CMS Expert Guide to cash pooling in Switzerland

a) Intro

There is no specific statutory framework dealing with cash pooling in Switzerland. In a landmark decision rendered in 2014, the Swiss Federal Court provided very severe guidelines that are to be considered by companies participating in a cash pool. In its judgement that provoked many, mostly critical, responses from commentators but that remains prevailing case law to date, the Swiss Federal Court confirmed that the provisions on capital maintenance (prohibition to return paid-in capital and statutory reserves) and on dividend distribution set limits to the granting of upstream or cross-stream loans.

b) Social interest and due diligence

Cash pooling enables advantages in liquidity management and planning as well as savings in borrowing costs. Nevertheless, it is associated with considerable risks if the loans within a cash pool are not granted at arm's length terms. The board of directors must exercise due diligence when participating in cash pools and act in the best interest of the company. Group interests may be taken into consideration only if they are not contrary to the interests of the company. In order to mitigate the risk of formally unlawful profit distributions, it has become best practice in intra-group situations to specifically mention the financing of affiliates, even without appropriate consideration, in the purpose clause of a company.

c) Upstream or cross-stream loans 

Theoretically, there are no restrictions on the granting of loans by Swiss companies to their affiliates, and such intra-group loans are not subject to the limitations contained in the statutory provisions on capital maintenance and profit distribution mentioned above as long as such intra-group loans are granted in all respects at arm’s length terms. This requires not only the payment of interest at market rate, but also the application of the protections that a commercial lender would usually require (in particular, assessment of the solvency and creditworthiness of the borrower, the right of the lender to prematurely terminate the loan if the financial situation of the borrower deteriorates, and appropriate risk diversification (i.e. no bulk risks)). If this dealing at arm's length is not entirely complied with, there is a risk of a prohibited distribution of protected equity towards the shareholder under the guise of an intragroup loan. The above mentioned decision of the Swiss Federal Court also introduced a novel concept whereby upstream or cross-stream loans lead to a blocking of free equity, i.e. the dividend distribution capacity of a Swiss legal entity is decreased by the amount of the upstream and/or cross-stream loans that do not fulfil the arms' length test criteria. As a consequence, Swiss companies need to formally recognize this new type of reserve in their balance sheet.

d) Hidden distribution of profits / prohibited capital repayment

The Swiss Federal Court decision set very severe guidelines regarding the arm’s length test. In the specific matter, however without checking the above criteria in a detailed manner, it laid a special focus on the (non-) provision of collateral and the (non-) assessment of the solvency of the debtor. The fact that the loans were not secured and the lender did not consider the solvency of the borrowers (despite indications on financial distress appearing on the horizon) led the court to conclude that the transactions were not at arm’s length. If an intra-group loan (other than a mere downstream loan) is found not to be at arm’s length, then any sums transferred to the borrower under the loan will be treated as a profit distribution or – if such payment exceeds the amount of the freely distributable reserves of the lender – as a capital repayment. Both of these situations are subject to balance sheet limitations and formal requirements. 

The above-mentioned decision of the Swiss Federal Court also introduced a novel concept whereby upstream or cross-stream loans lead to a blocking of free equity, i.e. the dividend distribution capacity of a Swiss legal entity is decreased by the amount of the upstream and/or cross-stream loans that do not fulfil the arms' length test criteria. As a consequence, Swiss companies need to formally recognize this new type of reserve in their balance sheet.

Auditors now generally require that the board of directors provides evidence that an arm's length analysis has been performed and that it came to a final conclusion. If no documentation is available on such analysis or if the board of directors or experts engaged express doubt as to the satisfaction of the arm's length test, the intragroup loan would not be considered at arm's length and the auditors would check whether the special reserve was recognized in the balance sheet.

The above principles apply equally to intra-group guarantees that are granted in connection with a notional cash pooling arrangement and to the actual fund outflows in case a guarantee is called upon.

e) Liquidity protection 

In addition, the directors and managers must ensure that even if all funds contributed to the cash pool or paid under an intra-group guarantee are lost, the company still has sufficient liquidity to pay its debts as they fall due.

f) Insolvency proceedings – avoidance actions 

Both the pool leader and the pool bank may be obligated to repay amounts received if the payments by the company exceeded the limits described above. Furthermore, in the event of bankruptcy of the company, the bankruptcy administrator could bring avoidance actions against payments made by the company to the pool leader and/or the bank.

a) Intro

Deviations from market conditions result in a heightened duty of care in the monitoring of the loan. If the transfer of sums to a physical cash pool or the grant of, or payment under, an intra-group guarantee is made in contravention of the capital maintenance and profit distribution provisions, or as a result of these actions the company becomes insolvent due to a lack of liquidity, the members of the board of directors and the management of the company may become personally liable for the shortfall. In certain circumstances, the immediate parent company and the ultimate group parent company may also become liable. Furthermore, the auditors may also face liability if the above rules are violated.

b) Liability of directors and managers

The members of the board of directors and the managers are personally liable to the company, the shareholders and the creditors for damages arising from any intentional or negligent breach of their duties. Accordingly, if directors or managers do not observe sufficient care in the qualification of the loan or in the monitoring of payments made thereunder, they may become personally liable. 

c) Liability of shareholders

Upstream or cross-stream payments made at the expense of the protected reserves or of the (absolutely protected) share capital are null and void. Such payments lead to a reimbursement obligation by the shareholder and, in the event of a repayment of share capital, to a revival of obligation of the shareholder to pay-in the share capital.

Furthermore, the parent company that e.g. enjoins the company to take part in the cash pool or to perform certain payments can be held liable as de facto director. 

d) Liability of auditors

The auditors need to ascertain if the directors performed a proper arm's length analysis of the intragroup loan respectively the cash pool agreements and, if the loans are not at arm's length, the auditors need to check whether appropriate reserves were made in the balance sheet (or demand the making of such reserves). Failing such actions the auditors may become liable in the event of a bankruptcy of the company. The auditors' liability was the subject of the proceedings that lead to the above-mentioned 2014 decision, and the Swiss Federal Court indeed found the auditor to be liable for damages incurred by creditors of the bankrupt company.

a) Intro

It is practically impossible to comply with all arm’s length requirements referred to in the above 2014 decision of the Swiss Federal Court. This is particularly so in the case of a cash pool where the intra-group loan relationships are not established directly by the individual group companies but rather through the cash pool bank as an intermediary. Further, the question whether an intra-group agreement complies with market standards is almost invariably open to argument and it is therefore difficult to predict whether a judge will ex post confirm that a particular intra-group agreement is arm’s length in nature. It is therefore highly advisable to take appropriate measures to ensure that the aggregate potential loss that a Swiss company could suffer in relation to a cash pooling arrangement is limited at all times to the amount of its freely distributable reserves. The following behavioural and contractual measures help in reducing the exposure:

b) Monitoring by board of directors and management

When calculating the freely distributable reserves, the mandatory allocation to the legal reserve and possible withholding tax due on distributions must be taken into account. In a physical cash pool, the only way in which such limitations can be maintained is by the rather cumbersome manual control of the flow of funds in order to make sure that assets exceeding the freely distributable reserves are at no time blocked in the cash pool.
In addition, the directors and the managers should also monitor the creditworthiness and solvency of the participating pool members when adhering to the pool and throughout the participation in the pool. They should ensure that the intra-group loans do not constitute a bulk risk (proportion of intra-group loans vs. balance sheet total).

c) Articles of association

The purpose clause in the articles of association of the company should contain explicit wording regarding the granting of financing to other group companies, including through upstream and cross-stream loans and securities, and it should also explicitly state that the concerned companies may promote the interests of other group companies, even without receiving adequate consideration (i.e. consideration that is not at arm’s length).

d) Internal cash pooling agreement

The basis for the arm's length test is a written contract documentation providing for e.g. (i) the right to regular information on the financial status of the pool leader and the other pool members (annually or better on a half-year or even quarterly basis), (ii) an adequate interest provision, (iii) the possibility for the company to terminate the participation in the cash-pool and to be repaid, and (iv) the possibility to offset claims.

e) Bank agreement 

Likewise, external cash pooling agreements with banks should allow the company to exit the cash-pool (e.g. if the creditworthiness of other members deteriorate). In a zero- or target balancing cash pool the agreements should ideally also provide for the (contractual) right to reclaim payments made should the company require such funds for capital protection reasons (e.g. if losses are incurred due to poor business performance of the company). In the case of intra-group guarantees (e.g. in the event of a notional cash pool), the risks can be limited by agreeing with the bank that the exposure under the guarantee shall be limited to the amount of the freely distributable reserves as shown in an audited interim balance sheet as at the date the respective guarantee is called upon.

a) Intro

Swiss tax law does not provide for specific provisions regarding cash pooling systems. The following is an overview of the most relevant tax areas regarding cash pooling systems implemented between affiliated companies:

b) Thin capitalisation rules

The Swiss Federal Tax Administration ("SFTA") has published in the Circular No. 6 of 6 June 1997 certain rules to be observed in case of intra-group financing with respect to an adequate capitalization of the borrowing Swiss entity. Generally, the Circular prescribes an asset-based test, whereas in case of finance companies a maximum debt ratio of 1:6 is typically accepted as adequate respectively as safe harbour. If the debt exceeds the maximum permitted debt ratios, the interest deduction will be denied and the excess interest will be reclassified as a deemed dividend, triggering 35% federal withholding tax (see below for further details on federal withholding tax). In addition, the excess debt will be reclassified as equity for purposes of the annual capital tax. 

c) Interest deductibility

As mentioned above, interest paid on related party debt which exceeds the thin cap rules is not admitted for deduction. Moreover, the SFTA publishes annual circulars setting out the accepted interest rates for loans among related parties; these interest rates are considered as safe harbour. If the applied interest rates exceed respectively undercut (depending on the position of the Swiss company) the minimum / maximum interest rates, the interest deduction on the difference will be denied (respectively added up) and reclassified as a deemed dividend, triggering 35% federal withholding tax (see below for further details on federal withholding tax). These tax consequences can be avoided if the Swiss company is able to demonstrate that the applied interest rates are at arm's length (despite deviating from the safe harbour rates), but this test can be very difficult to pass. In one of the rare precedents the Zurich Administrative Court ruled that the safe harbour rates may not be applied in a cash pooling system by the tax administration without further consideration, because the (comparably high) safe harbour rates are intended for long-term loans and may not necessarily be adequate in case of a cash pooling system.

d) Transfer pricing

In general, interest payments within the cash pooling system must comply with the arm’s length principle according to international transfer pricing guidelines. However, Swiss tax law does not prescribe any specific documentation requirements. We refer to the other tax sections for further details. 

e) Withholding tax

In principle, any payment to or – in the case of an intra- group guarantee – for the benefit of affiliates (except for pure downstream payments) made under obligations which are not at arm’s length constitute deemed dividend distributions for tax purposes, with the result that, firstly, the respective payments cannot be deducted as business expenses from taxable profits and, secondly, Swiss federal withholding tax of 35% becomes due on such payments (to be grossed up to 53.8% if the burden of the withholding tax is not passed on to the recipient of the payment). Depending on the domicile of the beneficiary and an applicable double taxation treaty (if any), the Swiss withholding tax may be partly or fully refundable. This applies regardless of whether the respective payment is made only out of the freely distributable reserves of the company or not, with the exception of so-called capital contribution reserves which can be paid out under an exemption from Swiss federal withholding tax.

In practice, it may be possible to reach a binding agreement with the Swiss tax authorities (in a so-called “tax ruling”) that payments of a Swiss company  under a physical cash pool or an intra-group guarantee system do not qualify as deemed dividend distributions, based on the argument that the cash pooling system is sufficiently beneficial for the Swiss company (both directly and indirectly through the advantages to the group as whole) to justify the related payments and solvency risks. However, the tax administration will carefully review the conditions applied within the cash pooling system (including the remuneration of the pool leader) in order to determine their arm’s length quality. 

Moreover, if the pool leader is resident in Switzerland, particular attention must be paid to the Swiss tax definition of client deposits, since federal withholding tax may be triggered on the interest payments of the pool leader if its number of creditors exceeds certain thresholds (while, generally, interest payments do not incur federal withholding tax). Due to certain changes to the Federal Ordinance on Withholding Tax which came into effect 1 April 2017, intra-group balances no longer count as harmful client deposits as long as no Swiss group company guarantees a bond issued by a member of the group, which facilitates the setting up of cash pools in Switzerland. A further reform of Swiss withholding tax (which is not expected to enter into force before 2024) might further facilitate cash poolings in Switzerland.

f) Corporation tax

Interest income earned by a Swiss company in a cash pool is subject to the regular Swiss corporate income tax at rates depending on the canton/municipality of residence and varying approx. between 12% -20%. 

g) VAT Rules

Financial services are generally VAT exempt without right to deduct. To the extent conceivable a court has never ruled so far whether the margin collected by the pool leader is VAT exempt interest or to be re-classified as a taxable service. In a similar case regarding insurance pooling the Swiss Federal Court ruled that the additional premium attributed to the lead insurer is to be re-classified as a taxable supply of services to the participating insurance companies. However, this ruling affected the old VAT law in effect before 2010; with respect to the new VAT law, the Court left the question open due to a lapse of the period of limitation in the specific case.