Next to the introduction of internationally accepted measures to replace the current cantonal and federal tax regimes (the first pillar of the strategy as discussed by Andreas Staubli, Remo Küttel and Benjamin Koch elsewhere in this publication) and the reduction of cantonal corporate income tax rates at the discretion of the cantons (second pillar of the reform strategy), other fiscal measures shall be introduced.
This third strategic pillar of the Swiss Corporate Tax Reform III (CTR III) project is aimed at introducing a bundle of measures to improve Switzerland's attractiveness for businesses internationally.
In this regard, the CTR III Project Steering Committee (Steering Committee) in its report of December 19 2013 in particular proposed the investigation and further elaboration of the following measures:
- Capital (net wealth) tax relief;
- Abolition of issuance stamp duty on equity;
- Improvements to the participation relief on dividends;
- Withholding tax relief;
- Introduction of a tonnage tax; and
- Improvements to lump-sum tax credit system.
Not linked to the reform but nevertheless very relevant in practice will be the rules based on current law which apply in case the conditions to qualify for a cantonal tax status are no longer met, hence the privileged tax status is lost and the company transitions to ordinary taxation. Due to its potentially important practical relevance, the current practice in this respect is outlined at the end of this article.
Capital tax relief
Concerning the adaption of capital tax (which is levied at cantonal and communal level in Switzerland), according to the Steering Committee in principle two different solutions are conceivable. The first possibility is the complete abolition of capital tax. Based on the higher resulting cantonal losses of tax revenues and the argument that by abolishing the capital tax the basic principle of tax harmonisation between cantons would be undermined, the report's stance towards this alternative is negative. Secondly, and a preferred alternative, is discussed under which certain classes of assets which are privileged for corporate income tax should also be treated preferentially for purposes of calculating the capital tax. Specifically, in this way the cantons could introduce a deduction from the capital tax base for participations, intellectual property rights and inter-company loans. Such a deduction on participations is known already, for example in the tax laws of the cantons Aargau and St. Gallen.
Abolition of issuance stamp duty on equity
The abolition of issuance stamp duty on equity has for a considerable time been the subject of political debate irrespective of the current work on CTR III and therefore is also the subject of a parliamentary initiative. On a motion of the Federal Council, the National Council in the spring session 2013 and the Council of States on November 7 2013 agreed to suspend this Bill in order for the abolition of issuance stamp duty on equity – which otherwise was favourably supported – to be embedded in the overall package of CTR III. The report sees the abolition of the issuance stamp duty as a suitable measure for enhancing Switzerland's attractiveness as a business location. Its effective realisation depends heavily on the general financial context of CTR III, because the abolition would result in a loss of tax revenues in the magnitude of approximately SFr 240 million ($262 million).
In our opinion, abolition of issuance stamp duty on equity is not one of the indispensable elements for a strong corporate tax location. It would of course be desirable, but to make the reform package financially more affordable it could at least temporarily be deferred.
Improvements to the participation relief on dividends
The present system of participation exemption contains inter alia the disadvantage that, because of the necessary deduction of the proportionate financing and administrative expense from the gross participation income, there is only far-reaching, but not complete tax relief on income from participations. Accordingly, a transition to a direct exemption system for participation income by means of divisional accounts was considered and in the context of CTR III the Swiss Federal Tax Administration (SFTA) worked out a corresponding concept. The application of the direct exemption method, however, would have the consequence that the acquisition cost principle would have to be abandoned, too. As a result, the creation of temporary valuation adjustments and write-offs of distressed participations would no longer be tax effective.
Representatives of business therefore spoke firmly against a direct exemption of participation income. Not least, they see no direct benefit of a conceptual change in the participation exemption for the present special status companies and in general it is questioned whether such a measure contributes significantly to enhancing the attractiveness of Switzerland as a corporate tax location. It was, however, requested that in the context of a modest revision today's already quite beneficial system could be further improved by eliminating the currently sometimes negative effect of the non-tax effective set-off of tax loss carry forwards against what is in principle tax-free participation income. The report does not comment on whether, from the perspective of the Steering Committee, a change to direct exemption is preferred or not, but it is expected that, given other more important priority measures, such change is not pushed hard at this stage.
Withholding tax relief
The existing withholding tax restrictions in connection with the issue of bonds abroad and use of the funds in Switzerland, when corresponding guarantees have been given by Swiss group companies, have the consequence that Swiss groups must conduct their financing activities at least partially abroad. This situation is an obstacle for the Swiss business and tax location, which needs to be corrected. For foreign groups, a corresponding change by means of a revision of the Withholding Tax Ordinance (VStV) Article 14a para. 1 (in force since August 1 2010) has produced the first benefits, but Article 14a para. 3 VStV specifically excludes Swiss groups from such benefits. As a consequence, para. 3 of Article 14a VStV should be eliminated as part of the reform.
Further, such a revision must be seen in a wider context: the Federal Department of Finance (in collaboration with the cantons and academic representatives) was instructed by the Federal Council to draw up a report on the reconstruction of the withholding tax. The results are expected later this year. As soon as they are available, the Federal Council will have to decide on the next steps in this matter and also to decide whether the reconstruction of the withholding tax is to constitute an independent project or rather be dealt with in the context of CTR III. Specifically, the current self-declaration withholding tax system will, at least partially – to the extent, for example, that the issuance of bonds and the like by Swiss issuers are concerned – be replaced by a paying agent system. This would mean that Swiss withholding tax may in future be levied by Swiss banks (as paying agents) and paid to the SFTA for Swiss citizens only (who have a refund claim if they properly declared the underlying income as a taxable item) but would not be obliged to do so for payments to foreign beneficial owners. The latter relief would have to be coupled, though, with respective information exchange to the states of the ultimate recipients of the income.
Introduction of a tonnage tax
This novel tax is mentioned by the Steering Committee in its report and concerns only profits of companies engaged in maritime transport. The tonnage tax is to subject various activities in connection with shipping (shipping activities) to a privileged taxation and in this respect replaces the usual corporate income tax. However, the report states unequivocally that the tonnage tax cannot be claimed for the profits of traders earned from trading in commodities.
Improvements to lump-sum tax credit system
According to existing rules, Swiss companies suffering foreign withholding tax on interest, royalties and so on, which is not fully recoverable according to a double tax treaty, can claim a (partial) credit against the Swiss corporate income tax triggered by such income. The current system is, however, not a full credit system but a so called lump-sum credit system which, for example, foresees that a maximum of one third of the foreign withholding tax can be credited against Swiss federal corporate income tax and that a maximum of two thirds can be credited against cantonal and communal corporate income tax. In addition, the actual amount creditable must be calculated taking into account the portion of Swiss income tax which falls due on the respective income calculated on a net basis. Due to the reduction of cantonal corporate income tax rates over the past years, these two factors in practice mean that in many cases the lump-sum tax credit calculation results only in minor amounts of the foreign withholding tax which can be relieved.
To avoid overloading the reform, business representatives had refrained from demanding that the unproductive and complicated (as well as administratively time consuming) current lump-sum tax credit system should be superseded by a modern, competitive tax credit system. However, a selective revision of the existing system was demanded, aimed at improving the current mechanism in certain aspects to make it more beneficial, for example by abolishing the fixed one third to two third allocation between the federal and cantonal level in favour of a split that more closely corresponds to the relative tax charge between the two Swiss levels plus suggesting a bundled approach to calculate the Swiss corporate income tax due on treaty protected income which should replace the current source by source country approach.
The CTR III report so far has not taken these demands explicitly into account. It only points out that, because of its relevance for licence box companies, these demands can properly be assessed in more detail only once the other reform measures have been further progressed.
Furthermore, at this point it should be noted that as a result of the Pelli motion at parliamentary level it is being discussed whether Swiss permanent establishments of foreign companies should in future also be entitled to the lump-sum tax credit.
Concept of tax systematic realisation
The planned amendments of the corporate taxation under Swiss tax law will trigger the change of tax status for many companies and their resulting Swiss tax burden. Such changes typically have been covered under the concept of the tax systematic realisation of hidden reserves. Currently there are three scenarios anticipated where the new law may lead to such changes in tax status: Firstly, there are those companies which have been taxed under a special tax regime, for example the Holding or Mixed Company regime and which will be taxed ordinarily in the future. Secondly, all those companies which will be eligible for innovation/licence box taxation will face a change in their tax status when they enter into or exit from this box status. Finally, companies immigrating to, or expatriating from, Switzerland are also in a similar situation.
The availability of a consistent tax treatment for such tax status changes equally covering and applicable to all scenarios mentioned above is important. The goal of the solution is to eliminate distorting effects that otherwise would result from tax rate differentials which would trigger over-taxation or under-taxation of untaxed hidden reserves existing at the time the company changes its tax status. The mechanism to be applied to achieve this is not new and is known as the concept of tax systematic realisation. It has been confirmed by various decisions of the Swiss Federal Court (see among others the decision dated March 12 2012, 2C-645/2011) as an important instrument to guarantee taxation according to the real economic substance and capacity of each taxpayer. This is a fundamental principle of the Swiss tax system and anchored in the Swiss Constitution and included in the provisions of the currently enacted corporate tax law (see Article 58 para. 1 letter c of the Law on Direct Federal Tax). It is planned that this existing and proven concept should continue to apply.
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Armin Marti is an international tax services partner and corporate tax leader for PwC Switzerland. He has vast experience in international tax consulting for multinational groups and in-depth technical knowledge in international tax structuring and in transfer pricing.
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Laurenz Schneider is a director in the international tax structuring team of the tax and legal practice at PwC Switzerland. He is Tax Accounting Services Leader of the Swiss firm and has large experience in global and European structuring and tax management.