Switzerland: Tax implications for Swiss pension funds investing in alternative assets
Trend of Swiss pension funds investing into alternative assets to complement traditional equity and debt investments
Trend of Swiss pension funds investing into alternative assets
There is currently a trend of Swiss pension funds investing into alternative assets, partly due to the low (even negative) interest rate environment. The tax implications of such alternative investments can be complex and are not always on the radar of Swiss pension funds.
Given the current low (even negative) interest rates, Swiss institutional pension funds increasingly are looking for more exotic asset classes and markets in order to achieve a minimum investment return.
There is a trend of Swiss pension funds investing into alternative assets (e.g., private equity, private debt, direct lending, direct and indirect real estate, fund-of-funds, etc.) to complement their traditional equity and debt investments.
Common matters that may need to be considered include the following.
Alternative investments in the United States
The U.S. tax system is complex, and alternative investments into the U.S. market may give rise certain risks for Swiss pension funds, including:
- If the Swiss pension fund is allocated an amount of “effectively connected income” (ECI) from the U.S. investment, this will trigger a U.S. tax return filing obligation for the Swiss pension fund, plus potential U.S. tax liabilities.
- If the U.S. investment includes exposure to U.S. real estate assets (so-called “FIRPTA assets”), U.S. withholding taxes and U.S. tax return filing obligations may arise for the Swiss pension fund. However, these can generally be mitigated if the pension fund fulfills the criteria to be a “qualified foreign pension fund.”
Failure to comply with a U.S. tax return filing obligation, and late or non-payment of U.S. tax liabilities, can result in penalties and audit by the U.S. tax agency (IRS).
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 until now have made their alternative investments directly on the balance sheet of the pension fund, and borne the Swiss stamp transfer tax leakage—both on acquisition and on disposal.
However, a significant number of Swiss pension funds are now considering establishing a separate Swiss single-investor fund solely for their alternative investments (e.g., Swiss FCP or Swiss LP). The new Swiss “L-QIF” regulatory form may open new opportunities.
Income 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 income tax treaties in Switzerland’s treaty network. However, the administrative process to obtain such treaty benefits has become more burdensome in recent years, especially in instances when 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 tax treaty benefits, and this often means that custodians do not apply the reduced treaty rates at source (when 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.
Read an October 2021 report prepared by the KPMG member firm in Switzerland
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