Many entrepreneurs wonder whether they should distribute profits each year or rather leave them in the company. From a tax perspective, it can be advantageous to retain profits in the business instead of paying them out regularly and being taxed as income. If the shares of the company are sold later, you realize a tax-free capital gain – and in the best case “sell the full wallet” including retained profits, because the sale proceeds are correspondingly higher. This is precisely where indirect partial liquidation comes into play. This special rule can result in the tax-free capital gain being retroactively reclassified as taxable income. However, those who know the rules can prevent this and make use of the advantage – but must also ensure that the buyer does not drain the company’s cash within the next five years.
The Relevant Legal Basis and Constituent Elements
The concept of indirect partial liquidation is governed by the Federal Act on Direct Federal Taxation (DFTA), Art. 20a para. 1 lit. a. From this provision, you can extract the individual elements that must be met for an indirect partial liquidation to exist.
To illustrate these elements and their application, Circular No. 14 of the Swiss Federal Tax Administration (FTA) is also relevant. The FTA’s circulars are administrative guidelines that concretize and harmonize the interpretation and application of tax laws. While they primarily bind the tax authorities, in practice they are highly significant for legal certainty for taxpayers and advisors, serve as orientation in applying the law, and are publicly available on the FTA’s website.
The Conditions at a Glance
- Sale for Consideration
This refers to a normal sale of company shares for money or also an exchange.
- 20% Threshold
The rule applies only once at least 20% of the company changes hands. This threshold can also be reached through several sales within five years – or when several sellers act together.
- System Change
Indirect partial liquidation requires that an individual sells participation rights from their private assets and that the participation ends up in the buyer’s business assets – either in the business assets of an individual (including elective business assets) or in those of a legal entity (always business assets there). This system change is the crucial point.
- Five-Year Period
The law scrutinizes the five years following the sale very closely. Distributions of substance during this period are critical. Each new sale triggers its own five-year period.
- Distribution of Substance
These include not only dividends but also hidden profit distributions and benefits in kind – for example, loans or guarantees provided by the target company in favor of financing the purchase. The key question is always: do funds flow out of the company to finance the purchase price or its funding?
- Distributable, Non-Business-Essential Assets
Only what was already distributable at the time of sale and not required for business operations is relevant. Profits generated after the sale are not problematic. Whether assets are essential to business depends on their economic function and is assessed on a case-by-case basis.
- Seller’s Involvement
The seller must be involved in some way – actively, by granting loans or allowing guarantees, or by enabling other measures that make later financing of the purchase out of the company possible. Or passively, if it was apparent that the financing of the acquisition would not work without distributions of substance from the company. What matters is not only actual knowledge but also whether the financing situation was recognizable.
Legal Consequences – What Happens in an Indirect Partial Liquidation?
If the requirements of an indirect partial liquidation are met, the seller loses an important advantage: the otherwise tax-free capital gain is partly reclassified as taxable income. In practice, this means:
- Taxation as Income
The affected part of the sales proceeds is taxed as investment income.
- Measurement by the “Smallest Amount”
The taxable amount is only the smallest of: (i) sale proceeds, (ii) amount distributed, (iii) reserves existing at the time of sale, and (iv) non-business-essential assets – each proportionate to the participation sold.
- Consequences for Buyers and Company
The tax consequences primarily affect the seller. For the buyer and the target company, the general rules apply (e.g., dividend taxation, withholding tax), without any additional special burden due to the indirect partial liquidation.
Need for Action – What Sellers Should Pay Attention To
For entrepreneurs planning succession or a sale, indirect partial liquidation is a topic with two sides: a tax opportunity if profits are retained in the company, and a risk if the buyer extracts substance after the sale. In practice, a multi-step approach is advisable:
- Early Analysis of Financing
Even before the sale, you should examine how the buyer will finance the purchase price. Pure debt financing that cannot be sustained without later distributions of substance carries particular risk.
- Contractual Safeguards
Contractual provisions can help: dividend blocks, restrictions on loans or guarantees, as well as reporting obligations. In addition, indemnification clauses, warranties, or purchase price adjustments (e.g., via escrow or indemnity) can be agreed to protect the seller in case of subsequent taxation.
- Documentation and Traceability
Clear documentation of financing, use of funds, and business development provides legal certainty – especially for distinguishing between “old substance” and new profits.
Conclusion
Indirect partial liquidation is not only a risk but also a genuine planning opportunity. Instead of paying out profits regularly and being taxed, you can retain them in the company and later sell them tax-free as part of your shares, benefiting from a higher sale price – the “full wallet.” To preserve this advantage, however, the rules must be observed: in particular, the five-year period and the handling of distributions of substance are crucial.
Those who seek advice early and secure themselves contractually can not only manage the risk but above all achieve one thing: a tax-optimized exit.
