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Switzerland: Embracing the worldwide trend of increasing substance requirements

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Reto Savoia


Yan Hurdowar

In a fast-evolving tax world characterised by increased scrutiny from tax authorities, politicians and the general public, addressing substance requirements has become a key concern for multinationals. While substance is a wide-ranging term from a tax standpoint, it is the issue of economic substance which is increasingly under focus. Economic substance (or tax substance as it is sometimes called) stands for the actual business activities of a company and its effective role within a wider group. The economic substance of a company is typically assessed based on its personnel (headcount, level of skills and remuneration), the significant people functions it undertakes, the risks it assumes as well as the key assets (for example valuable trade and marketing intangibles) it owns. Recent tax surveys provide clear evidence that tax audits increasingly target the correlation between the taxable income of multinationals' operating entities and the level of economic substance of such entities. In such audits, taxpayers, who are unable to demonstrate adequate economic substance, frequently find themselves having to defend where their effective place of management is or why no deemed permanent establishment arises from the way they conduct their business. Recent trends also demonstrate a growing tendency by tax authorities to re-assess the remuneration of intra-group transactions based on their actual economic substance, for example arguing for profit split methodologies for IP generating activities and in more extreme cases, even seeking a recharacterisation of such transactions.

Substance has been put at the forefront of the tax agenda with the July 2013 OECD Action Plan on BEPS stating its firm objective of preventing "practices that artificially segregate taxable income from the activities that generate it." There is a clear intention to tackle substance issues through the following actions: counteracting harmful tax practices (Action 5), the prevention of treaty abuse (Action 6), the prevention of artificial avoidance of PE status (Action 7), aligning transfer pricing outcomes with value creation (Actions 8, 9 and 10). Further, multinationals can anticipate unprecedented visibility on the location of their value generating activities and where their profits are taxed on the back of transparency measures enforced through information exchange provisions and Action 13 of the BEPS Action Plan on transfer pricing documentation.

Switzerland is ideally positioned to take advantage of the aforementioned developments since Swiss based global/regional hubs already have significant substance by virtue of their highly skilled personnel, the valuable intangibles they own and exploit as well as their strategic importance in global value chains. Already, Swiss taxpayers have to abide by several economic substance thresholds when applying for existing Swiss tax regimes. The upcoming Swiss Corporate Tax Reform III should also prove favourable as preferential tax regimes such as the licence box, with incentives such as R&D&I deductions and tax credits, are anticipated to enhance the degree to which Swiss taxpayers can benefit from their existing economic substance. These incentives coupled with other tax opportunities such as notional interest deductions and an overall decrease in the headline cantonal tax rate are expected to enable Switzerland to remain a location of choice for its attractive tax system.

Reto Savoia (rsavoia@deloitte.ch)

Tel: +41 58 279 6357
Yan Hurdowar (yhurdowar@deloitte.ch)

Tel: +41 58 279 8152

Deloitte

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