The crux of withholding tax

In Switzerland, the so-called anticipatory tax serves as a kind of security tax. It enables the federal government to secure its tax revenue from capital gains. Let's take a closer look at anticipatory tax and its counterpart abroad, withholding tax.

Swiss anticipatory tax

Anticipatory tax is a security tax, i.e. a kind of deposit, which gives holders of securities a financial incentive to declare their investment income in their tax returns. For this reason, anticipatory tax is deducted at source. Anyone who owns a Swiss share that pays a dividend of 100 Swiss francs will only receive 65 Swiss francs from the bank. The remaining 35 percent, i.e. the anticipatory tax, initially goes to the federal treasury.

In order to reclaim it, shareholders declare their securities in their tax returns. A few months after the correct declaration has been made, the federal government refunds the tax previously withheld to the taxpayer. Of course, investment income, including interest income from bonds and distributions from funds, is still subject to ordinary income tax. The amount of this tax depends, among other things, on the taxpayer's place of residence and total income.

US withholding tax

Similar mechanisms exist abroad. For example, the US levies a withholding tax of 30 percent on dividends paid to foreign investors. The good news is that Swiss investors can reclaim the entire 30 percent in two steps.

Thanks to the double taxation agreement (DTA) between the US and Switzerland, investors resident in Switzerland can reduce the 30 percent to 15 percent. The condition for this is that the custodian bank is recognized by the US as a qualified intermediary. If this is not the case, or if you are a foreign citizen, you can alternatively submit the completed W-8BEN form to your custodian bank. This confirms your tax residence in Switzerland to the US. In this way, you receive 85 percent of the dividends paid out directly.

By correctly declaring US securities in your Swiss tax return, i.e. on Form DA-1, you can now have the remaining 15 percent credited in the US to avoid double taxation completely. Cantons such as Aargau, Appenzell Innerrhoden, Bern, and Vaud require you to fill out a separate form, R-US 164, «Application for refund of additional tax withheld by the US.» In the other cantons, including Zurich, this form is not necessary or is already included in the DA-1.

This procedure is relevant for US funds and equities. However, due to potential US estate taxes, some investors do not want to invest directly in US securities. In this case, funds or ETFs domiciled in Ireland are often the best alternative for Swiss investors who want to invest in US equities. These funds can be identified by their ISIN beginning with IE....

Thanks to a favorable tax agreement between the US and Ireland, these funds and ETFs are only required to pay 15 percent instead of 30 percent on dividends.

Laborious reclamation for individual securities

Switzerland has concluded double taxation agreements (DTAs) with over a hundred countries. This allows private investors to use the DA-1 form to claim back the portion of withholding tax that is retained in other European countries, for example.

However, reclaiming the portion of withholding tax not covered by the DTA involves considerable effort. You have to fill out the forms for each individual foreign country in which you own shares or other securities in the respective national language. The legal terms and abbreviations used on the applications are also challenging.

Furthermore, these processes are lengthy and usually even subject to fees. Depending on the custodian bank that has to submit the forms abroad, fees of several hundred dollars may be incurred. For small investors, these additional costs are not worthwhile from a purely financial point of view. And even holders of larger positions are happy to forego the tedious bureaucracy, which can take up to 24 months in Italy, for example.

Advantage of funds

Investors who invest in tax-efficient funds rather than individual securities leave the processes involved in reclaiming withholding tax from the respective countries to the fund provider. This saves investors the trouble of filling out foreign forms. A declaration in the local tax return is sufficient.

Those who invest in accumulating funds benefit optimally from the compound interest effect due to reinvestment. However, even if these funds do not pay dividends, the income is still subject to ordinary income tax in Switzerland.