Double taxation treaties

When income crosses a border, two states may claim to tax it: the one where the income arises and the one where the recipient resides. This is juridical double taxation, and without correctives it would make any cross-border activity unsustainable. Double taxation treaties (DTTs) serve exactly this purpose: allocating taxing power between the two countries and preventing the same franc from being taxed twice. Switzerland has around a hundred of them in force, with almost all its relevant economic partners.

What a treaty actually does

A DTT does not abolish taxes: it distributes the right to tax between the source state and the residence state. For each category of income the treaty establishes who may tax, to what extent and how any residual double levy is eliminated. The rules largely follow the OECD Model, which makes treaties comparable to one another in structure.

The typical areas:

• Business profits: taxed in the state of residence, unless the enterprise operates in the other state through a permanent establishment (a fixed place of business). In that case the source state taxes the profits attributable to that presence.
• Dividends, interest, royalties: the source state may withhold a tax, but within a maximum treaty rate, often well below the domestic one.
• Employment income: as a rule taxed where the work is performed, with specific rules for cross-border commuters and secondments.
• Real estate: taxed where the property is located.

The question of tax residence

Everything starts from one question: where the taxpayer is resident. A person or a company cannot invoke a treaty unless it is resident in at least one of the two states. When both countries consider it resident, the DTT applies the so-called tie-breaker rules: for individuals, what counts is a permanent home, centre of vital interests, habitual abode and nationality; for companies, what counts is the place of effective management.

This interplay is delicate for the entrepreneur who sets up a Swiss company but lives abroad: if effective management remains across the border, the treaty may relocate the company’s residence and defeat the structure.

Withholding tax and reduced rates

Switzerland levies a withholding tax of 35% on dividends and on certain interest. It is a high security levy, designed to be recovered. For the foreign beneficiary, the treaty reduces the tax to the agreed rate and allows a refund of the excess. In practice:

• the reduced rate is applied directly, where the treaty permits, or
• the 35% is withheld and the refund of the difference is claimed using the appropriate form.

Without activating the treaty, that 35% remains tied up or even lost: a procedural, not substantive, error that costs real liquidity.

How double taxation is eliminated

When both states retain a right to tax, the residence state applies one of two methods:

• Exemption: income already taxed abroad is exempted at home (often with a progression reservation).
• Tax credit: income is taxed at home, but the tax paid abroad is set off.

For foreign income subject to withholding tax at source, Switzerland provides mechanisms of lump-sum tax credit (computo globale) that avoid the double burden. Knowing which method applies changes the net result appreciably.

Recurring mistakes

• Taking the domestic rate for granted: without activating the DTT you pay more than due.
• Ignoring the permanent establishment: an operational presence abroad can shift the taxation of profits.
• Overlooking refund deadlines: claims have precise time limits, beyond which the right lapses.
• Confusing formal residence and effective management: it is the latter that counts in doubtful cases.

How we handle it

At SIH ONE we start from the map of flows: who pays, who receives, in which state and on what basis. We check the applicable treaty, identify the reduced rates, manage the reduction and refund of the withholding tax and coordinate the method of eliminating double taxation with the client’s personal position.

Do you have flows between Switzerland and abroad and want to avoid paying twice? Let’s check the right treaty for you.