Transferring profits to private assets: What entrepreneurs need to keep in mind
It is one of the key questions of any entrepreneur: What options do they have available to transfer profits from their company to their private assets while paying as little in taxes as possible? How can they respect their obligations under corporate law but lower their wealth taxes and create optimal conditions for transferring equity at any time? What effect will corporate tax reform (Tax Proposal 17) have on these questions?
When entrepreneurs are deciding what strategy to apply in order to transfer excess liquidity and the current free cash flow from their company to their private assets while paying the least amount possible in taxes, there are two main strategies: reinvestment and withdrawal. In the case of the former, the net profit is not distributed, and the focus is placed on a tax-free capital gain as part of a sale of equity. This strategy is used only in rare instances, however, because the buyer is usually not prepared to finance a corporation with a high amount of excess liquidity. Furthermore, cases such as this can create problems involving indirect partial liquidation. Under Tax Proposal 17, this option is set to become even less attractive in the future – in most cantons at least. If the gains earned through operations cannot be reinvested profitably and it is not in the company's interest to pay off debt, then the available liquid funds should be paid out to shareholders in accordance with the shareholder value approach. This will prevent the Board of Directors from planning to engage in unprofitable capital spending or initiating an acquisition strategy that is not in line with the company's policies simply because the funds are available.
Basic questions for withdrawing funds
Before business owners can choose which method of withdrawal to use, they first need to ask themselves some basic relevant questions, such as:
- Does the company have excess liquidity?
- Is there a way to transfer funds back to natural persons who hold their equities in their private assets without affecting taxes by lowering the par value or repaying capital contribution reserves?
- Is there a need to buy back treasury shares, thereby transferring funds to individual shareholders or all shareholders?
- Are there ways to pay a non-cash dividend, for instance by having holding, domiciliary, or mixed companies distribute their securities safekeeping accounts to shareholders so that the shareholders can receive the future capital gains on their investments tax free?
- Is there a safe and profitable investment strategy in place, one that takes into account the entrepreneur's private income and financial situation, for the funds that he or she is to receive?
- In this context, does the company have a top management (bel-étage) "1e" pension plan so that withdrawals can be transferred to tied pension provision?
Once these and other relevant questions have been answered – ideally in close consultation with specialized financial and tax experts – the next step is to choose the right method of withdrawal. Business owners who wish to do so need to take Tax Proposal 17, which is currently being debated, into account as well as the new options created as part of pension provision, especially "1e" pension plans.
Methods of withdrawal
Entrepreneurs have various methods of withdrawal at their disposal. Their choice should always be made in consideration of the respective individual and overall financial situation as well as their associated financial goals.
Salary and the Federal Act on Occupational Retirement, Survivors' and Disability Pension Plans: In view of Tax Proposal 17, cantons are planning to lower their regional corporate income tax rates. If a corporation increases the entrepreneur's salary to more than CHF 126,900*, it now has the option of introducing a "1e" pension solution. By giving the owner a raise, the company also increases its wage expenses and the employer contribution to the entrepreneur's employee benefits insurance, which is a way for the entrepreneur to withdraw funds from the company over the long term. Moreover, it creates a contribution gap. The entrepreneur can close that gap by making additional purchases, which lowers the amount of taxable income. With regard to the entrepreneur's tied pension provision, the income is exempt from income tax and the accumulated capital is not subject to wealth tax. In addition, the increased expenses for compensation and benefits lead to a reduced capitalized income value, which is reflected in the company's taxable value of assets.
Dividend: Withdrawal of excess liquidity in the form of a dividend distribution, including recognized forms such as extraordinary dividends and advance dividends. It may also be attractive to distribute existing securities safekeeping accounts belonging to a holding, domiciliary, or mixed company to the shareholders as non-cash dividends before the law amended in accordance with Tax Proposal 17 (and the expected higher partial taxation rates) enters into force. The fact that capital gains achieved in one's personal assets from the sale of securities are generally tax-free makes this option even more enticing. The possibility of whether a holding company should be transformed into a parent company or a domiciliary company should be liquidated also needs to be examined. By creating a parent company structure, a business might be able to reduce its shareholder's wealth taxes. In addition, the company should examine whether the shareholder ought to hold its shares through a personal holding company.
Shareholder loans: The shareholder can finance the corporation's business operations by means of a shareholder loan instead of equity capital. If the company's need for financing or liquidity declines at least partially – whether temporarily or permanently – it can pay back the loan quickly even during the current financial year. That may also be a way to distribute funds to various shareholders, regardless of their ownership interest but based on their financing ratios (taking the loans into account). If the corporation has a justified need for additional capital later on, shareholder loans can be quickly granted once more.
Share buyback: Corporations can buy back their treasury shares for a wide variety of reasons: to "buy out" a current shareholder, to provide participation rights for an employee participation plan, to create convertible bonds or warrant bonds, or to have currency for an acquisition. However, there are some principles that need to be followed. If a corporation purchases its treasury shares for the purpose of destroying the securities and lowering the associated par value, then the security's return on equity will increase. Repurchasing treasury shares with a view to carrying out a capital reduction is treated as a partial liquidation of the company buying back the stock for the purposes of Swiss withholding tax and direct taxes. If only individual shareholders are selling their holdings to the corporation, then the company acquires the securities asymmetrically. If the company makes a buyback offer to all shareholders and issues put options as rights of redemption, it is adhering to the principle of pari passu and enabling the shareholders who hold shares in their private assets to take part in the share repurchase. If a corporation buys treasury shares with the aim of reselling them, at a profit if possible, within the period permitted by law, it is not only distributing funds to its shareholders but also making an investment in itself.
Repayment of capital contribution reserves or par value: As part of Tax Proposal 17, there is once again discussion about limiting the option to repay capital contribution reserves. The Council of States' Committee for Economic Affairs and Taxation (CEAT) favors introduction of the principle of proportionality, which means the corporation paying back the capital contribution reserves should at the same time distribute a portion of its profits. How high that ratio needs to be – perhaps 2:1 or 1:1 – is still being debated. The recommended course of action is to give top priority to examining and planning a withdrawal of capital contribution reserves. A par value reduction can be examined at any time and executed in compliance with amended corporate law. The repayment is tax free at the federal level and generally at the cantonal level as well.
Bonus shares and increase in par value: "Bonus shares" are equities that have been paid up from funds belonging to the company. Shareholders without sufficient liquid assets can use these kinds of shares to increase their equity holdings in the company. In other works, this is also a means of withdrawing funds. Furthermore, the par value of all existing equity securities can be increased by paying them up using funds belonging to the company. Depending on the shareholder's canton of residence, the increase in par value carried out will be subject only to direct federal tax.
Shifting non-operational assets or excess liquidity to entrepreneurs reduces their degree of dependence on the company, giving owners the financial and legal freedom to diversify their wealth across different asset classes – in other words, to perform comprehensive asset structuring and planning. Diversification remains the most important basic rule when it comes to investment of assets. Although every entrepreneur knows this rule, it is often ignored. Entrepreneurs' total assets often contain significant risk concentration from investments in companies and retained corporate profits.
It is important for entrepreneurs to carefully address the issue of diversifying their liquid and illiquid assets. That is why they need to consult an expert to define their personal risk and return profile so their assets can be restructured and continuously monitored. Financial literature refers to the benefits of diversification in the context of portfolios as "the only free lunch" on the markets. The various methods of withdrawing funds should be used to the advantage of the entrepreneur and, during the advisory process, the entrepreneur's overall tax situation needs to be analyzed and a timely and tax-neutral transfer of excess liquidity to their private assets examined. All the while, the entrepreneur's overall strategy, with respect to succession management, for example, must also be taken into account.
* As of January 1, 2019, the entry threshold (minimum annual salary) for 1e plans increases to 127,980 francs.