Revised proposal for a new Swedish law on withholding tax on dividends – are there any news regarding securities lending and dividends to funds?

On 7 June 2022, the Swedish Ministry of Finance published a revised proposal regarding a new law on Swedish withholding tax on dividends that will replace the current Swedish Withholding Tax Act. The revised proposal contains several changes to the initial proposal published in April 2020, which can be read about here. The consultation period for the revised proposal was due on 7 October 2022. This article contains comments on the revised proposal with regards to tax liability for foreign UCITS funds and foreign special funds, securities lending and approved intermediaries. 

Withholding tax liability

According to the current Swedish Withholding Tax Act, the person entitled to the dividend is subject to withholding tax if the person is a natural person, the estate after such a person or a foreign legal entity. The person entitled to the dividend is the one entitled to collect the dividend for its own benefit at the time of the dividend distribution. In the revised proposal, it is proposed that a person who is not subject to unlimited Swedish tax liability and who is entitled to the dividend should be subject to withholding tax. In comparison to the current legislation, this means that foreign associations which are not legal entities can also be liable to withholding tax. 

The assessment of who is entitled to the dividend is proposed to be made in a civil law context, which is in accordance with the current Swedish Withholding Tax Act. This usually, but not always, means that the registered shareholder is liable for withholding tax even if the right to dispose over received funds may be limited. This interpretation differs from the initial proposal, according to which the interpretation was proposed to be aligned with the meaning of the term “beneficial owner” in an international context. See Deloitte’s article regarding the differences between the initial and revised proposal with respect to tax liability.

Exemption for foreign UCITS funds and special funds

In the revised proposal, it is proposed that dividends to foreign undertakings for the collective investment in transferable securities (UCITS) funds and foreign special funds that are resident within the European Economic Area (EEA) should be tax-exempt. The same is proposed to apply for foreign special funds that are resident in a state outside the EEA with which Sweden has concluded a double tax treaty containing an article on information exchange. This proposal is in line with the current Swedish Withholding Tax Act and does not entail a change as such. 

The initial proposal, however, proposed to include definitions of the terms “foreign UCITS funds” and “foreign special funds” in the new legislation. It was pointed out, inter alia, by the consultation bodies that it should be clarified that there is no requirement on the legal form for the definition of a foreign special fund to be met (this due to the judgement from the Swedish Supreme Administrative court, case number HFD 2020 ref. 3). 

Contrary to the initial proposal, such definitions are not proposed in the revised proposal. Instead, it is proposed that the meaning of a foreign UCITS fund is equivalent to such fund companies covered by the Swedish Act on Investment Funds. In order to be considered a foreign special fund according to the revised proposal, it is proposed that the fund essentially is comparable to a Swedish special fund and is subject to the same civil law regulations, although a complete resemblance between the Swedish and the foreign conditions is not required. The foreign fund should generally be subject to the same requirements that are applicable for Swedish special funds with regards to investment strategy, openness and the principle of risk spreading. According to the revised proposal, the tax treatment of the foreign fund in its country of residence should not be relevant in this assessment, which means that even a fiscally transparent company could be considered a foreign special fund. The assessment of whether a foreign special fund is comparable to a Swedish special fund is suggested to be made on a case-by-case basis.

Securities lending

In the initial proposal, securities lending arrangements (and related manufactured dividends) and so-called cum-cum setups were a debated topic. Securities lending arrangements entail that a person (natural or legal) lends securities to another person. From a Swedish civil law perspective, such arrangements mean that the legal ownership of the securities is transferred to the borrower and that the lender does not retain any rights regarding the lent securities, such as the right to dividend distributions.  

The initial proposal contained several approaches to prevent tax abusive practices through securities lending. In a situation where a borrower receives a dividend and at the same time has entered into an agreement to pay manufactured dividend to the lender, it was proposed that the lender, as a starting point, would be considered entitled to the dividend and thus liable for tax, even if the actual dividend was received by the borrower. This since the lender is the one that obtains the actual financial benefits of the dividend. A special rule on tax liability was also proposed, which implied that the borrower could also be considered as entitled to the dividend and thus liable for withholding tax. The application and the correlation of the rules regarding tax liability was not clear and the initial proposal was therefore heavily criticized in these parts. The initial proposal was therefore not considered to be an effective way to prevent tax avoidance, inter alia with regards to the fact that the proposal was not in accordance with double tax agreements entered into by Sweden.

In the revised proposal, security lending agreements are not as debated as in the initial proposal. It is stated that security lending agreements normally are entered into without the purpose of avoiding taxation for either party, e.g., because the borrower is speculating on a price drop (short selling). Contrary to the initial proposal, it is now proposed that the civil law interpretation should be applicable also in relation to security lending agreements. This even though share lending is treated differently from a Swedish corporate income tax perspective depending on whether the shares are lent for short selling or not. This means that the person who lent the shares prior to a dividend distribution and therefore does not hold the shares when the dividend is paid, should not be considered entitled to the dividend and therefore not subject to withholding tax on the dividend. Instead, it is proposed that the borrower in a security lending agreement should be considered as entitled to the dividend, even though it has been agreed that the borrower should compensate the lender through a manufactured dividend.

agreed that the borrower should compensate the lender through a manufactured dividend.However, the revised proposal contains a special rule on tax liability which could become applicable for security lending agreements that take place for the purpose of tax avoidance. The rule implies that tax liability may be triggered although no legal ground as such exists for levying withholding tax, provided that the agreement is predominantly aimed at obtaining an undue tax benefit. This means that it is still the borrower that will be considered tax liable for the dividend, however, even though the borrower is subject to unlimited tax liability in Sweden (such persons are generally not subject to withholding tax) or would otherwise have been exempt from withholding tax liability. This new tax avoidance rule is not intended to be applied in violation of existing double tax treaties, but the procedures covered by the rule should in principle be those that are also assessed as tax avoidance according to double tax treaties.

Approved intermediary 

The starting point is that the company making the dividend distribution is ultimately the one that is obliged to withhold tax on the dividend. An option was proposed in the initial proposal to allow a company other than a distributing company or a fund to assume the responsibility to withhold, declare in a special tax return and pay withholding tax on dividends; a so-called approved intermediary. This was suggested to be possible only after approval from the Swedish Tax Agency. The proposal entailed a change of the current legislation under which institutions holding nominee-registered shares are responsible for withholding tax on dividends. According to the initial proposal, in a situation where an institution holding nominee-registered shares would not be an approved intermediary, the responsibility for withholding the tax was suggested to be put on a party that would not necessarily have the required information of the person who has the right to the dividends, e.g., the fund management company. This was criticized by the consultation bodies.

Deloitte’s comments

The clarifications and updates regarding security lending agreements in the revised proposal are awaited. The initial proposal, which had a significantly greater focus on such agreements, raised many questions and application issues. The revised proposal may appear to be somewhat more foreseeable and less complicated to apply in practice. However, the revised proposal still entails several interpretation and application difficulties. Some of the consultation bodies consider e.g., that there is a lack of sufficient guidance regarding the assessment of who is entitled to the dividend in transactions with similar financial implications as security lending agreements. Some of the consultation bodies also continue to question the system of approved intermediaries, which is unique in its kind and does not resemble any system applied in other countries. The incentives for foreign companies to become approved intermediaries are argued to be few and a possible consequence is therefore that the possibility for a relief at source will not be used to the extent as intended. Thus, it is argued that the number of applications for tax refunds will increase.

The possibility for foreign UCITS funds and foreign special funds to continue to be exempt from withholding tax is expected. It may initially appear to be negative that the revised proposal (in contrary to the initial proposal) proposes not to include definitions of foreign UCITS funds and foreign special funds, especially due to the fact that the Swedish Tax Agency has previously had the opinion that foreign persons with legal personality cannot be considered comparable to foreign special funds. Unfortunately, the proposal does not clarify how such an assessment should be made. On the other hand, developments in case law may be considered as sufficient to support that legal personality should not alone be decisive in the assessment of whether a foreign fund should be considered comparable to a Swedish fund. The Swedish Tax Agency has also recently published a written standpoint (with ref. No.: 8-1893666) which is very welcomed, since the Swedish Tax Agency now has clarified its view that the legal form of foreign equivalents to both Swedish UCITS funds and special funds is not decisive for the comparability analysis under the Swedish Withholding Tax Act. Thus, the Swedish Tax Agency appears to have changed its view and confirms that funds that are foreign persons with legal personality can also be comparable to a Swedish special fund.

It will be interesting to follow the development of the revised proposal on withholding tax on dividends, as it is known today, and if it will remain the same now after the consultation bodies’ responses have been published. We are monitoring this development. 

If you have any questions about withholding tax, do not hesitate to contact our tax experts.