Tax transparency and tax morality are the hot topics in the world of taxation. Multinationals are under strong public pressure due to their legal tax practices enabling them to pay little or no taxes. Moreover, due to budget deficits and economic turbulence in recent years governments are using the increasing public interest in taxation to further increase the pressure on multinationals. However, the question is rather about legitimacy as legality. Official bodies such as the OECD or EU are engaging intensely in the discussions; the OECD action plan on BEPS (Base Erosion and Profit Shifting), especially, contains the most pressing agenda items.
In recent years Switzerland has been able to manage its economy in a notable way, while many other European countries were rather sailing in stormy waters. The Swiss economy with its wide range of industries is highly competitive. Its excellent network of free trade agreements and a vast number of investment protection agreements and double tax treaties make Switzerland a very attractive business and holding location. Under international pressure, Switzerland was compelled to reform its tax system. The priority in this process is clear: ensure the country's competitiveness in the future despite the international pressure and current turmoil in the world of taxation. At the same time, the Swiss government has made clear that its proposed changes shall be in compliance with the initiated OECD reforms as well as EU regulations.
From this model to the next one
At a glance, the specificities and advantages of the existing Swiss holding regime can be summarised here:
Low income tax rate
Since a holding company is exempt from income tax at the cantonal and communal level, the effective income tax rate applicable to such company amounts to 7.83% (federal tax rate).
Beneficial participation reduction system
The participation reduction applies to:
- Dividend income: either a participation of at least 10% in a company's equity or a fair market value of at least SFr1 million ($1.05 million) is required. No minimum holding period applies.
- Capital gains: the sale of a participation of at least 10% of a company's equity that has been held for a minimum holding period of one year is required. The SFr1 million threshold also applies provided at least 10% of the share capital has been held once in the past. The participation reduction applies to the gain exceeding the acquisition costs (recapture of previous value adjustments do not benefit from the reduction).
- No further test applies (such as minimum taxation or performing active business at the subsidiary's level). This allows tax-free repatriation of profits resulting from offshore subsidiaries or passive investments.
The exemption is an indirect one. Income tax is calculated on the basis of total taxable profit (including the participation income) and then reduced in the proportion of the net participation income (gross income less allocable administration and financing expense).
No controlled-foreign company (CFC) rules
Switzerland does not have any CFC legislation. Income from foreign subsidiaries is never subject to tax in Switzerland before actual distribution if the subsidiary's effective place of management is not in Switzerland.
Deductibility of capital losses/goodwill treatment
Amortisations on participations (that is, unrealised capital losses) are deductible if they are commercially justified and booked in the financial statements of the company. Realised capital losses on the sale of participations are deductible for income tax purposes.
Deduction of costs
Acquisition costs and costs on disposal are deductible for income tax purposes. Interest payments can be deducted if they are at arm's length.
Switzerland has no specific transfer pricing rules. There is no specific documentation legislation and, as a general rule, the arm's-length principle in line with OECD guidelines applies.
Reduced net wealth tax
Swiss holding companies are subject to an annual net wealth tax ranging between 0.001% and 0.176% of the equity at year end, depending on the location. The net wealth tax will most likely be abolished through the amendments of the corporate tax reform III (see below).
Capital contribution principle
Capital contributions made by shareholders are no longer subject to withholding tax at the time of the actual repatriation. This principle, introduced in 2011, offers interesting planning opportunities especially in terms of foreign group relocations to Switzerland. At the time of the relocation, the group assets can be contributed to the Swiss (holding) company at fair market value against high equity value (share capital and share premium) and distributed in the future, free from withholding tax, as dividend payments out of the equity created at contribution (limited in time, however a long exertion period applies).
No withholding tax on interest and royalties
Interest (except for bonds and collective fundraising vehicles), royalties, management fees, service fees, and technical assistance fees are not subject to Swiss withholding tax.
Beneficial VAT treatment
Swiss holding companies are regarded as subject to VAT. Dividend income and sales of investments do not result, in most cases, in a reduction of the input tax deduction. However, a holding company can take the business activities of its subsidiaries into account to determine its own input VAT relief, which most likely optimised its input VAT quota.
As indicated above, since 2007 Switzerland has been put under pressure by the EU about its tax regimes – such as its holding or mixed company regimes – because of their incompatibility with the proper functioning of the free trade agreement concluded between the European Economic Community and Switzerland in 1972 (EC State aid decision C (2007)411)). After lengthy negotiations and discussions between Switzerland and the EU in recent years, both parties signed a memorandum of understanding on July 1 2014, which commits Switzerland to the abolition of certain tax regimes, especially those incorporating different treatment of domestic and foreign income (ring fencing). In particular this implies an abolition of the holding and mixed company regimes. The abolition of these tax regimes will be linked with the introduction of new measures compatible with international legislation and aimed at replacing the benefits available under the regimes. This package is under preparation in the course of the so-called corporate tax reform III.
Trends in corporate taxation and upcoming amendments
EU on tax regimes – corporate tax reform III
In the course of the corporate tax reform III, the Swiss government is clearly committed to induce necessary changes in the domestic tax law to remain one of the most attractive business locations. Given the legal process needed at a political level, the abolition should not be approved by the Federal Parliament before 2018. With respect to the experience in other countries (see Luxembourg 1929 holding regime or Belgium coordination centres) it is most likely that transitional measures for the existing regimes be implemented.
Regardless of the new developments, certain attractive regulations of the Swiss tax system will certainly persist and new regulations implemented within the corporate tax reform III might even enhance the attractiveness of Switzerland as a business location. In any case the holding location Switzerland will remain attractive because:
- The most attractive aspects of Switzerland as a holding location which are listed above, including a very favourable participation exemption, no CFC rules and one of the most extensive treaty networks will not be affected by the expected abolition of the holding tax regime. Indeed, these discussions only concern the applicable income tax rate on a cantonal/communal tax level for non-participation income. Hence, the core beneficial aspects of the holding company regime – if at all – will not be affected by these negotiations.
- Due to the announced abolition of certain cantonal tax regimes, Switzerland is working on alternative solutions to remain competitive in the long run. Under the consideration of attractive solutions applied in EU member states, a report prepared by an expert group was issued in December 2013. This report recommends the introduction of these measures, for example: incentives for innovative business activities (IP box and R&D incentives) as well as a notional interest deduction on equity. The so-called consultation processs is going on with the 26 cantons and the resulting detailed report is expected in September or October 2014. It should mean that Switzerland will be able to reengineer its tax system to EU compatibility but actually outrun its competition within Europe.
- As an accompanying measure to the one mentioned above, the general trend in terms of corporate income tax in Switzerland is a decrease of the applicable rates. Various cantons, such as Neuchatel, Lucerne, Vaud and Glarus, have already lowered their corporate income tax. Recently, the canton of Geneva has proposed a decrease of its ordinary effective tax rate to 13%. Furthermore, there are signs that various cantons are preparing significant tax reforms behind the scenes.
OECD on BEPS, tax transparency and tax morality
The recent developments in the world of taxation have been highly concentrated on the discussions around BEPS, tax transparency and tax morality. Whereas the OECD within its BEPS action plan aims to increase tax transparency and equip governments with the domestic and international instruments to avoid harmful tax competition, governments, non-governmental organisations (NGOs) and especially the media and the public are rather demanding discussions that refer to tax morality, too. Besides having to be in line with legality, multinationals are confronted by a new challenge of achieving legitimacy when applying tax practices to reduce their overall effective tax rate. However, which measures of the BEPS action plan will actually be implemented is still vague. Moreover, implementation will be challenging given the widely differing national rules, policies and objectives of each OECD member and especially also considering each country's own agenda for improving its attractiveness as a location.
The recent discussions as well as the possible implementation of respective BEPS measures will likely increase the attractiveness of Switzerland. Unlike other jurisdictions, headquarters of multinationals in Switzerland usually have real substance. Swiss tax regimes are in general far less aggressive with reference to possible effective tax rates than respective regimes applied in certain member states of the EU or elsewhere. This shows that Switzerland has more to offer to holding or headquarter location than its attractive tax regimes.
International tax, free trade agreements and investment protection treaties
Switzerland is party to more than 120 investment protection agreements and therefore has – after Germany and China – the third-largest such network worldwide. Besides being highly active in entering into new free trade agreements, Switzerland has one of the largest double tax treaty networks, with more than 90 double tax treaties in force or signed. New double tax treaties recently signed include those with Argentina, Hungary, Australia and China. These will enter into force upon approval of the national parliaments. Double tax treaties with Peru and Kazakhstan have also entered into force recently.
Maintaining and improving attractiveness
The tax world is changing towards more tax transparency and a higher sensitivity about tax matters. However, the exact outcome of the discussions under way is not predictable yet. In recent years Switzerland has been, more than once, put under political and economical pressure. However, it has proven itself as being able to handle the tax and economic turmoil remarkably. Hence, Switzerland is without doubt capable of handling future challenges resulting from the planned changes in domestic tax law as well as from discussions in the wider world of taxation and thereby improve its attractiveness, not only as a holding but also as a general business location.
Stefan has had a career of almost 18 years in tax law. After working for some years as a scientific assistant in tax law at the University of St Gallen he joined one of the large international accounting firms in 2000. Stefan joined KPMG in October 2006 and became a partner in 2008. He heads the corporate tax practice in Switzerland.
Stefan's area of work covers, in particular, international tax structuring and M&A transactions. He has vast experience in consulting multinationals as well as private equity investors in Swiss and international tax law. Stefan is also a frequent lecturer at the Swiss Tax Academy and the University of Applied Sciences in Zurich.
After a master's degree in law, Sébastien Maury started his professional career in January 2003 with KPMG in Zurich. In 2006 he became a Swiss certified tax expert. In 2007 and 2008, Sébastien has been working in-house with an airline catering and logistics provider with dual headquarters in the US and Switzerland. After rejoining KPMG, he worked from January 2010 to July 2011 with the US firm where he headed up the Swiss tax centre of excellence in New York.
Since his relocation to Switzerland, he has been a member of the international corporate tax team in Zurich, where he advises various corporate clients on international as well as Swiss tax matters, focusing on Swiss inbound business. Sébastien is fluent in French, German and English.