • 1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

    • 2. The term “permanent establishment” shall include especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

    • 3. A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration or development of natural resources, constitutes a permanent establishment only if it lasts more than twelve months.What does this Mean?

When it comes to Permanent Establishment rules — it can get very complicated since it involves business, and especially with the introduction of the TCJA, the rules are still kinda-sorta in a state of flux. The most important concept of permanent establishment is that unless a company has a permanent establishment “fixed place of business” in this specific country then they are generally not going to be taxed by that country on the income generated in that country.

Real Property Income in the US Switzerland Income Tax Treaty

• • • 1. Income derived by a resident of a Contracting State from real property (including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other State.

    • 2. The term “real property” shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to real property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of real property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships and aircraft shall not be regarded as real property.

    • 3. The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of real property.

    • 4. The provisions of paragraphs 1 and 3 shall also apply to the income from real property of an enterprise and to income from real property used for the performance of independent personal services.

What does this Mean?

When it comes to real property income, the Switzerland & US Tax Treaty provides that any income generated from the real property situated in one of the contracting states may still be taxed in that state — in other words, for example, if a US person resides in the United States and has an income generated in Switzerland, then Switzerland can still tax the income even though the person is a resident of the other contracting state — and nothing would prevent the state of residence from taxing it as well. (Foreign Tax Credits should minimize the tax outcome).

Dividends in the Switzerland & US Tax Treaty

• • • 1. Dividends derived and beneficially owned by a resident of a Contracting State may be taxed in that State.

    • 2 However, such dividends may also be taxed in the Contracting State in which the dividends arise according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed

      • a) 5 percent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 percent of the voting stock of the company paying the dividends;

      • b) 15 percent of the gross amount of the dividends in all other cases. Subparagraph b) and not subparagraph a) shall apply in the case of dividends paid by a person which is a resident of the United States and which is a Regulated Investment Company.

        • Subparagraph a) shall not apply to dividends paid by a person which is a resident of the United States and which is a Real Estate Investment Trust, and subparagraph b) shall only apply if the dividend is beneficially owned by an individual holding an interest of less than 10 percent in the Real Estate Investment Trust.

What does this Mean?

When it comes to dividends, the general proposition is that even if dividends are paid by a company of one contracting state (Switzerland) to a resident of the other contracting state (US), it is the other contract state that gets to tax the dividends (US) — although they can still be taxed in this state of source but only up to a limited amount of tax. When it comes to dividends, there are many exceptions, exclusions, and limitations to be cognizant of — which will vary based on the taxpayer-specific facts and circumstances.

Interest in the US Switzerland Income Tax Treaty

• • • • Interest derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State.

      • The term “interest” as used in this Convention means income from debt-claims of every kind, whether or not secured by mortgage, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, and including an excess inclusion with respect to a residual interest in a real estate mortgage investment conduit. However, the term “interest” does not include income dealt with in Article 10 (Dividends). Penalty charges for late payment shall not be regarded as interest for the purpose of this Convention.

      • The provisions of paragraph 1 shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the interest is attributable to such permanent establishment or fixed base. In such a case, the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services) shall apply.

What does this Mean?

The taxation of interest is a bit more straightforward than dividends, but still has its own set of complexities to be aware of. From a baseline perspective, interest earned in a contracting state (Switzerland) which arises from the beneficial ownership for a person in the other contracting state (US) is only taxable in that other state — shall vs may. Of course, there are some exceptions and exclusions to the first paragraph which taxpayers should evaluate carefully for their specific situation.

Capital Gain in the Switzerland & US Tax Treaty

• • • Gains derived by a resident of a Contracting State that are attributable to the alienation of real property situated in the other Contracting State may be taxed in that other State.

    • For the purposes of this Article, the term “real property situated in the other Contracting State” shall include a) real property referred to in Article 6 (Income from Real Property); and b) shares or other comparable rights in a company that is a resident of that other State, the assets of which consist wholly or principally of real property situated in that other State, or an interest in a partnership, trust, or estate, to the extent attributable to real property situated in that other State. In the United States, the term includes a “United States real property interest” as defined in the Internal Revenue Code as it may be amended from time to time without changing the general principles thereof.

    • Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or such fixed base, may be taxed in that other State in accordance with its law.

What does this Mean?

Capital gains are also a common source of passive income. Essentially, if real property is alienated which culminates in a taxable event in a contracting state, then it is taxable in that contracting state. There are specific definitions to be aware of depending on whether the property is located in Switzerland or the United States –and different rules may apply to each based on their own respective tax regimes. In addition, there are specific definitions involving what is termed as “real property situated in a contracting state.”

Exchange of Information: US Switzerland Income Tax Treaty

• • • The competent authorities of the Contracting States shall exchange such information (being information available under the respective taxation laws of the Contracting States) as is necessary for carrying out the provisions of the present Convention or for the prevention of tax fraud or the like in relation to the taxes which are the subject of the present Convention.

The exchange of information portion of the tax treaty is commonplace. It basically provides that each contracting state will exchange information with the other — necessary to carry out the purpose of the treaty. It also explains how the exchange of information may not be restricted under certain other articles of the treaty — but there are also limitations regarding the requirements that a contracting state may or may not have to adhere to.

Reporting Forms for Switzerland Pension

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

• • • Single or Filing Separate (in the U.S.): $50,000/$75,000

    • Married with a Joint Returns (In the U.S): $100,000/$150,000

    • Single or Filing Separate (Outside the U.S.): $200,000/$300,000

    • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• • • Gift from a Foreign Person

    • Gift from a Foreign Business

    • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• • • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

    • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

    • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

    • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

    • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company). The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to the filing requirements.

Received a Gift or Inheritance From Switzerland?

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business, or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Switzerland Report U.S. Account Holders?

There are thousands of Foreign Financial Institutions within Switzerland that report US account holder information to the IRS. The list can be found here: FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• • • Bank Accounts

    • Investment Accounts

    • Retirement Accounts

    • Direct Stock Ownership

    • ETF and Mutual Fund Accounts

    • Pension Accounts

    • Life Insurance or Life Assurance Policies

Totalization Agreement & the United States/Switzerland

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

• • • An agreement, effective July 1, 1988, between the United States and Switzerland improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries. It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

    • The agreement covers Social Security taxes (including the U.S. Medicare portion) and retirement, disability and survivors insurance benefits. It does not cover benefits under the U.S. Medicare program or the Supplemental Security Income (SSI) program.

    • This document covers highlights of the agreement and explains how it may help you while you work and when you apply for benefits.

The United States has entered into 26 Totalization Agreements, including Switzerland.

US Switzerland Income Tax Treaty is Complex

In conclusion, The US and Switzerland tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income, and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure on matters involving the United States-Switzerland Tax Treaty.

Contact our firm for assistance.