The Federal Tax Administration (FTA) already walked the walk by implementing several practice improvements with respect to value added tax (VAT) in Switzerland during 2005. However, the Federal Council has now also suggested that the FTA abandon the practice to make businesses pay VAT for formal mistakes even if the State has not lost any (VAT).
In addition, the government will review the current VAT Act. It is expected that a first draft of a completely new legislation should be available during 2006. The most important changes are said to include an abolition of all tax exemptions and a flat tax rate that is lower than the current standard rate of 7.6%.
Recent improvements in the practice introduced in 2005
As of last year, the following changes have been implemented:
Reduction of formal requirements for exportation documents: it is still required to maintain original export documents to support a 0% VAT rate on exports. But, since 2005, the FTA will no longer assess and levy the tax on exports where the value on the commercial invoice or sales invoice is not completely identical with the value on the exportation document (for example, because of different rates to translate foreign into Swiss currency or typos). This practice will be applied as long as the goods can still be identified as being exported.
Foreign exchange rate: for most inter-company transactions covered by invoices in foreign currency, it is no longer required to use the official exchange rate to translate the revenues and VAT credits into the VAT return. Instead, an internal rate may now be used. This change will reduce the administrative burden for businesses which had to maintain different foreign exchange rates for the same currency because of VAT. The internal rate is however not applicable for import tax purposes.
Recovery of import VAT: credits for VAT paid upon importation no longer require the reclaiming party to be mentioned as importer of record on the importation declaration. Instead, the taxpayer can reclaim VAT paid if he is in possession of the original customs import document and a valid purchase invoice that is recorded in his accounts.
Supply and installation contracts: as of 2005, foreign businesses selling products with installation in Switzerland may be released from a taxation of the turnover of the past five years in case they register for Swiss VAT retroactively. This simplification is beneficial for foreign businesses which will also have supplies and installations in Switzerland in future and have to register for Swiss VAT anyhow. If foreign businesses do not register retroactively the risk exists that the deduction for the import VAT is challenged at the level of the Swiss client.
The importation value of the products to be installed, for indirect tax purposes, should be declared as the full contract value. The value should include the value of the product itself, the cost of installing the product and the cost of transportation of the product to its first destination within Switzerland.
Simplified formal requirements for purchase invoices: purchase invoices can be issued to all addresses that are used by the taxpayer. It is no longer a condition for the recovery of VAT charged on purchase invoices that invoices must be issued to the taxpayer's address registered with the cantonal commercial register.
Cash receipts: the threshold for VAT recovery from low value cash receipts has been doubled from CHF200 ($155) to CHF400. For the taxpayer, it is possible to recover VAT charged on cash receipts that do not mention the taxpayer's name and address, if the receipt is issued for expenses of no more than CHF400.
VAT on self supply: certain taxable events for businesses engaged in construction have been abolished. Pension funds and banks with their own real property will significantly benefit from this change.
Reduction of VAT recovery for holding companies selling shares: the sale of shares may lead to an adjustment of the VAT recovery rate of the selling entity. As a general rule, the FTA accepts that the reduction is calculated as 0.02% of the relevant turnover.
Composite products with different tax rates. As a general rule, the tax rate applicable for 70% of the overall value of the good or service can be used for the composite product as a whole. Unfortunately, there are still exceptions to this general rule. For instance, the rule is not applicable for accommodation and composite goods or services where a tax exemption is applicable on a part of the good or the service.
Reduced formal requirements with respect to invoices in 2006?
As a result of the suggestion of the Federal Council to reduce the formalism in Swiss VAT, it is likely that the FTA will announce additional changes for future VAT audits shortly. It is possible that the FTA may forgo the raising of surcharges, for example if:
the name of the recipient of the supplies is evidenced but not mentioned on the invoice.
mistakes on import or export documents (for example, wrong currency) as they would lead to the loss of the right to reclaim VAT paid from today's perspective.
inappropriately worded contracts or invoices are issued (for example, management services to or from abroad).
The major part of the yearly CHF400 million ($310 million) additional VAT surcharges accrue because of such formal mistakes spotted by the authorities in audits. Swiss companies therefore have to bear VAT cost which would not be levied if appropriate paperwork was maintained. It is the intention of the government to abolish those penalties raised for insufficient paperwork.
Review of the VAT Act during 2006
The Federal Council has also initiated an overall review of the current VAT Act. Taxpayers and politicians are complaining more and more about the complexity of the current VAT system. Furthermore, some of the intended improvements cannot be implemented by a sole modification of the practice of the FTA. A first draft is expected during 2006. The following issues are being discussed:
Introduction of one single flat rate: Instead of today's rates (7.6% as standard rate, 3.6% for accommodation and 2.4% for goods covering basic needs) and more than 25 tax exemptions, one single flat tax rate shall be introduced. The level of the rate will be calculated in a way that the fiscal revenue from VAT should not change.
Abolition of all tax exemptions (taxe occulte): The abolition of all tax exemptions (for example, for healthcare, real estate, financial and insurance industries and the educational, social, cultural and public sectors) seems to be a fairly ambitious objective most of all from a political point of view.
However, it should be remembered that the abolition will not coercively lead to higher prices for consumers. Under the current system, tax-exempt revenue also means that such businesses are restricted in recovering VAT incurred on relating expenses.
Thus, the tax levied on expenses is not recoverable and hence is passed on to the consumer as an additional hidden cost element in the purchase price of the product. As a result tax-exempt products are not completely free of VAT for the consumer. Value added tax is still paid, but on an earlier stage and consequently calculated on a lower tax base.
It may even be worse under the current system. If business A is selling tax-exempt supplies or services to business B and business B uses the supplies to manufacture a taxable product, tax is levied on the tax.
The reason is that business A is passing on irrecoverable VAT incurred on expenses as a hidden cost in the price. Business B cannot reclaim the irrecoverable VAT as the tax is not shown on its purchase invoice. The irrecoverable tax is however included as a hidden cost element in the price. For the sale of its own products VAT is charged at the tax rate calculated on the full product price, including the hidden tax. As a result, the tax exemption for the supplies and service leads to a more expensive product for the final consumer.
The abolition of the tax exemptions will relieve businesses from having to calculate restricted VAT recovery ratios. Not only will this decrease the administrative burden and legal uncertainty associated with the handling of VAT but also, no tax will be levied on tax. Therefore, the abolition of the tax exemption may lead to lower prices for certain products. Where the replacement of a tax exemption with the flat tax rate leads to additional tax being levied, the market supply and demand will determine whether or not the prices will rise. History tells that the introduction of a general indirect tax is not completely borne by customers but businesses bear some of the additional cost too.
It should also be remembered that the tax exemptions are constituted mandatory in the Sixth Directive governing VAT in the member states of the EU. Switzerland, with the introduction of a flat rate and the abolition of the tax exemptions will therefore differ from the EU regulation. The new Swiss law will certainly lose similarities with the VAT laws in EU countries. Certain businesses might want to consider moving operations into Switzerland.
Restriction of joint liability in case of a VAT group taxation: according to today's VAT legislation, if an entity leaves the VAT group it continues to be jointly liable for any tax liabilities arisen before the release. Hence, the buyer of an entity from a Swiss VAT group takes on the unlimited joint liability for all known and unknown VAT liabilities of all group members of the seller. A modification of the Swiss VAT Act is imperatively required to limit these wide liability consequences of a Swiss VAT group.
VAT savings for financial services business in Switzerland
The sale of a financial investment being exempt from VAT, the seller is neither liable to register for VAT nor will he charge any VAT to the investor, so VAT does not have an impact on financial investments from the investor's perspective. The sale of shares into an investment fund as well as the sale of derivatives by a financial services business in Switzerland are also VAT exempt.
Since a substantial part of the revenue of Swiss banks is tax exempt, the banks only have a limited VAT recovery rate. Even nowadays, Switzerland is an interesting place for banks and insurance companies. As the VAT rate is rather low, the cost of irrecoverable tax on investments and expenses is rather low too. In addition, there are administrative simplifications put in place particularly for banks and insurance companies to calculate their VAT recovery ratio easily.
Under a new law as suggested, there may be even greater advantages. If all tax exemptions are abolished and there is no need to limit VAT recovery, there will be no irrecoverable tax cost on investments and expenses in Switzerland at all.
Some businesses have yet put structures in place to avoid irrecoverable VAT on expenses. If the headquarters of a bank is in an EU country with a branch office in Switzerland, irrecoverable VAT on services such as consultancy fees and information services may be avoided.
Charges of foreign services providers to a Swiss branch should in most countries be free of local VAT. In Switzerland, VAT is assessed by the branch on the purchase (reverse charge mechanism). However, the tax assessed can be reclaimed if the services purchased are re-supplied and charged on to the headquarters of the Swiss branch. In most EU countries, branches and their headquarters are considered one single person from a VAT perspective. As a consequence, there will be no assessment of local VAT by the headquarters. The European Court of Justice is reviewing the structure and will release an according judgement soon.
More discretion
With the changes in its practice in 2005, the FTA has initiated the turnaround from a formalistic VAT system to a more pragmatic law which better matches with business needs. The Federal Council obviously supports this approach by suggesting more changes to simplify VAT. Lastly, a new VAT Act can bring significant VAT benefits for businesses and will strengthen the economy in Switzerland.
For the FTA, the prompt implementation of improvements of the practice is most important since the revised VAT Act will enter into force in 2008 at the earliest. Immediate changes in the practice can, however, widely eliminate existing inconveniences for the time being.
It is too early yet for an all-clear call. Indeed, taxpayers can partly undertake appropriate steps already today (for example, improvement of processes to avoid formal mistakes and reservations regarding practice changes in a VAT audit by the FTA).
Biographies |
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Mathias Bopp, a certified tax expert, is a senior manager and leads the indirect tax practice of PricewaterhouseCoopers in Bern. The range of his client relationships includes a number of the world's largest publicly listed multinationals and international middle market businesses in Switzerland.
Michelle Heer, an attorney-at-law and certified tax expert, is value-added tax (VAT) manager with PricewaterhouseCoopers in Berne. She has several years of experience in the area of international VAT consulting. She focuses on multinational and national corporations in relation to structuring and trade as well as in coordinating indirect tax issues at group level. |
