The new Swiss VAT regime which came into force on January 1 2010 makes Switzerland an even more attractive location, particularly for holding companies. Further development of Swiss tax laws and the practice of the tax authorities intend to increase the attractiveness of Switzerland as a location for international corporations and in particular for group financing activities.

New VAT regime for holdings and acquisition vehicles

In the last few years and months, VAT has been increasingly important for governments around the world – even the US is considering the implementation of a federal VAT system. Value added tax is not only different from other taxes because it has to be self-declared; it is also one of the few taxes which it may be advantageous to pay. If a business performs an entrepreneurial activity and is VAT registered, the VAT incurred on expenses and investments can be recovered from the revenue authorities. As the mere holding of participations is so far not considered as an activity within the scope of VAT, holding companies did not perform an entrepreneurial activity for VAT purpose and could not get VAT registered in many instances.

For many years now, European VAT professionals have been discussing the question of whether holding participations qualifies as entrepreneurial activity for VAT purposes or not. So far, settled case-law, especially within the EU, stated that the mere acquisition, holding and selling of participations do not constitute an entrepreneurial activity and is thus not subject to VAT. Such a business activity would however be necessary to reclaim VAT incurred on expenses and investments.

In its recent AB SKF decision (C-29/08), the European Court of Justice (ECJ) had to judge the case of a company intending to sell its participations to collect cash to finance other taxable activities of the company. The local tax office accepted as a first step the deduction of input VAT incurred with the acquisition of the shares as AB SKF rendered taxable managing services to the subsidiaries. Thus, input VAT incurred with the cessation of the business activity (by selling the shares) would also have to be deductible. The superior Central Bureau of Finance appealed to the ECJ against the decision of the local tax office, requesting that such sale of shares does not allow the deduction of the input VAT incurred in this connection.

The ECJ accepted that in this case the sale of shares qualified as business activity. However, the ECJ also stated that selling shares remains a VAT exempt activity under article 135, paragraph. 1 lit. f of the Recast 6th Directive without the right to deduct input VAT. Furthermore, the ECJ stated that input VAT incurred in connection with a sale of shares is only recoverable if there is a direct relation with the overall business activity of the company or the related costs are incorporated in the taxable products or services of this company.

Further to this decision, input VAT incurred when selling shares for reorganisation purposes might not be deductible within the EU or only under strict conditions. Value added tax on legal, consultancy and other fees in this respect would thus constitute an irrecoverable cost to EU holdings and acquisition vehicles.

This decision cannot be transferred into the general situation under the Swiss law. Originally, in 1994 the legislature categorised dividends as outside the scope of VAT ("non-turnover"). This category hence was always different to the receiving of consideration for tax exempt supplies such as the sale of shares. Nevertheless, as the practice developed, the tax administration held that VAT recovery on expenses and investments is only possible in case of a direct link of the expenses or investment to the provision of a taxable supply. This practice resulted in a general restriction of VAT recovery on expenses incurred in the framework of acquiring, holding and selling of shares (share deal). At the same time, VAT recovery on expenses incurred when the acquiring or disposal of a set of assets and liabilities that constituted a unit in an enterprise viable by itself (asset deal) was possible in most instances.

Under the new Swiss VAT law, there are a few fundamental changes. First, the provision of taxable supplies is no longer conditional on the right of recovering VAT on expenses and investments. Instead, the entrepreneurial activity itself is the condition for VAT recovery. It is noteworthy that also the provision of tax exempt supplies is deemed to be entrepreneurial. By definition, "a person carries on a business, who [a.] independently performs a professional or commercial activity with the purpose of the sustainable earning of income from supplies; and [b.] acts externally under his own name" (article 10 paragraph 1 VAT law). Still, there is no right to input tax deduction on supplies which are used for the rendering of tax exempt supplies.

Second, there is a category of flows of funds that do not qualify as consideration for the lack of a supply. Capital contributions, interest-free loans, recapitalisation payments, forgiveness of debt, dividends and other profit shares are within this category. Article 33 paragraph 1 VAT law rules explicitly that such flows of funds do not result in a reduction of the input tax deduction.

Third, article 29 paragraph 2 of the Swiss VAT law states that there is a right for input VAT deduction, in the course of the business activity, for the purchase, holding and sale of participations. This paragraph was introduced by the Council of States in the session of June 2 2009, thus only 10 days before the definitive acceptance of the new text of the law. By introducing this additional rule, the council intended to put these activities on a par with taxable asset deals, having no impact on the input VAT deduction, and share deals requiring a correction of the input VAT deduction.

Furthermore, article 29 paragraph 4 of the Swiss VAT law allows holding companies to refer to the business activity of the enterprises held for their own input VAT deduction.

This situation, by itself, does not differ so much from the possibilities given by the EU. Some EU countries also have rules allowing a holding company to deduct incurred input VAT based on the business activity of their participations.

But unlike the EU, Switzerland has now made it clear by introducing article 9 of the VAT Ordinance, that buying, holding and selling of participations itself is a business activity. With this decision, Switzerland accepts holdings and acquisition vehicles as taxable businesses with a general right to recover VAT on expenses and investments.

This situation appears to reflect the fundamental principles of VAT optimally as a consumption tax based on the system of net all-phase taxation with input tax deduction. The system of a net all-phase taxation with input tax deduction (article 1 paragraph 1 VAT law) requires that no irrecoverable VAT be incurred through the value chain up to the non-business end use. Likewise, the principle of competitive neutrality (article 1 paragraph 3 letter a VAT law) requires that businesses are treated equally regardless of the number of levels in their structure. The principle prohibits taxing the consumption of an identical product with an identical price differently, depending upon how many holding companies existed throughout the value chain. Any holding company that incurs an irrecoverable VAT will raise the cost of the product under the assumption that profits for the business owners are the same. Furthermore, it is not in the scope of Swiss VAT aiming at taxing the non-business end use to tax and lower the profits achieved by running a business.

The potential input VAT recovery for holding companies given by the new Swiss VAT law and the corresponding ordinance, may give Switzerland an advantage over many countries in relation to the irrecoverable cost of buying, holding and selling of participations.

Even if the new ordinance has not been tested in court (there is no mean of testing the law in court), the opportunities arising from the new rules are significant. Not only will holding companies in Switzerland benefit from a low irrecoverable VAT cost of 7.6% incurred on expenses relating to tax-exempt debt financing functions, but they will additionally have the possibility to deduct their input VAT incurred on expenses relating to the buying, holding and selling of participations.

Corporate income tax treatment of transaction costs

In Switzerland, the statutory profit and loss statement is the basis for the determination of the taxable profit. Thus, the tax treatment in principle follows the accounting treatment as long as the expenses and the income is business related to justified and at arm's length.

Hence, in the case of costs related to a transaction in which several group companies have been involved, detailed analysis is required about whether the costs and the allocation of these costs to involved group companies is reasonable and at arm's length. Depending on the nature of such transaction costs (for example, related to a (re-)financing, structuring, disposal or acquisition) a reasonable allocation key needs to be determined. Such a key could be based on drawn down debt in the case of financing costs.

To defend allocated transaction costs in the case of a tax audit, proper documentation is recommended of the allocated transaction costs including the underlying allocation key to ensure tax deductibility for corporate income tax purposes.

Since January 1 2010 some communes in the Canton of Schwyz offer Europe's lowest effective tax rates for ordinarily taxed companies. The Canton of Schwyz is located in the German-speaking part of Switzerland.

Wollerau as the most attractive municipality for corporate income tax offers an effective tax rate of only 11.75%, which is lower than the former leader Ireland with 12.5%. It is important to note that low ordinarily taxed companies offer many advantages to international enterprises compared to companies profiting from a special tax regime (for example, mixed companies). They are not affected by blacklists (Italy) or anti-abuse regulations (double tax treaties with France, Belgium, and Italy). Furthermore, they are eligible for lump-sum tax credit for foreign withholding tax.

Lump-sum tax credit means that a not-recoverable foreign withholding tax (for example, source tax on interest or licence income) can be deducted from the tax burden in Switzerland. For example, a tax credit for a 10% foreign withholding tax would result in an effective taxation of the respective income of 1.75% in Wollerau.

Even though the Canton of Schwyz is the most attractive canton for corporate income taxes, there are other attractive cantons such as Obwalden and Appenzell Ausserrhoden – both located in the German-speaking part of Switzerland – offering an effective tax rate of 12.66%.

The issuance of bonds by Swiss companies is subject to a capital stamp duty which is between 0.06% and 0.12% a year of the face value depending on the maturity of the bond. Furthermore, a withholding tax of 35% is levied on the respective interest payments.

According to the Swiss Federal Tax Administration's practice, a liability qualifies as a Swiss bond for the abovementioned tax treatment if a Swiss company raises interest-bearing loans from either 10 creditors at equal conditions or from 20 creditors at different conditions and if the total loan amount is more than SFr500,000 ($466,000) (so-called 10/20-rule).

The continuing borrowing of money in the course of a cash pooling activity can lead to withholding tax consequences if more than 20 affiliated companies are involved and if the credit amount is more than SFr500,000 (the cash leader then qualifies as a bank from a Swiss withholding tax perspective). Especially the fact that the 10/20-rule did not distinguish between intercompany and third-party made Switzerland a quite challenging location for several intra-group finance functions (for example, cash pooling).

To mitigate this, the Swiss Federal Department of Finance has drafted a proposition for a new law about intragroup financing. According to the proposed new legislation loans between related companies (ownership > 50%) will not be regarded as bonds anymore, irrespective of the conditions and the number of creditors.

A remaining pitfall is that Swiss-based groups that raise funds from third parties in foreign countries (for example, by issuing foreign bonds) covered by guarantees by Swiss group companies may not profit from the new regulation because this set-up may be regarded as potential withholding tax avoidance.

The new regulation should enter into force by April 1 2010 and is regarded as the first of several similar projects to improve Swiss attractiveness as a location for group financing functions.

Basically, a dividend distribution from a Swiss company to its shareholders is subject to 35% withholding tax. This withholding tax rate of 35% on dividend distributions may be reduced to 0% or can be settled via a notification procedure if the shareholder is entitled to benefit from a double tax treaty or from the Swiss – EU savings agreement. It should be noted that a reduction at source and/or notification procedure is only available if a formal application has been filed before the dividend distribution. Granted approvals are generally valid for three years.

To combat tax avoidance schemes, the Swiss Federal Tax Administration imposes strict substance requirements, in particular for foreign holding companies applying for such double tax treaty benefits on dividend distributions received from Swiss subsidiaries.

When reviewing if a foreign holding company is eligible to benefit from a double tax treaty the federal tax authority applies a two-step approach. In a first step, it analyses whether the foreign company is a company which is generally entitled to benefit from the respective double tax treaty (including beneficial ownership test).

In a second step, the federal tax authority analyses whether the benefit of the respective double tax treaty is abusive. Therefore, it reviews the substance of the foreign holding company on a case by case basis. According to the practice, the federal tax authority requested in particular business substance such as local office/business premises, a full or at least part-time employee who is reasonably skilled to maintain the function of a holding company; sound business reasons for the holding location and locally held shareholder and board meetings.

According to the latest experience, it seems that these substance requirements for holding companies have been mitigated. A holding company, which business purpose is to acquire, to hold and to manage its participations only, often do not have extensive business substance at its domicile. In particular it typically does not need many employees or its own offices and board meetings often take place outside of the domicile country. For such holding companies, the federal tax authority has mitigated the substance requirements which are necessary to benefit from a double tax treaty. According to latest developments, it seems that the federal tax authority mainly focuses on debt financing parameters. The debt-equity ratio must be in line with the Swiss thin-capitalisation rules (30% equity) or the lower ratio based on the local thin-capitalisation rules, but not less than 15% equity. If the foreign holding company is in line with the debt-equity ratio, the benefit of the double tax treaty shall not be qualified as abusive on the ground of not sufficient business substance.

When setting up a new holding structure or in the case of a restructuring of an existing holding structure it is recommended to review whether the foreign holding company fulfils the requirement to benefit from the respective double tax treaty. In addition, before distributing any dividend from a Swiss subsidiary to a foreign shareholder it shall be reviewed as to whether the necessary approval by the Federal Tax Authority has been received and/or is still valid.

Disadvantage ended

With the new VAT regime Switzerland has removed the unjustified VAT disadvantage that countries operating a VAT system have suffered compared to countries that do not operate a VAT system (for example, US). The new VAT regime, in particular the input VAT recovery opportunity for holding companies, as well as the developments in its tax law make Switzerland even more attractive as location for holding companies and international group companies with financing activities in Switzerland.

Biographies
		Markus Prinzen PricewaterhouseCoopers Birchstrasse 160 8050 Zurich Switzerland Tel: +41 58 792 53 10 Fax: +41 58 792 44 10 Email: markus.prinzen@ch.pwc.com Markus Prinzen is the lead partner for M&A tax services at PricewaterhouseCoopers in Switzerland. Prinzen holds a law degree and is a Swiss certified tax adviser. He has been working for PricewaterhouseCoopers since 1994. In 2001, he was seconded to the London firm and worked for six months as the Swiss contact in the international structuring and finance group. Prinzen focuses on buy-side due diligences, sell-side assistance, international integration projects and restructurings.He is an experienced tax adviser of large Swiss and international groups (often quoted at Swiss and foreign stock exchanges) and accompanies initial public offering candidates. Further, he is the tax leader for Life Sciences and has a lot of experience with clients in this industry.
		Mathias Bopp PricewaterhouseCoopers Birchstrasse 160 8050 Zurich Switzerland Tel: +41 58 792 44 34 Fax: +41 58 792 44 10 Email: mathias.bopp@ch.pwc.com Mathias Bopp is a VAT partner of PricewaterhouseCoopers in Switzerland. Mathias Bopp is a certified Swiss tax expert, Dr iur (Thesis „Value Added Tax and Internet"). He has been working for PricewaterhouseCoopers since 2001 and has worked in Zurich, New York and Chicago. The range of his client relationships includes a number of the world's largest publicly listed multinationals and international middle-market businesses in Switzerland as well. Bopp is a specialist in the VAT aspects relevant to M&A. He is also experienced in the planning and implementing of tax optimised structures for businesses in the financial services sector, the consumer goods industry, telecoms, airlines, information technology and entertainment sector.
		Marcel Angehrn PricewaterhouseCoopers Birchstrasse 160 8050 Zurich Switzerland Tel: +41 58 792 42 56 Fax: +41 58 792 44 10 Email: marcel.angehrn@ch.pwc.com Marcel Angehrn joined the M&A group of the tax and legal service line of PricewaterhouseCoopers in 2006. Before this, he worked for eight years in the firm's corporate and private client tax practice. Angehrn is a certified Swiss trustee and certified Swiss tax expert. In 2008/2009 he spent nine months on a secondment to the M&A group of PricewaterhouseCoopers in London. Angehrn has a wide experience of tax due diligence and structuring in local and cross-border transactions. He specialises in tax advice to companies and private equity providers on a wide range of M&A transactions, as well as advice on sale and purchase agreements.
		Timo Haack PricewaterhouseCoopers Bahnhofplatz 10 3001 Berne Switzerland Tel: +41 58 792 76 20 Fax: +41 58 792 75 10 Email: timo.haack@ch.pwc.com Timo Haack holds a German and French law degree and obtained a Swiss DAS in VAT in 2009. He started working with PricewaterhouseCoopers in Luxemburg in 2006. In 2007, he joined the VAT Team of PricewaterhouseCoopers in Berne. Haack specialises in cross-border VAT transactions and has relevant experience of EU VAT law, the implementation of new VAT concepts, analysing SAP data from a VAT point of view (VATLook), as well as the transnational supplies of goods and services.