Switzerland: Safe Haven No More?
Sponsored by Co-Handelszentrum
06 November, 2014
Switzerland is currently at a critical juncture in its long history as a safe haven for investors all over the world. Having agreed to corporate tax reforms with the European Union that will result in the abolition of certain tax-privileged company formats, it is also under pressure from several directions to adhere to ever more stringent international tax transparency rules. In this feature we summarise corporate taxation in Switzerland, the newly proposed corporate tax reforms, and Switzerland's position of global automatic information exchange, and attempt to ascertain whether or not Switzerland's safe haven status is in jeopardy.
Introduction to Switzerland
Located in the heart of Western Europe, Switzerland is a peaceful, prosperous, and modern market economy with low unemployment, a highly skilled labour force, and a per capita GDP among the highest in the world. Switzerland's economy benefits from a highly developed service sector, led by financial services - the balance sheet total of all Swiss banks was CHF2.85 trillion (USD3 trillion at current exchange rates) at the end of 2013 - and a manufacturing industry that specializes in high-technology, knowledge-based production.
Economic and political stability, a transparent legal system, exceptional infrastructure, efficient capital markets, and low corporate tax rates also make Switzerland one of the world's most competitive economies; the World Economic Forum rated Switzerland as the world's most competitive economy for the sixth year in a row in The Global Competitiveness Report 2014-2015.
Switzerland is not a member of the European Union, but two sets of 'bilateral agreements' with the EU are gradually bringing the country closer to the EU, and the Swiss have brought some of their economic practices into line with the EU's.
Switzerland is not an offshore jurisdiction such as the Cayman Islands, or Jersey. It is nonetheless a low-tax jurisdiction, having a series of specialised corporate forms which can be used by international investors and multinational companies to reduce their tax bills to a significant extent.
The regular economy in Switzerland is moderately taxed, but locals have access to the tax-privileged company forms as much as foreigners, if they comply with the rules which broadly prevent any local business operations (see below).
As an OECD, 'respectable' country, Switzerland has double tax treaties with more than 100 other countries.
The Corporate Tax Regime
Due to the federal structure of Switzerland there is no centralized tax system, with some taxes being levied exclusively by federal authorities whereas other taxes are concurrently levied at cantonal, communal and federal levels. Although the rate of tax levied at a federal level is consistent, that levied at a cantonal level varies from canton to canton. Because significant differences presently exist in the rates of taxes levied at cantonal level, the choice of canton is an important element in all tax planning.
For corporate income tax purposes a company is deemed resident in Switzerland if it is either incorporated in Switzerland or effectively managed from there. The General Assessment Rule is that resident companies are assessed on their worldwide income except for profits generated by enterprises, permanent establishments and real estate situated abroad, whereas non-resident companies are only assessed on profit generated by enterprises, real estate and permanent establishments situated in Switzerland as well as interest on loans secured on Swiss real estate.
Corporate income tax payable to the federal authorities may be tax deductible for the purposes of an assessment to cantonal corporate income tax and vice versa.
The federal corporate income tax rate is 8.5% flat. Cantonal tax rates are levied at rates of up to 24% using a scale based on the relationship of profits to net worth. Cantonal corporate taxes average about 18%. Municipal tax on corporate income is calculated as a small proportion of cantonal tax.
A note of caution, however: there are substantial differences between the federal government and cantons, and between individual cantons, in the calculation of taxable income. The applicable rules must therefore be checked in any given situation.
The Swiss branch of a foreign company pays the same rates of corporate income tax on profits, income and capital gains as would be paid by a Swiss-resident corporate entity. Profits remitted abroad by the branch are not subject to any tax in Switzerland. However, exposure to corporate tax can be substantially reduced - it is often possible for taxpayers to become effectively exempt from Swiss corporate tax - by structuring a corporate group in such a way as to qualify for one of Switzerland's aforementioned tax-privileged company formats, which are outlined next.
The Stock Corporation ("Societe Anonyme" or "Aktiengesellschaft") is the form almost universally used by foreign investors. However, the 'Holding' Company is a Stock Corporation with a particular tax status. Holding companies benefit from reductions in corporate income tax and capital gains at federal and cantonal levels, and from a reduction in net worth tax at cantonal level.
For federal tax purposes a company is defined as a holding company if it holds either a minimum of 10% of the share capital of another corporate entity or if the value of its shareholding in the other corporate entity has a market value of at least CHF1m (known as a "participating shareholding"). The reduction in the level of corporate income payable tax depends on the ratio of earnings from "participating shareholding" to total profit generated.
Although the definition of a holding company varies among cantons, broadly speaking a corporate entity is a holding company for cantonal corporate income tax purposes so long as it either:
- derives 51%-66% of its income from dividends remitted by the subsidiary; or
- holds 51%-66% of the subsidiary's shares.
Due to its low tax regime, established location and business friendly environment, canton Zug is by far the most popular choice for establishing a Holding Company in Switzerland, accounting for 25 percent of all Holding Companies incorporated in Switzerland.
Domiciliary Companies are Stock Corporations that are both foreign-controlled and managed from abroad, have a registered office in Switzerland (i.e. at a lawyer's premises) but have neither a physical presence nor staff in Switzerland. They must carry out most if not all of their business abroad and receive only foreign source income. The use of domiciliary companies can result in savings in corporate income tax levied on income and capital gains and net worth tax.
Mixed Companies are Stock Corporations which have the characteristics of both domiciliary companies and holding companies but which do not qualify as either. There is no benefit at federal level, but at cantonal and municipal level there are corporate income tax benefits if the mixed company meets the following conditions:
- the company is foreign controlled;
- a minimum of 80% of its total income comes from foreign sources;
- the company has close relationships to foreign entities.
Branch offices, whether of foreign companies, or of Swiss companies in other cantons, must be registered in the Commercial Registry of the canton in which they are located. The branch must have a nominated, Swiss-resident representative.
Branches need not publish their annual financial statements, but branches of foreign corporations constitute 'permanent establishments' from a tax point of view, and will therefore be taxed on local source income both at federal and at cantonal level as if they were resident corporations. There is no withholding tax on transfers of branch profits to a foreign parent.
Corporate Tax Reform III
In April 2014, Swiss cantons expressed their support for plans to reform and improve the nation's corporate tax system under the third series of corporate tax reforms (corporate tax reform III).
Launched in September 2012, corporate tax reform III's objective is to change Switzerland's corporate tax system in the tense areas of competitiveness, financing of government expenditure and international acceptance. Furthermore, the proposals seek to ensure an acceptable distribution of tax revenue between the Confederation and the cantons, and between the cantons themselves.
Switzerland has been under pressure from the EU to make changes to its corporate tax rules for a number of years, specifically in relation to the special tax-privileged company formats described above. Until recently, Switzerland flatly rejected the EU's demands, arguing that Brussels has no legal basis to force changes to Swiss corporate tax law. However, the growing global focus on corporate tax avoidance, and the emergence of multilateral initiatives such as the OECD's BEPS project, has changed the landscape dramatically in the past couple of years.
The final report on corporate tax reform III was published by the Federal Council in December 2013. This recommended, among other things, the introduction of preferential taxation of royalties (a so-called "royalty box") for cantonal taxes and further examination of the restricted interest-adjusted profit tax model at federal and cantonal level. Both of these instruments are used in various OECD member states and could allow Switzerland to remain competitive for particularly mobile corporate activities. The report also recommended that the abolition of the issue tax on capital should be thoroughly examined in addition to cantonal taxes on capital. The report also proposed that the cantons should modify their profit tax rates where they consider this necessary to maintain their international competitiveness.
Commenting on the outcome of the cantonal consultation on the report, the Swiss Federal Department of Finance explained on April 30 that:
"Switzerland's attractive tax environment for companies has made a significant contribution to the country's prosperity in recent years. Companies based here create jobs, make investments, and provide an important source of tax revenue. Companies with cantonal tax status have accounted for half of the Confederation's profit tax receipts in recent years."
"International developments, particularly [from] the Organisation for Economic Co-operation and Development, have led to a situation whereby certain provisions of existing Swiss legislation are no longer compatible with international standards. As a result of this diminishing acceptance, companies are confronted with reduced legal and planning certainty. The aim of the latest corporate tax reform is to consolidate international acceptance. This will provide clarity for companies with respect to the key legal parameters.
"At the same time, the reform includes a substantial package of further measures designed to improve the system of corporate tax legislation. The work undertaken by a joint federal and cantonal project organization constitutes the basis for the key aspects of the reform. In December 2013, the project organization prepared a report that set out and evaluated various measures. The proposed measures have generally been welcomed by the cantons."
In September 2014, the Swiss Federal Council confirmed plans to abolish cantonal corporate tax breaks because they are no longer considered to be in keeping with international standards. Companies with cantonal tax status have accounted for roughly half of the Confederation's profit tax receipts in recent years. However, the Council is concerned that, as a result of the diminishing international acceptance of these arrangements, companies are increasingly faced with reduced legal and planning certainty.
Nevertheless, the Council confirmed proposals for the introduction of a royalty box, to allow income from intellectual property to be taxed at lower rates, and an interest-adjusted profit tax. To compensate for the loss of the special tax regimes, it is envisaged that ordinary rates of cantonal corporate tax will be lowered, and the cantons will also be able to introduce targeted capital tax reductions, while the issue tax on equity capital will be abolished. Additionally, adjustments will be made to the rules on participation deductions and the offsetting of losses. Comprehensive regulations will be introduced for the disclosure of hidden reserves.
The changes are to be implemented primarily in the cantons and their communes and are likely to lead to a moderate fall in their profit tax revenues. The Council will therefore introduce a capital gains tax on securities to account for this shortfall. It will also make adjustments to the partial taxation system for dividends.
The changes are to be subject to consultation until January 31, 2015. The Government said international tax developments that occur in the interim will be factored into the final plans.
Administrative Assistance and Information Exchange
Until recently, Switzerland's laws on confidentiality largely prevented the country from participating in administrative assistance programmes in the area of taxation. This began to change some years ago mainly as a result of pressure from the US Government, which has accused Swiss banks of helping its citizens evade US taxes, the EU, with its Savings Tax Directive (STD), and of course the OECD, which is the driving force behind moves to adopt more comprehensive information sharing. As a result, Switzerland is in negotiations with the EU regarding a strengthened STD with beefed-up information sharing provisions; has renegotiated several double tax agreements to include standard information exchange provisions; and has signed an intergovernmental agreement with the US Treasury to allow Swiss financial institutions to tell the US Internal Revenue Service about American account holders under the Foreign Account Tax Compliance Act (FATCA).
Switzerland also endorsed the OECD Declaration on Automatic Exchange of Information (AEI) in Tax Matters on May 6, 2014, which commits participants to a new single global standard on AEI. The Swiss Federal Council insisted, however, that: there must be only one global standard (at present there are several, including the OECD Multilateral Convention on Information Exchange, DTAs and bilateral tax information exchange agreements, FATCA, the EU Administrative Cooperation Directive; and the G5 AEI pilot to which more than 40 countries are signed up); that exchanged information should be used solely for the agreed purpose (principle of speciality); information exchange should be reciprocal; data protection must be ensured; and the beneficial owners of trusts and other financial constructs should also be identified.
Furthermore, the Federal Council stressed that, where appropriate, the issues of regularization of past undeclared assets and income and market access are to be incorporated into negotiations on the automatic exchange of information. It also said that, in general terms, the introduction of the automatic exchange of information should create a level playing field, and Switzerland's reputation and that of its financial centre in the area of taxation should be improved.
In the draft mandates, the Federal Council specifically recommends taking the following steps in the further course of action:
- The introduction of the exchange of information is to be negotiated with the EU such that the ongoing negotiations on extending the EU savings tax agreement will be reoriented;
- Regarding implementation of FATCA, a switch from a Model Two to a Model One IGA should be negotiated with the United States, so that data would be exchanged automatically between the competent authorities on a reciprocal basis;
- Negotiations on the automatic exchange of information with other selected countries is to be examined. During an initial phase, priority would be given to the introduction of the automatic exchange of information with countries with which there are close economic and political ties, and which, if appropriate, provide their taxpayers with sufficient scope for regularization, and which are considered to be important and promising in terms of their market potential for Switzerland's finance industry; and
- The introduction of the automatic exchange of information with foreign countries would be conducted by means of separate bilateral agreements with the partner countries. Moreover, implementing legislation would be required in national law. Existing legislation excludes the automatic exchange of information.
The relevant parliamentary committees and cantons are being consulted on the draft mandates which are expected to be adopted by the Federal Council by the end of 2014.
How Will These Changes Affect Switzerland?
In terms of the corporate tax reforms, it might appear on the surface that Switzerland is surrendering a huge tax advantage to other low-tax countries by abolishing the holding, domiciliary, mixed and other tax-privileged company formats. However, in reality, the Federal and Cantonal Governments are aiming to replace these so-called harmful elements of the Swiss tax regime with something equally, if not more, beneficial to resident and foreign investors.
It is expected that after the Corporate Tax Reform III is fully implemented, taxpayers will benefit from the following:
- Lower headline corporate tax rates for all Swiss resident companies;
- A generous participation exemption regime with no minimum participation requirement and no minimum holding period;
- The absence of controlled foreign company rules;
- Unlimited loss carry forwards;
- Group loss relief;
- Elimination of the capital issuance tax;
- Notional interest deduction on equity; and
- A generous intellectual property income tax regime (the royalty box).
Furthermore, a long legislative process means that the existing regime will not be fully replaced for a number of years. An approximate timetable could be as follows: consultation ends January 31, 2015; formal legislation submitted to parliament in mid-2015; possible referendum on the legislation, unlikely before the end of 2016; introduction of the reforms in the cantons in January 2019 at the earliest.
Unfortunately, Switzerland doesn't have much choice when it comes to applying new rules for the exchange of information between Governments for tax purposes, and risks being ostracised by the international community if it refuses to sign up to initiatives like the OECD's new common standard for automatic information exchange. However, the fundamental tenets of privacy remain enshrined in Swiss law, and as the conditions being insisted on by the Federal Council in return for its support for the new standard show, Switzerland will always fight to uphold the best interests of individual privacy.
In summary it is difficult to divine exactly what the future holds for Switzerland as a result of the legal and administrative reforms touched on here. It is fairly evident that banking secrecy laws will be compromised somewhat as a result of ongoing international transparency initiatives. However, the proposed tax reforms, combined with the Swiss Government's desire to safeguard confidentiality where possible, should assure that the country remains a magnet for foreign investors for some time to come.
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