US Switzerland Tax Treaty: Benefits and Rules

The United States and Switzerland maintain a bilateral income tax treaty to address issues of double taxation and coordinate on matters of fiscal administration. This agreement establishes rules for taxing income for individuals and companies with financial connections to both nations. The primary goals are to prevent the same income from being taxed by both countries and to establish a framework for preventing tax evasion. By clarifying taxing rights and obligations, the treaty seeks to foster economic cooperation and reduce barriers to cross-border trade and investment.

Determining Treaty Eligibility

The U.S.-Switzerland tax treaty establishes which country has the primary right to tax an individual or entity based on their “residency.” Under Article 4 of the treaty, a person is considered a resident of a country if they are liable for tax there based on criteria such as domicile, residence, or place of management. An individual could be considered a resident under the domestic laws of both the U.S. and Switzerland, creating a dual-residency scenario.

To resolve this, the treaty provides a series of “tie-breaker” rules that are applied sequentially. If one test is inconclusive, the next is applied until a single country of residence is determined. The tests for an individual are:

• The location of a permanent home.
• The country where their personal and economic relations are closer (center of vital interests).
• The individual’s habitual abode.
• The country of nationality.

If a single state of residence cannot be determined through these steps, the competent authorities of both countries are tasked with settling the question by mutual agreement.

The “Saving Clause,” found in Article 1, preserves the right of the United States to tax its citizens and certain residents as if the treaty did not exist. This means that even if a U.S. citizen is determined to be a resident of Switzerland under the tie-breaker rules, they remain subject to U.S. taxation on their worldwide income.

There are exceptions to the Saving Clause that allow specific treaty benefits to remain available to U.S. citizens. For example, the articles related to relief from double taxation, non-discrimination, and the mutual agreement procedure are not overridden by this clause. Benefits related to social security payments and certain government pensions are also preserved.

Taxation of Specific Income Types

The U.S.-Switzerland tax treaty provides specific rules for various categories of income, modifying the domestic tax laws of each country to prevent double taxation. These provisions determine which country has the primary right to tax certain income and often limit the tax rate that can be imposed by the source country.

Dividends

Article 10 of the treaty addresses the taxation of dividends paid by a company in one country to a shareholder residing in the other. The treaty sets maximum withholding tax rates, capping the rate at 15% for portfolio investors. A lower rate of 5% applies if the beneficial owner of the dividends is a company that holds at least 10% of the voting stock of the dividend-paying company. Without the treaty, the statutory withholding rate in the U.S. would be 30%.

Interest

Under Article 11, interest income is generally exempt from tax in the country where it arises if the beneficial owner is a resident of the other country. This means that interest paid from a U.S. source to a Swiss resident is not subject to U.S. withholding tax, and vice versa. This exemption does not apply if the interest is attributable to a “permanent establishment” or a “fixed base” that the recipient has in the source country.

Pensions, Annuities, and Social Security

The treaty distinguishes between private pensions, government-service pensions, and social security payments. According to Article 18, private pensions and other similar remuneration are taxable only in the recipient’s country of residence. The Saving Clause, however, can impact the taxation of private pensions for U.S. citizens, potentially allowing the U.S. to tax a pension even if the recipient resides in Switzerland.

Pensions paid for government service are treated differently under Article 19 and are generally taxable only by the country that is paying them. Social Security payments fall under special rules, giving the paying country the sole right to tax the benefits.

Capital Gains

Article 13 outlines the rules for taxing capital gains. The treaty allows gains from the sale of real property to be taxed in the country where the property is located. Gains from the sale of other types of property, such as stocks or bonds, are taxable only in the seller’s country of residence. An exception exists for gains from the sale of personal property that is part of a permanent establishment, which can be taxed where the permanent establishment is located.

Business Profits

The taxation of business profits is governed by Article 7, which introduces the concept of a “permanent establishment” (PE). A PE is a fixed place of business, such as an office or factory, through which an enterprise carries on its business. The business profits of an enterprise from one country can only be taxed by the other country if the enterprise has a PE there. If a PE exists, the source country can tax the profits, but only to the extent that they are attributable to that PE.

The Limitation on Benefits Provision

The Limitation on Benefits (LOB) article, found in Article 22, is designed to prevent “treaty shopping.” This practice occurs when residents of a third country structure their investments through a Swiss or U.S. entity to gain access to the treaty’s reduced tax rates. The LOB article ensures that only bona fide residents of the U.S. and Switzerland with a substantial connection to one of the countries can enjoy the treaty’s advantages.

To receive treaty benefits, a resident of one of the countries must be a “qualified person.” The LOB article provides a series of objective tests that an individual or entity can meet to be considered a qualified person. Meeting any one of these tests is sufficient to establish eligibility.

Publicly Traded Company Test

One of the most straightforward tests is the publicly traded company test. A company is a qualified person if its principal class of shares is regularly traded on a recognized stock exchange in either the U.S. or Switzerland.

Ownership and Base Erosion Test

Another test is the ownership and base erosion test. This two-part test requires that at least 50 percent of the company’s ownership is held by qualified persons. It also requires that less than 50 percent of the company’s gross income is paid out to non-residents in the form of deductible payments, such as interest or royalties.

A company that fails these primary tests may still qualify for benefits if it is engaged in an active trade or business in its residence country. This applies if the income derived from the other country is connected to that business.

Claiming Treaty Benefits

Individuals and entities eligible for benefits must formally claim them on their U.S. tax return. This process requires filing Form 8833, Treaty-Based Return Position Disclosure Under Section 6114. Filing this form is necessary whenever a taxpayer takes a position that a U.S. tax treaty overrules or modifies an aspect of U.S. tax law.

Completing Form 8833 requires the taxpayer to provide specific information about their claim. The taxpayer must identify the specific treaty and the article(s) under which they are claiming benefits. The form also demands a concise summary of the facts on which the treaty-based position is based, including why the taxpayer is eligible for the benefit. The taxpayer must also provide a brief explanation of the law or provision being modified by the treaty position.

Failure to file Form 8833 when required can result in penalties. The penalty for an individual can be $1,000 per failure, while for a C corporation, it can be $10,000.

Exchange of Information and Administrative Assistance

The U.S.-Switzerland tax treaty contains provisions that facilitate cooperation between the tax authorities of both nations. Governed by Article 26, this allows the U.S. and Switzerland to request and obtain information relevant for carrying out the treaty or for enforcing their domestic tax laws. This exchange is not limited by domestic bank secrecy laws, representing a tool in combating tax evasion.

This framework for information exchange is related to the Foreign Account Tax Compliance Act (FATCA). FATCA requires foreign financial institutions to report information about financial accounts held by U.S. taxpayers to the IRS. Switzerland has entered into an intergovernmental agreement with the U.S. to facilitate FATCA reporting by Swiss financial institutions.

The practical implication for a U.S. person with a bank account or other financial assets in Switzerland is a high likelihood of automatic reporting. Information such as the account holder’s name, address, U.S. taxpayer identification number, and account balance is regularly transmitted to the IRS. This gives U.S. tax authorities visibility into the foreign financial activities of U.S. taxpayers.