The objective of the proposed Swiss corporate tax reform is to ensure that the Swiss corporate tax system is in line with international minimal standards, which recognize as harmful the cantonal preferential tax regimes for holding, domicile and mixed companies. Accordingly, these privileged tax regimes need to be abolished by the cantons.
It should be noted that Switzerland levies taxes on a federal and cantonal and communal level. Therefore, the detailed tax treatment and the applicable tax rates of a company are dependent upon its place of tax residency.
The Swiss Parliament approved the final draft bill regarding the corporate tax reform, which includes major changes for multinational enterprises (“MNEs”) with Swiss operations, on September 28, 2018.
The corporate tax reform is subject to public vote which will take place on May 19, 2019. Some of the new tax provisions could enter into force in 2019, with the main part in 2020.
If the corporate tax reform were to be rejected, the Swiss government has announced its plan to abolish the privileged tax regimes at latest by end of 2020; otherwise, the Organization for Economic Co-operation and Development (“OECD”) and the EU will place Switzerland on their blacklist, which would result in adverse tax treatment of cross-border transactions for Swiss tax-resident companies.
Abolishment of Mixed Company Status
Normally, MNEs would benefit from mixed company status for their Swiss operations (e.g. having a Swiss trading and distribution company) whereas foreign source income would only be subject to taxation at cantonal level on a quota between 10 percent and 30 percent, depending on their presence in Switzerland. Such mixed company status would reduce the effective tax rates substantially.
Given that the cantons need to abolish the preferential tax regimes in any case, it would be expected that companies would move their activities to other jurisdictions with lower tax rates. Therefore, in order to remain an attractive business location for international groups, the cantons will reduce their corporate tax rates for all companies.
In the case of the cantons of Zurich and Zug, the consequences of the abolishment of the mixed company status would result in the following tax rates (please note that in Switzerland the tax rates depend upon where the companies have their place of tax residence and the following tax rates are for illustrative purposes only):
Proposed Tax Measures
The reduction of the corporate tax rates would not be enough to keep such Swiss entities in Switzerland (e.g. the canton of Zug current effective tax rate of approx. 8.8 percent compared to proposed effective tax rate of approx. 12 percent) and therefore various tax measures have been proposed for reducing the taxable basis for companies losing their preferential tax status as follows:
- tax neutral step-up in tax basis as a transitional measure for mitigating the tax impact on the abolish of the preferential tax regimes;
- research and development (“R&D”) super deduction;
- notional interest deduction for cantons having an effective tax rate higher than 18 percent, e.g. in the case of the canton of Zurich;
- introduction of a patent box; and
- other tax measures not relevant for MNEs with Swiss operations.
Step-up in Tax Basis—Based on Current Tax Law
Under the current tax rules the cantons in general allow a tax neutral step-up in the tax basis if companies had given up their preferential tax regimes. The hidden reserves and goodwill generated during the preferential tax regime period could be disclosed in the tax balance sheet and depreciated for tax purposes accordingly.
Based on this depreciating model the taxable income could be reduced substantially even if subject to ordinary taxation. Depending on the relevant canton where the company is tax resident, the depreciation period would be between five to ten years. A step-up under the old corporate tax provisions will only be possible before the new corporate tax provisions would become effective, i.e. it is expected to be until the end of 2019, or at latest by the end of 2020.
The step-up under the current tax law would be subject to a limitation benefit of 70 percent of the taxable basis, i.e. that a minimum of 30 percent of the taxable income before application of any tax measures deductions would be taxable.
The available hidden reserves and goodwill would be reflected in the tax balance sheet and therefore would have the result that a deferred tax asset would need to be recognized for International Financial Reporting Standards (“IFRS”) purposes.
Step-up in Tax Basis—Based on New Tax Rules
Under the proposed new corporate tax rules gains deriving from the realization of hidden reserves and goodwill created under the preferential tax regime would be subject to a lower special tax rate. The taxation at a special tax rate would be possible during the five years following the introduction of the new corporate tax provisions.
The special tax rates differ from canton to canton, e.g. the canton of Zurich proposes a special tax rate of 1.04 percent, the canton of Zug of 1.6 percent.
The proposed step-up under the new tax rules would not be subject to limitation benefit as under the current tax law. The amount of the available hidden reserves and goodwill would be confirmed by the tax authorities separately and therefore no deferred tax asset would be recognized for IFRS purposes.
R&D Super Deduction
To provide that Switzerland remains an attractive location for R&D activities the cantons can offer a super deduction for R&D activities. A maximum deduction of 50 percent of the Swiss R&D expenses would be granted for tax purposes.
The Swiss R&D expenses would be determined based on the personnel expenses for R&D plus a mark-up of 35 percent for other expenses and 80 percent of third party or group companies expenses for the Swiss R&D activities.
Notional Interest Deduction
For the canton of Zurich, having a majority of Swiss taxpayers, it would not be possible to reduce its effective corporate tax rates more than the proposed approximate 18.2 percent, given the reduction would affect all companies tax resident in the canton of Zurich.
The canton of Zurich would therefore grant a notional interest deduction for excess equity which would reduce the taxable basis substantially: as excess equity would qualify equity which on a long-term basis would not be regarded as necessary for running ordinary business operations.
The cantons would have to introduce a patent box regime in line with the OECD standard, i.e. applying the so-called nexus approach. The patent box regime could result in a maximum reduction of 90 percent of the taxable base depending on the cantons. The patent box regime would be quite complex and applicable only for a limited number of companies performing R&D activities in Switzerland.
All the proposed tax measures, i.e. step-up under the current tax law (not under the proposed new tax law), R&D super deduction and notional interest deduction would be limited to a 70 percent tax relief of the taxable basis.
Based on a high-level calculation the applicable average tax rates which should be taken into consideration for companies losing their mixed company status could be as follows (please note that in Switzerland the tax rates depend upon where companies have their place of tax residence and the following tax rates are for illustrative purposes only):
It is very difficult to assess whether the proposed corporate tax reform will pass the public vote on May 19, 2019.
Nevertheless, MNEs with Swiss operations should review their tax position and assess the impact of the abolishment of the preferential tax regimes by the cantons. Also, holding companies could benefit from the step-up measures on hidden reserves on their assets not being qualifying investments (i.e., 10 percent shareholding in the capital of the company) which could benefit from the participation exemption when realizing any gain.
The following should be carried out as immediate action points:
- Assessing the two possibilities of step-ups of the hidden reserves and goodwill under the current and new corporate tax provisions and taking into account:
- the limitation benefit of 70 percent for the step-up under the current tax law;
- the available tax period of five years (under the new corporate rules) and ten years (under the current tax law);
- Determining the hidden reserves (being the difference between the fair value and the tax value of the assets) and self-build-up goodwill (performing a fair market valuation);
- Assessing the impact of the two step-up methods on deferred tax assets for IFRS purposes.
Elga Reana Tozzi is Counsel with Niederer Kraft Frey Ltd., Zurich, Switzerland.
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