Real estate: How a purchase of Swiss real estate can work tax efficiently
When investors in Swiss real estate set up a tax-efficient investment vehicle, they should have one eye on the sale of the investment in the future, says Reiner Denner and Christoph Frey of KPMG.
In recent years the Swiss real estate market has proved to be a fairly safe investment place with real estate values being stable or even increasing substantially. This has caught the attention of many Swiss and foreign investors. While prices at certain hot spots such as Zurich, Geneva and St Moritz seem to have peaked, there are still many interesting investment opportunities in different areas of Switzerland. Whereas the purchase by foreign investors of apartment buildings and dwellings is still subject to restrictive authorisation by the appropriate cantonal and federal authority, investments in commercial real estate business generally do not need to be officially authorised. For example, last year, Credit Suisse completed the largest-ever sale of a single property in Switzerland to a foreign investor. The transaction value was about Sfr1 billion ($1.1 billion).
Direct and indirect investment in Swiss real estate
A decision between a direct or an indirect acquisition structure is the base for a tax efficient investment in Swiss real estate. With the purchase of Swiss real estate, foreign investors, who may invest directly in Swiss real estate, become subject to tax where the property is located in Switzerland. Rental income is taxable in Switzerland based on unilateral law. The applicable effective income tax rate for companies varies from 12.2% (for example, Lucerne) to 24.2% (for example, Geneva) depending on the location of the property.
When Swiss or foreign investment funds invest directly in Swiss real estate, a privileged taxation is granted, that is, only half of the statutory tax rate of 8.5% is levied (4.25%) at a federal level. At a cantonal and communal level, similar privileges are applicable. For example, rental income from real estate in Zurich is taxed at a combined effective rate of 11.8% (Federal, cantonal and communal level) if held directly by an investment fund as opposed to the ordinary income tax rate which amounts to 21.2%.
Another advantage of Swiss funds investing directly in Swiss real estate is that no Swiss withholding taxes are levied on fund distributions derived from rental income and capital gains from the sale of real estate.
Foreign investors may indirectly invest in Swiss real estate through a foreign ownership company or, as often seen, with a Swiss real estate company. For ongoing taxation, the abovementioned ordinary income tax rates apply. While there is generally no planning potential with regard to the applicable tax rate, there is a lot of potential to set up a tax efficient finance structure for Swiss real estate investments. The implementation of a smart investment set-up may pay also off at a future resale of the Swiss real estate.
Tax efficient financing of real estate investment
Swiss tax law neither contains a definition of the arm's-length principle, nor is the issue of transfer prices between related parties specifically addressed in the law. Even so, the Swiss tax authorities can adjust a taxpayer's profits onto an arm's length basis. For intra-group financing the tax authorities have published thin capitalisation rules and safe harbour interest rates.
Switzerland is a member of the OECD and has accepted the OECD guidelines without reservation. On March 4 1997, the federal tax authority issued a circular letter instructing the cantonal tax authorities to adhere to the OECD guidelines when assessing multinational companies. Such circulars are only guidelines. The cantonal tax authorities are not bound by such instructions for cantonal and communal taxes, which leaves some room for different approaches between cantons.
The thin capitalisation rules are based on a detailed analysis of a company's assets. An office building, for example, may be financed with debt, with a ratio of up to 80%. In a worst case situation, intercompany interest expenses may be reclassified as a hidden profit distribution, partly exceeding this accepted ratio. However, in practice such an adjustment is rarely seen because the applied intra-group interest rates are often below the safe harbour interest rates.
The Swiss federal tax authorities publish the safe harbour interest rates once a year. In 2013 the rate applicable on intercompany loans in euros is 1.75%. Loans denominated in Swiss francs where the Swiss company is the debtor may bear an interest rate of 2% to 3.25% depending on the use of the respective funds. As a general rule, higher interest rates might also be acceptable if adherence to the OECD's arm's-length standard can be proved.
Considering these guidelines, foreign investors have great flexibility generally to structure the financing of their Swiss real estate company. This may also involve financing from destinations with a favourable tax treatment of interest income derived from such intercompany loans. The latter will generally not affect the tax deductibility of the interest expenses in the Swiss real estate company. Since tax grouping is not applicable in Switzerland, hybrid debt financing structures are difficult to implement.
An additional consideration is that there is Swiss withholding tax of 3% (federal-level withholding tax, similar rules at cantonal level) on interest payments in case of loans/mortgages granted by a foreign borrower being securitised with Swiss real estate.
Swiss real estate companies that have their main or all of their business in Switzerland may structure their intra-group financing differently. As many of these companies have used so-called offshore-converters in the past, some pressure from the federal tax authorities led to a restructuring of their financing set-up.
The concept of an offshore-converter unit was mainly that a Swiss top holding company finances an offshore subsidiary with equity which in turn grants loans to operational Swiss group entities. Whereas the interest expenses were fully tax deductible at the level of the operating companies, interest income was not taxed offshore. As a last step, the funds of the offshore company would be distributed by dividends to the top holding company, which would apply the participation exemption regime on this income.
A recent decision of the Federal High Court dated October 5 2012 (Reference no 2C_708_2011) negated the substance of an offshore-converter which was structured as a branch of a Swiss group company.
Today multiple-tier Swiss holding structures provide for a tax efficient financing structure.
Future sale – structuring considerations
Though investors generally focus on a longer term investment in Swiss real estate, they would be wise to consider a future disposal of the investment when setting up the investment structure.
As already mentioned, a foreign investor – respectively the investment vehicle owning the Swiss property – becomes subject to tax in the place where the property is located. Switzerland consists of 26 different cantons each with its own cantonal and communal tax laws. However, two main taxation systems can be categorised concerning the taxation of real estate capital gains, the so-called monistic and dualistic tax systems. In both systems real-estate capital gains resulting from an asset deal are taxed.
In a monistic system (cantons Zurich, Berne, Basel-Stadt, Basel-Land, Schwyz, Ticino, Uri, Jura, Nidwalden), private and business assets are subject to real-estate capital gains tax. In the dualistic system, which exists in the remaining cantons, business assets are subject to ordinary profit or income tax; private assets are subject to real estate capital gains tax.
In case of a share deal (disposal of shares in a company holding Swiss real estate) the majority of the cantons also levy capital gains tax, under the assumption that the company holding the Swiss real estate qualifies as a real estate company for Swiss tax purposes (definitions vary depending on cantonal practice).
However, the sale of shares in companies conducting a real business (for example, an own hotel business) will generally not trigger a taxation, though depending on the cantonal practice applicable taxation may even be triggered in such an 'active business case'. It can therefore be interesting not to separate a management company from the Swiss real estate company holding the real estate to keep the potential for a tax neutral disposal in future.
In the course of the structuring it is important to analyse the respective practice of the canton where the property is located. It is also crucial to understand that double tax treaty conventions with certain countries (for example, Austria, Belgium, Denmark, Germany, Luxembourg and Sweden) grant a capital gains tax exemption on the sale of shares in a Swiss real estate company. Those treaties define that gains generated from the sale of movable assets, including shares in a Swiss real estate company, may only be taxed in the country where the seller is located (article 13 paragraph 4 of the OECD model tax convention on income and capital is not included in those treaties). If the capital gain on the sale of these shares is, for example, subject to a participation exemption in the country of the seller, a capital gain might not be taxed at all. As a consequence Luxembourg investment structures with investments in Swiss real estate are common. Investors should use an existing operating entity for such a foreign investment company to fulfil minimum substance requirements and benefit from the respective double tax treaty conventions.
The most interesting question in this context is whether the Swiss cantonal tax authorities grant a so-called 'step-up of basis' which may be achieved because, based on Swiss unilateral law, capital gains tax was triggered but not levied based on a double tax treaty convention. It means the difference between tax book value and fair market value was generally subject to taxation at a cantonal level, however taxes were not payable. As a consequence the tax book value should increase and the same difference shall not be taxable at the cantonal level in future anymore (step-up of basis). In this context an optimisation of the deferred tax position on the real estate should also be possible. It is recommended to have clarity on the tax implications before a transaction by filing an advanced binding tax ruling.
A lot of discussions and disputes are taking place around this topic. While certain cantons tend to grant such a step-up of basis only if cash tax is paid (for example, canton auf Berne – therefore no step-up in case of a double tax treaty relief), other cantons feel strictly bound to the cantonal tax law where no such special conditions are defined (for example, canton of Zurich). We believe the first standpoint is only feasible if the respective cantonal tax law explicitly foresees such a restriction. This is however mostly not the case. Court decisions on this are expected in the future.
What is possible
Foreign investors have full flexibility to invest in Swiss business real estate, while investment funds are entitled to a favourable tax rate for direct real estate investments. Investors are generally free to finance their Swiss real estate in a tax efficient manner as long as the thin capitalisation rules are respected. This may also include group financing companies located in favourable tax jurisdictions. It is strongly recommended to implement an investment structure which provides for a potential tax efficient resale of the Swiss real estate in future.
KPMG in Switzerland
Tel: +41 58 249 24 40
Reiner Denner is a tax partner with KPMG Switzerland. He is a specialist for international tax planning in connection with real estate investment structuring, company restructuring, M&A and supply chain structuring.
Reiner heads the KPMG real estate tax group in Switzerland. He has substantial experience with clients in the real estate and trading sectors. His client experience includes structuring of real estate investment and finance in Switzerland and abroad as well as optimising supply chain structures with principal and commissionaire structures. Experience includes advising on real estate investment funds and real estate finance structuring.
KPMG in Switzerland
Tel: +41 58 249 27 85
Christoph is a senior manager with KPMG's corporate tax services group based in the Zurich office. He studied business economics at the University of Zurich and is a Swiss certified tax expert. Christoph joined KPMG in 2004. He specialises mainly in the real estate tax sector, advising some of the most important Swiss real estate companies, real estate funds, pension funds and investment foundations with real estate investments on all tax aspects. He is lecturer at Zurich HWZ / master of advanced studies in real estate management and has published several articles on real estate taxation.