Introduction. On June 7, 2021, the IRS published in Announcement 2021-11, 2021-23 I.R.B. 1196 the new Competent Authority Arrangement (“CAA”) of May 6, 2021, by and between the competent authorities of the United States and Switzerland (“Authorities”) regarding pension or other retirement benefits that may be eligible for tax relief under paragraph 3 of Article 10 (Dividends) of the U.S. – Switzerland bilateral tax treaty (“Treaty” or “Convention”). The CAA was entered into by the Authorities under paragraph 3 of Article 25 (Mutual Agreement Procedure or “MAP”) of the Treaty governing bilateral agreements on the Convention’s interpretation. The CAA supersedes a CAA entered into by the Authorities on December 10, 2004 (“2004 CAA”).
The Treaty previously was amended by the Protocol, signed on September 23, 2009 (“Protocol”), which deleted and replaced paragraph 3 of Article 10 (Dividends) of the Treaty (“Article 10(3)”). The Protocol expanded the scope of pension or retirement benefits eligible for Treaty relief under Article 10(3). The revised Article 10(3) added individual retirement accounts (“IRAs”) to the list of programs resident in a Contracting State, distributions of dividends to which by a company resident in the other Contracting State would be exempt from source-country taxation. The CAA is effective retroactively for dividends paid on or after January 1, 2020.
Article 10(3) Generally. There are two requirements for Article 10(3) to apply. First, the pension or retirement arrangement must satisfy the limitation on benefits clause in Article 22(2) of the Treaty. Article 22(2) states that an entity described in Article 4(1)(c), which includes a retirement plan, may be entitled to Treaty benefits if more than half of its beneficiaries, members or participants, as the case may be, are entitled to Treaty benefits. Article 4(1)(c)(i) refers generally to a qualified retirement plan which is a tax-exempt employees’ trust established in a Contracting State, and which is established or sponsored by a person resident in such Contracting State within the meaning of Article 4.
The second requirement under Article 10(3) is that the pension or retirement arrangement resident in the other Contracting State must not control the company resident in the first Contracting State and making the contributions to the foreign plan or arrangement. The benefits under Article 10(3) with respect to dividends paid by a treaty country resident corporation to a qualified plan or individual retirement arrangement in the other treaty country are distinguished from benefits under Article 18 of the Treaty with respect to distributions from qualified plans.
Dividend distributions under Treaty generally. Generally, Switzerland imposes a 15 percent withholding tax on profit distributions from Swiss corporations. For this purpose, profit distributions generally include dividends, liquidation proceeds, and hidden profit distributions. Under the Treaty, source-country taxation of dividends was limited to a percentage of the gross amount of the dividends if the beneficial owner of the dividends was a resident of the other treaty country. By contrast, the Treaty provided an exemption from source-country tax with respect to dividends beneficially owned by a qualified retirement program, so long as the pension plan or IRA did not control the dividend-paying company.
The Treaty defines “dividends” as income from shares or other rights, not constituting debt claims, that participate in profits. Dividends also include income subjected to the same tax treatment as income from shares under the law of the country in which income arises. Under the Protocol, participation in the profits of the obligor is a factor in determining whether an instrument characterized as a debt-claim should be treated as equity for purposes of the Treaty.
Article 10(3) Benefits for IRAs. Article 10(3) may provide Treaty relief in a scenario, in which an IRA invests assets in stock of a corporation domiciled in the Treaty country. For example, an individual may direct his IRA custodian to invest IRA assets in Swiss corporation stock. In that case, the Swiss corporation may distribute dividends to its stockholders, including the IRA. Generally, such dividend distribution would be subject to a withholding at source under Swiss tax law. However, under Article 10(3), the distribution of dividends would be entitled to the zero percent tax rate. Thus, the IRA as an investor in Swiss corporation stock would not be subject to Swiss withholding tax on the periodic dividend distribution by the Swiss corporation.
Conversely, under Article 10(3), Swiss individual retirement solutions, known commonly as Pillar 3a arrangements, would not be subject to withholding at source by the U.S. on dividend distributions from investments in U.S. corporation stock. Thus, for example, a Swiss retiree residing in the U.S. and investing in U.S. corporation stock through a Pillar 3a arrangement would not be subject to U.S. withholding tax on periodic dividend distributions from the U.S. company.
Action Items for IRAs Receiving Swiss Company Dividend Payments. Thus, treaty relief would apply only if the pension or retirement program, or individual retirement savings plan did not control the foreign company making pension or retirement contributions to the arrangement or plan. In recent years, IRA owners have been seeking higher rates of return and have been more open to using an IRA to invest in alternative assets, such as bitcoin. The growing trend of using an IRA to invest outside traditional asset classes may involve an increase in IRA investments in privately held foreign companies within a scope of Article 10(3). Therefore, IRA owners would find of benefit to consult with counsel regarding the definition of control, which would disqualify the Swiss company dividends distributed to an IRA from Article 10(3) benefits.