The choice of the optimal IP location is of key importance not just from the perspective of effective IP management, but for the competitiveness and success of the enterprise as a whole. Switzerland combines an excellent business and taxation environment with a high quality of living, an attractive mix that for years has made it the location of choice for multinational companies and international investors alike. The country's economic and political stability, transparent legal system, exceptional infrastructure, efficient capital markets and low tax rates are particularly attractive for the exploitation of IP rights and the exercise of IP related management functions.
The choice of a tax efficient IP location and structure can not only safeguard, but substantially increase the value of the IP and thereby the enterprise value for years to come. This requires, however, that the IP location and structure has sufficient substance, management functions and activity, so that it can be viewed as the true beneficial owner of the IP and be entitled to the attributed income based on accepted taxation and transfer pricing rules of the countries involved.
Fiscal definition of IP from a Swiss perspective
IP is the right to use intangible assets or to economically exploit IP (owned by others) under a licence arrangement. Swiss tax laws do not specifically include a definition of IP or income arising from its use. Instead, Swiss tax practice follows the generally accepted definitions of the OECD Model Tax Convention on Income and Capital (OECD-MC).
Article 12 paragraph 2 of the OECD-MC describes IP as the right to use any copyright of literary, artistic or scientific work including cinematograph films; any patent, trade mark, design or model, plan, secret formula or processes; or information concerning industrial, commercial or scientific experience.
This definition of IP is also included in Chapter VI of the OECD transfer pricing guidelines and is being considered now by the OECD's Working Party VI, which is to advise on and clarify aspects of ownership, valuation and timing. The classical definition of IP may be extended to include soft intangibles (for example, workforce in place and management) and some changes could address the difference between economic and legal ownership of IP. In particular, the function of the effective management of IP may become more important in the determination of ownership rights from a tax perspective.
Hence, the proper establishment of IP management functions for IP structures will become even more important in the future from an operational and tax perspective.
International tax planning for IP in general
The general objective of international tax planning for IP is to optimise the IP structure from an operational efficiency perspective, while taking into account different levels of taxation in different jurisdictions and minimising unnecessary tax leakage (such as from withholding tax). Compensation for the use of IP can either be through royalty payments, or be embedded in the product price. For the purposes of this article, our discussion focuses mainly on the exploitation of IP through licensing in return for royalties.
In this regard, these general principles should be considered:
- Ensure that royalty payments are tax deductible for IP using companies;
- Take advantage of the fact that royalty payments are taxable net of all tax effective deductions, in particular, tax effective amortisation, interest expense, residual withholding tax and other tax deductible expenses;
- Support the valuation(s) of the transferred IP by means of proper transfer pricing analysis and determine the correct transfer pricing for corresponding royalty payments;
- Execute the IP management functions of the IP company at its place of business, making the IP company bear the costs of developing, maintaining, financing and exploiting the IP so as to establish sufficient substance and true legal and economic ownership of the IP;
- Reduce or eliminate withholding taxes on royalty payments by way of applicable double tax treaties, subject to potential anti-abuse provisions in such treaties, and by way of potential withholding tax credits for residual withholding tax;
- Carefully consider tax regulations adopted by various countries concerning controlled foreign corporations (CFC regulations) and the corresponding taxation of passive income at the level of the group company controlling the IP company;
- Account for profit repatriation and exit considerations (that is, opportunities to migrate or sell the IP at a later date without adverse tax consequences) when planning the structure.
Tax efficient IP exploitation by using Switzerland
Migration of the IP
In general, the transfer of IP to Switzerland can be achieved by migration of the company that holds the IP or by a legal and/or economic transfer of the IP by way of sale (purchase of existing IP or buy-in payment for the development of future IP) or by contribution without consideration.
The sale from a related party to a Swiss IP company has to be effected at fair market values. A step-up to fair market value for accounting and tax purposes, which provides a higher basis for future tax effective amortisation and debt financing, is generally possible in case of a company migration. A contribution can be made at fair market or book value.
In any case, the potential exit taxation in the country of origin needs to be considered and factored into the design of a tax optimal model to transfer IP. A potential exit taxation can be mitigated or reduced in various ways depending on the circumstances and the country of origin, such as a transfer to a Swiss permanent establishment (PE) as an interim step; a transfer via an interim jurisdiction; a transfer which takes into account differences between the respective civil and tax law; or by the phasing out of old IP in the country of origin while phasing in the new IP in Switzerland.
Besides income tax, VAT or stamp taxes, among others, have to be considered.
Ongoing taxation – various Swiss taxation alternatives for IP
Under the mixed company status only a fraction of typically between 10% and 25 % of foreign source income will be taxed for cantonal/communal tax purposes, while the company is ordinarily taxed for federal tax purposes. This translates into an effective combined federal/cantonal/communal tax rate (ETR) of between about 8 % and 11 % on foreign sourced net royalty income, depending on the location of the IP company.
The principal requirement for mixed company status, which is granted based on a ruling, is that at least 80% of income and generally 80% of the expenses are foreign source related, that is, with foreign counterparties. Taking into account tax deductible expenses, in particular IP amortisation and interest expense, the ETR on gross royalty income over the life of the IP can be as low as 1% to 3%.
Nidwalden IP Box
The Nidwalden IP Box, which is available in the Swiss canton of Nidwalden and is under evaluation by other cantons and on federal level, leads essentially to the same tax benefits as the mixed company, as it results in a tax rate of 8.84 %, which can again be effectively reduced to between 1% and 3 % by IP amortisation and interest expense. The difference between the Nidwalden IP Box and the mixed company is: In the mixed company, only a portion of foreign source income will be taxed on a cantonal level. In the Nidwalden IP Box, only a portion, that is, 20% of all IP income, as that term is defined in article 12 paragraph 2 of the OECD model tax treaty, will be taxed for cantonal/communal tax purposes, irrespective of its source, domestic or foreign. It is anticipated that the concept of the IP box may become more relevant in the future in case the mixed company status, which differentiates between foreign and Swiss source income, at some stage should be refreshed or replaced following an on-going dialogue Switzerland is having with the EU.
IP tax considerations also play a vital role for Swiss principal companies, though such companies have a broader business activity than a pure IP company. Even so, the IP associated with their business activity is usually a key value driver. In a principal company the remuneration for the use of the IP is either embedded in the product price and benefits from the principal company rate of between 5% and 9% or it is (re-)charged separately and taxed at the ordinary /mixed company rates. The Swiss Federal Tax Authority (SFTA) may in the future, depending on the specific case, treat principal companies that directly hold the IP differently from principal companies that license the IP from another group company.
Swiss companies with a foreign IP branch
This can be an efficient structure which can result, in certain cases, in an ETR of below 1%. Switzerland unilaterally exempts foreign branches from Swiss income taxation if the foreign activities constitute a PE from a Swiss domestic tax perspective. The Swiss rules as to what constitutes a PE have been broadly construed and there is no subject-to-tax clause (that is, the income attributed to the PE does not have to be subject to a minimum tax in the PE location to be exempt from the Swiss tax base).
Accordingly, if IP related activities in the foreign branch rise from a Swiss perspective to the level of a PE, Switzerland allocates the corresponding income to the foreign PE respectively exempts the corresponding income from Swiss income taxation. The income allocation between the Swiss head office and the foreign PE is typically determined based on a functional analysis supported by a transfer pricing analysis. Depending on the industry and the factual circumstances, such foreign PE locations might include places such as Dubai, Singapore or Liechtenstein. In most cases it is unnecessary to have a double tax treaty with the country where the foreign PE is located.
Double tax treaty considerations
Because many countries levy a withholding tax on royalty payments, it is important for an IP company to benefit from an extensive double tax treaty network. Switzerland is an attractive location as it has a wide double tax treaty network and in addition (based on the EU-Swiss Interest Savings Agreement) has access to benefits similar to the EU Interest and Royalties Directive. The non-recoverable withholding tax rate on royalties is usually in the range of between 0% and 10%. Switzerland also offers a tax credit system for non-recoverable withholding taxes restricted to the corresponding Swiss income tax liability and the tax status of the IP company.
An IP company resident in Switzerland has to consider the so-called Swiss unilateral anti-abuse decree. A Swiss resident company is only entitled to double tax treaty benefits if the income is not predominantly paid on to beneficiaries in a third country (by means of royalties, depreciation, interest payments or other charges). The anti-abuse decree is, however, only applicable when the income in question is derived from a country whose double tax treaty with Switzerland has no specific anti-abuse provisions. There is a clear trend towards specific anti-abuse provisions in the double tax treaties that have been executed or revised in the last two years. Such new or revised double tax treaties no longer fall under the unilateral anti-abuse measures. Accordingly, the Swiss anti-abuse decree tends to have less importance than it had historically.
Enhanced activities and substance
Developments such as the proposed amendments to Chapter VI of the OECD Guidelines raise the bar in relation to critical IP management-related functions and substance that needs to be in place for the IP company to qualify as the true beneficial owner of the IP.
Switzerland is able to provide tailor-made and robust solutions. Switzerland is, given its excellent business and taxation environment and high quality of living, well positioned to host such IP companies with enhanced activities and substance.
Tax practice leader Switzerland
Tel: +41 (0)58 279 63 57
Reto Savoia is a partner in international tax and leads the Deloitte tax practice in Switzerland. He has significant experience in the area of cross-border structuring, including establishing tax efficient IP and finance structures for Swiss and international groups.
Partner, international tax
Tel: +41 (0)58 279 63 12
Jackie Hess is a partner in international tax leading the business model optimisation service offering for tax in Switzerland. Jackie has significant experience in the area of supply chain transformation projects including principal company and cross-border IP structuring.
Senior manager, international tax
Tel: +41 (0)58 279 63 51
Nicolai Fischli is a senior manager in the Deloitte international tax practice in Switzerland. He has significant experience in the area of IP tax planning in relation to Switzerland as well as Liechtenstein.