A large multinational reinsurance group, resident in Zurich, sold several pieces of real estate in Zurich in 2006, generating a substantial capital gain. The Zurich cantonal tax authorities refused to allow the deduction of operational losses from the real estate capital gain.
In Switzerland capital gains realised on private property is tax exempt but an exception applies to real estate. Capital gains tax on real estate is taxed at a cantonal (regional) level.
The capital gains on the sale of business properties are either taxed together with other business profits, with the general corporate income tax, or with the special real estate capital gains (RECG) tax imposed on private real estate capital gains, depending on the canton.
When RECGs are part of a corporate income tax basis, losses from business operations automatically offset the capital gains realised from the sale of property.
Up until 2006, Zurich, and certain other cantons, imposed a special RECG tax and was able to tax capital gains from the sale of real estate regardless of operational losses.
In 2006 a federal court ruled that in inter-cantonal situations it was unconstitutional that a canton, where a RECG materialised, could impose a special RECG tax without accounting for operational losses from other cantons.
The relevant cantons had to allow for the deduction of operational costs from the RECG tax basis when the taxpayer was resident outside the canton in question.
The Zurich canton still refused to deduct operational losses from the RECG basis.
Last month, after a number of proceedings, the Zurich Administrative Court, ruled the capital gains tax law was unconstitutional because it did not accept operational losses deducted from the basis of RECG tax.
The ruling was not immediately effective though and the onus was placed on the cantonal legislator to change the law in a way that was constitutional.
"In Swiss legal practice, it is very uncommon to allow a provision that is found to be unconstitutional to continue to be applied," said Stefan Widmer, of Prime Tax in Zurich, who acted on behalf of the multinational. "There must be an overriding public interest in keeping an unconstitutional law in place."
Widmer's team intends to file a protest, on behalf of the client, with the highest court in Switzerland, the Federal Supreme Court, this week demanding the provision, disallowing operational losses to be deducted and for it to be removed immediately. If the provision is removed then the capital gains tax basis could be reduced by operational losses for all similar disputes.
The decision of the case is expected to set a precedent for other cantons experiencing the same difficulties and is eagerly awaited.
"This case is a milestone in Swiss tax history and would virtually do away with special capital gains tax on business property. The decision in this case is also important for many companies in the Swiss business community as similar cases have been put on hold, awaiting the ruling in this leading case," said Widmer.
