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Private capital gains

Entrepreneurs in Switzerland thinking of selling the businesses they have built up over a lifetime can relax again. So can the Swiss MBO and LBO market. After a heated two-year debate, the Swiss parliament has finally fixed up the mess that was created by the Swiss Supreme Court in its controversial decision rendered in June 2004.

Before June 2004, both the federal and cantonal tax authorities had a consistent practice in their assessment of capital gains realized when one or more private shareholders sold out to a business investor. These capital gains were considered private and therefore income-tax free under two cumulative tests: (i) the purchaser did not receive, in the five years post acquisition, any dividends or constructive dividends out of the target's free reserves existing as of the acquisition; and (ii) the purchaser and seller did not collaborate in making these dividends or constructive dividends. As long as dividends and constructive dividends were made out of profits earned post acquisition, leverage and management buyouts could be structured without resulting in a taxable capital gain for private sellers. The Swiss Supreme Court in its June 2004 decision ended this favourable tax treatment, raising much insecurity for the Swiss MBO/LBO scene.

On June 23 2006, the Swiss parliament enacted various amendments to the Federal Income Tax Act of December 14 1990, applicable retroactively to non-final tax returns covering profits earned in the tax years 2001 and later and still subject to a possible referendum. Any income taxation should now be limited, as a first test, to MBOs/LBOs where dividend and constructive dividends are made out of non-operating free reserves existing as of the acquisition. As a second test, the seller's passive collaboration would be given if they knew or should have known that the dividends or constructive dividends were used to finance all or part of the purchase price for the target in an MBO or LBO. The tax authorities and tax courts usually presumed this second test met in the past and will, most probably, continue to do so.

Thomas Rihm

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