Memo to clients. Double taxation agreement between Liechtenstein and Switzerland. First Advisory Group. No. 2 September 2015.

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1 Memo to clients No. 2 September 2015 Double taxation agreement between Liechtenstein and Switzerland Introduction In recent years, Liechtenstein has introduced comprehensive measures with the objective of ensuring it is perceived as an internationally recognised and attractive tax location. Within the framework of these measures, Liechtenstein and Switzerland signed a new double taxation agreement (DTA) on 10 July The DTA is scheduled to enter into force on 1 January This is dependent, however, on the progress of the respective national approval procedures. The DTA is a comprehensive agreement seeking to avoid the double taxation of income and assets and is based on the recommendations of the OECD (Model Tax Convention on Income and on Capital). It replaces the existing agreement of 22 June 1995 between Switzerland and Liechtenstein which covers various tax issues but only governs the taxation of certain income. Asset management structures covered by the agreement, especially foundations With regard to the persons and taxes covered by the agreement, as well as the general provisions (Art. 3 of the OECD Model Tax Convention) and definitions (Art. 4 and 5 of the OECD Model Tax, Convention), there are essentially no differences between the DTA and the OECD Model Tax Convention. This is not surprising, as most DTAs concluded by Liechtenstein and Switzerland with other countries are largely based on standard international practice and the OECD Model Tax Convention. Compared to other agreements, however, the terms person and company are more comprehensively defined; the term company in particular includes legal persons as well as legal entities and special endowments and estates that are treated as legal persons for tax purposes. The Protocol to the DTA includes the following specifications: There are essentially no restrictions on residence for controlled foundations for which no Swiss persons are involved (e.g. a taxpayer who resides abroad establishes a foundation without the involvement of any Swiss residents with Swiss shareholdings or real estate). However, both the provisions aimed at preventing abuse and possible inheritance taxes or gift taxes must be taken into account. In the event of a link to Switzerland, non-controlled foundations are to be deemed to be resident should it be possible to classify a foundation as such based on an individual appraisal. However, all of the following criteria must be met: The founder has not reserved a right of revocation in the foundation s formation documents (the foundation is irrevocable). The founder does not have the right to amend the foundation documents. Neither the founder nor any related party has the right to issue instructions in terms of exercising decisive influence within or vis-à-vis the foundation council. The beneficiaries have no legal entitlement to benefits from the foundation (i.e. similar to usufructuary rights in character). A special arrangement applies in accordance with a provision from the Protocol for charitable foundations, according to which such foundations are to be deemed to be resident. Persons who are exclusively subject to minimum corporate income tax in Liechtenstein under Art. 62 of the Liechtenstein Tax Act are not deemed to be resident in Liechtenstein. These include, for example, private asset structures (PVS) under Liechtenstein Law. Cross-border employment In the case of cross-border commuters, the respective state of residence holds the right of taxation as before. The cross-border commuter criterion does not apply if the person does not return to his domicile for professional reasons after finishing work on more than 45 working days in a calendar year. The provision regarding the taxation of cross-border commuters is based on an overall view at the time of the negotiations and represents a balanced solution. Compensation to the board of directors Compensation and similar payments received by a person domiciled in one of the contracting states for his or her membership on the board of directors of a company domiciled in the other contracting state can be taxed in the state of the distributing company. Therefore, the fee of a Swiss member of the board of directors of a Liechten- First Advisory Group

2 Memo to clients stein company will in future be taxed at 12%, whereas in Switzerland an exemption will be made subject to a progression clause. The function of the board is defined such that it may only perform a supervisory role, but not engage in any commercial activities. Therefore, compensation for the foundation council is generally taxed in accordance with the rules for self-employed or non-self-employed work. Pensions The DTA now also governs the taxation of AHV pensions and benefits from occupational pension plans, stating that these can only be taxed in the state of residence, provided that they are not from the public service sector. The DTA thus eliminates the current double taxation of AHV pensions from Liechtenstein. To take account of pensioners who were not previously crossborder commuters, Switzerland will also pay Liechtenstein an annual compensation payment in the amount of CHF Dividends, interest and licenses The avoidance of double taxation in the area of withholding tax is one of the DTA s most important cornerstones. This means that Swiss withholding tax will no longer be applied to interest and licenses for persons and companies resident in Liechtenstein provided that they satisfy the arm s length principle. The agreement also no longer stipulates the levying of withholding tax on dividends from significant holdings (i.e. at least 10%) as well as for dividends paid to Liechtenstein pension funds after a minimum holding period of one year. In the case of portfolio dividends (i.e. where the significant participation level of 10% is not reached, so-called diversified holdings) and dividends paid to natural persons, the Swiss withholding tax rate will be reduced from 35% to 15%. The DTA also contains no provisions on existing reserves, i.e. reserves which were in place prior to the DTA s entry into force. The same taxation rules should therefore apply. The national laws according to which Liechtenstein exempts dividends from taxation and Switzerland grants a participation deduction will also continue to apply. apply, however, if the dividends, interest and licenses are assigned to a person who would benefit from a more favourable or equivalent DTA with Switzerland should the transaction be excluded. Example of treaty shopping with dividends or interest State which does not have a DTA with Switzerland Liechtenstein Switzerland Related company limited by shares Company limited by shares Based on the provisions on the abuse of the agreement, Switzerland is not required to refund the withholding tax if the structure was established with the purpose of benefiting from the advantages provided under Art. 10 or 11. Exchange of information It should be noted that the DTA does not contain any provisions regarding the automatic exchange of information (AEOI). The exchange of information is based on the general OECD standard. This should ensure the comprehensive exchange of tax information at the request of a state after the domestic options for procuring such information have been exhausted. With the revision of the Liechtenstein Administrative Assistance Act, group requests will also be permitted. This provision applies to matters following the entry into force of the DTA. Authors: Dr Wolfgang Maute, Florian Krobath, First Tax AG Provisions on abuse The benefits for dividends, interest and licenses provided for under the agreement should not apply to income from transactions which have the primary purpose of receiving these benefits and if the income would be assigned to a person residing neither in Liechtenstein nor Switzerland in the absence of the transaction in question (see graphic). The provisions on the abuse of the agreement do not 2

3 Tax transparency / non-transparency of a Liechtenstein foundation in accordance with Austrian law Introduction The fourth section of the agreement between the Republic of Austria and the Principality of Liechtenstein on cooperation in the area of taxation (Austrian BGBl III 2013/201, LGBl 2013/432) includes provisions on non-transparent asset structures. The background to this regulation is the hotly debated issue in Austria of the fiscal assessment of Liechtenstein foundations under Austrian law. In this regard, a type comparison between a Liechtenstein foundation and an Austrian foundation was undertaken by the Austrian tax authorities. The core issue was who actually held the foundation s assets. With regard to Liechtenstein foundations, the Austrian tax authorities in the past regularly resolved this issue on the premise that a Liechtenstein foundation was generally to be viewed as a transparent asset structure. In practice, this led to major uncertainty, especially as numerous questions, such as which characteristics are to be employed in connection with the type comparison remained open. This uncertainty was additionally fuelled by the assumptions made by the financial authorities that in general all Liechtenstein foundations are transparent and the transfer of assets to a Lichtenstein foundation does not yet mean that the founder is shielded from taxation on these assets and the resulting income. The foundation guidelines issued by the Austrian financial administration contain the rebuttable assumption that a Liechtenstein structure is transparent. Evidence to the contrary is admittedly allowed. Criteria for non-transparency A foundation is deemed to be non-transparent if the assets transferred to the foundation are effectively no longer influenced by the founder. Three criteria are used according to which should they be met a Liechtenstein foundation is to be classified as non-transparent. These criteria are as follows: Neither the founders nor beneficiaries or parties related to them are a member of the foundation council or a committee with the authority to issue instructions to the foundation council. Founders, beneficiaries or parties related to them do not have the power to dismiss the foundation council without good cause. No mandate agreement, whether express or implied, is in effect. In particular, the last criterion the existence of an express or implied mandate agreement appears to be rather vague in practice. The presence or non-presence of an implied mandate agreement is especially difficult to prove in practice. The practice employed by the Austrian financial administration identifies a mandate relationship of this type if certain indicators can be observed, such as de facto rights of the founder enabling him to exert influence. For this reason, any indication of possible de facto rights to exert influence on the foundation council must be avoided. Decision of the Austrian Administrative Court of 25 February 2015 With its ruling of 25 February 2015, 2011/13/0003, the Austrian Administrative Court for the first time comprehensively stated its position on the tax foreclosure effect (transparency/ non-transparency) of Liechtenstein foundations. The proceedings were based on the following circumstances: The founder, who passed away in 2009, established a foundation under Liechtenstein law in The primary beneficiaries of this foundation were the founder and his son and the foundation was managed by means of a mandate agreement. According to the annex to the mandate agreement, a bank domiciled in Switzerland was also authorised by the founder and his son «to instruct a foundation council». This foundation was self-disclosed in The founder, however, was of the opinion that the foundation s assets should not be attributed to him, as he had not exerted any de facto influence on the foundation s management. As such, he believed the foundation s assets should no longer be assigned to the founder. The Austrian financial administration performed a type comparison, comparing the Austrian private-benefit foundation with a Liechtenstein family foundation. This type comparison came to the conclusion that the Liechtenstein family foundation could not be compared with the Austrian Private Foundation Act due to the founder s authority to issue instructions to the foundation council provided for under the 3

4 mandate agreement. For this reason, it was ruled that the income from the Lichtenstein family foundation was attributable to the founder from a tax perspective. The Administrative Court deemed the assessment of the Austrian financial administration to be appropriate and rejected the appeal raised by the founder s estate. Essentially, the Administrative Court was of the following view: From a tax perspective, the question of to whom the income or revenue or proceeds of a Lichtenstein foundation are to be assigned is decided on the basis of economic considerations. The decisive point is whether the object of assignment has disposal over the source of income, which means the source of income is at its economic disposal and it can thus determine the way in which it is used. As regards the issue of assignment in connection with a Liechtenstein foundation, the relevant principles of Austrian law are to be applied. The economic ownership of the foundation s assets is thus decisive. If economic ownership has remained with the founder, which was ruled to be the case in this specific instance, the Liechtenstein foundation is not shielded from taxation. In other words: As the founder did not divest himself of the assets as economically required for the foundation to be classified as non-transparent, the assets in question remain part of the founder s overall assets from an economic perspective. No differentiation is made between domestic and international cases. Both are assessed according to the same criteria applied under Austrian law. In this specific case, the existence of the mandate agreement was significant for assessing the transfer of economic ownership. Due to the existence of the mandate agreement, the founder was deemed not to have given up the assets despite formally transferring them to the Liechtenstein family foundation. In this context, how the mandate agreement was structured was not deemed to be decisive. The Administrative Court rejected the differentiation made in practice between a hard or soft mandate agreement. In the case of a soft mandate agreement, the foundation council takes decisions independently should no instructions be issued by those authorised to do so. For hard mandate agreements, the foundation council reaches its decisions exclusively on the basis of the directives of those authorised to issue instructions. Should a mandate agreement of this kind be in place, the Administrative Court has ruled that the question of whether a Liechtenstein family foundation can be compared to an Austrian private-benefit foundation within the meaning of the Austrian Private Foundation Act as part of a type comparison is irrelevant. In general, it stated the existence of such a mandate agreement means that the founder and/or beneficiaries can issue comprehensive instructions to the foundation council. This thus gives rise to the economic perspective that the foundation s assets remain the economic property of the instructing person or persons and that the income generated from the foundation s assets must also be attributed to these persons. In this context, it is of no consequence that the foundation s assets have been transferred to a trustee for fiduciary management. Due to the mandate agreement comparable to a mandate as defined under paragraphs 1002 et seqq. of the Austrian Civil Code (ABGB) a special form of trusteeship emerges. Here, it is decisive that those authorised to issue instructions can do so on the basis of the mandate agreement s existence. The fact that a foundation council bound by the mandate agreement is authorised to act independently if this is required to protect the interests of the principal, also changes nothing in this respect. In effect, a mandate agreement of this kind results in an authority relationship between the founder and/or beneficiaries authorised to issue instructions and the foundation council. From an economic perspective, this results in those individuals authorised to issue instructions being deemed to be the owners of the foundation s assets. The fact that the mandate agreement granted instruction rights to the asset-managing foreign bank also made no difference to this assessment, as the commissioning of this banking institute for the (fiduciary) management of the assets still allows for the income to be assigned to the principal. The assets therefore from an economic perspective continue to be assigned to the founder and/or beneficiaries authorised to issue instructions. The fact that no instructions were actually issued is completely irrelevant to this assessment. It is conceivable that this assessment would be different if there was actually no possibility for such instructions to be issued. It was not necessary to make a judgement in this specific case, however. In effect, the existence of a mandate agreement gives rise to a situation in which the issuer of a mandate can continue to dispose of the assets dedicated to the foundation in the same way as of his or her own bank account. Appraisal of the ruling of the Administrative Court of 25 February 2015 For a Liechtenstein foundation to be classified as non-transparent, it is therefore decisive that ownership of the foundation s assets is not only formally transferred to the Liechtenstein 4

5 foundation but also economically. If the founder or a beneficiary possesses an instrument which allows them to enforce their will at any time as regards the foundation s assets by issuing instructions to the foundation council, the foundation is deemed to be transparent rather than non-transparent in nature. For the establishment of a Liechtenstein family foundation which is to be structured in a non-transparent manner, the following key conclusions can be drawn: 1. A mandate agreement regardless of its structure invariably serves to hinder the classification of a foundation as a non-transparent foundation. For this reason, no express or implied mandate agreement may be concluded. In practice, this situation can be countered by incorporating a provision banning the conclusion of a mandate agreement of this kind in the foundation deed. Of course, the foundation must comply with this ban accordingly in practice. In this context, particular mention must be made of the problematic issue of an implied mandate agreement. An implied mandate agreement could be deemed to exist if the founder is in effect able to enforce his will vis-à-vis the foundation council at any time, as the foundation council although not bound by a mandate agreement invariably yields to his will without consideration. A de facto ability to exert influence of this kind is also deemed to exist if a blank letter of resignation for the foundation council has been submitted. This allows for the resignation of a foundation council member to be legally enforced without the member s cooperation at any time. According to the stringent rules of the Austrian financial administration, an ability to exert influence is thus deemed to exist that is not granted to a third party by law. The presence of a blank letter of resignation of this kind thus serves to indicate the existence of an implied mandate relationship. In this context, the fact that the Liechtenstein foundation is set up on a fiduciary basis (by a trust office) for the Austrian founder could already be deemed to indicate the existence of an implied mandate agreement. 2. It is not only possible to argue economic ownership in the presence of a mandate agreement but also if certain rights to exert influence as regards the management of the foundation are held by the founder or the beneficiaries. In particular, such rights to exert influence also constitute powers of control. Liechtenstein foundation law provides the founder with a great deal of scope in structuring a Liechtenstein foundation. In particular, in addition to the foundation council, the founder can also employ other bodies, such as an advisory council which serves to monitor and supervise the foundation council. In light of the available information, the simple fact that a control body of this kind exists is only likely to be detrimental if the founder secures the ability via this advisory council to enforce his will as regards the foundation s assets at any time. In addition to the right to relieve a foundation council of its duties at any time either directly or indirectly via the advisory council, which detracts from a foundation s claim to be classified as non-transparent in any case, rights held by the advisory council, such as the option to dispose of the foundation s assets directly itself via powers to issue instructions to the foundation council, could also be damaging. It should be noted in particular that Liechtenstein foundation law allows for the founder as well as beneficiaries to be members of the advisory council. It should be questioned on a regular basis whether the relevant rights of the advisory council to be set up enable the founder or beneficiaries to effectively enforce their will as regards the foundation s assets. Should this be the case, a foundation must be viewed as transparent. In contrast, it is generally not problematic to grant the advisory council effective powers of control and possibly also powers of veto vis-à-vis the foundation council with a view to safeguarding and preserving the foundation s assets. In light of this judicature, such rights should not go so far that the foundation council is effectively stripped of its powers as the sole management body and can in effect merely act as a trustee for the founder or the beneficiaries. 3. Typical rights accruing to the founder, such as the right to object or the right to amend the foundation deed are not problematic in the context of foundation law. However, a right to object could be construed from a tax perspective to mean that the power to exert economic influence over the foundation s assets continues to exist. The Administrative Court has admittedly not commented in this regard. As the right to object may also be problematic for reasons of asset protection, it is recommended to clarify this matter with great care when setting up a non-transparent Liechtenstein family foundation and to draw the founder s attention to this problem. 4. The existing judgement shows that the great flexibility offered under Liechtenstein foundation law provides Austrian founders with options which would not be possible under Austrian private foundation law. However, it is not necessary to already assume the existence of a transparent foundation. The only decisive factor is that economic ownership remains with the foundation. Provided that this is guaranteed, the existence of a non-transparent foundation can be assumed. The Administrative Court has rejected the type comparison in this context. On the basis of the agreement, the use of a type comparison is questionable, as the agreement is decisive here. 5

6 Memo to clients Conclusions Liechtenstein foundation law offers Austrian founders numerous interesting benefits in terms of foundation organisation. On the basis of the agreement, it is ensured that a Liechtenstein family foundation will be viewed as non-transparent provided it complies with the so-called non-transparency criteria. Fundamental for being deemed to be non-transparent is not a foundation s formal structure but rather the economic situation of the family foundation. If ownership of assets has been transferred to the Liechtenstein family foundation from an economic perspective, a non-transparent foundation must be assumed. This results in numerous interesting organisational options, which are not available to Austrian private-benefit foundations under the Austrian Private Foundation Act. Author: Dr. Martin Attlmayr, Batliner Gasser Rechtsanwälte First Advisory Group Geneva Hong Kong Panama Singapore Vaduz Zurich First Advisory Group