Several legislative projects with impact on the tax laws are currently under discussion in the Swiss Parliament or have already been decided and are expected to enter into force between 2020 and 2022. These include the introduction of the Financial Services Act and the Financial Institutions Act, the elimination of the so-called marriage penalty for direct federal tax purposes, or the regulation regarding tax deductibility of financial sanctions. However, the most important reform with the most impact for companies domiciled in Switzerland is the Swiss tax reform.
For some time now, Switzerland has been in the political focus of the EU and the Organization for Economic Co-operation and Development (“OECD”) in order to abolish the internationally no longer accepted tax privileges granted at cantonal level. This is because these privileges are no longer compatible with the minimum standard for company taxation adopted by the OECD.
A first attempt to legally dispose of these tax privileges was initiated with Corporate Tax Reform III (“CTR III”) which, however, failed on February 12, 2017 in a public vote. Due to the urgency of the reform, a new edition of the reform was launched by the Federal Council on March 21, 2018.
The measures of the new Swiss tax reform do not deviate significantly from their predecessor. However, the measures have been somewhat weakened in comparison. Additionally, in view of the failure of the previous proposal, the Council of States considered it necessary to link the tax reform with a social equalization measure in order to make it more majority-compatible. Consequently, the bill was linked to an additional financing of the old-age and survivors’ insurance (“AHV/AVS”).
Despite the efforts of parliamentarians, the referendum on federal level against the reform was successfully launched on January 17, 2019. Therefore, on May 19, 2019, the public will vote on the Federal Act on Tax Reform and AHV Financing.
Main Objectives of the Reform
The Swiss tax reform pursues in particular the following three objectives:
- safeguarding the attractiveness of the location;
- international acceptance;
- productivity of tax revenues of the Confederation, cantons and municipalities.
Within this framework, the attempt was made to design the tax reform as balanced as possible. For example, the new special tax regulations are more restrictive and greater emphasis was placed on the interests of towns and municipalities. The goal is to promote Switzerland as an economic and tax location, focusing on the reduction of profit tax rates and on the internationally accepted instruments for the promotion of research and development (“R&D”).
Essential Content and Measures of Tax Reform
The bill proposes several changes impacting individuals as well as corporations. Those measures that will most directly affect Swiss domiciled companies include:
- Abolition of status companies: The core element of the reform is the abolition of cantonal status companies (holding, domicile/administrative and mixed companies). The abolition of the internationally criticized taxation as principal company or financial branch is not formally part of the tax reform, but is to be abolished at the same time at the administrative level. Transitional measures may facilitate the transition to ordinary taxation.
- Patent box: The main replacement measure that supports the tax reform is the introduction of a mandatory patent box in accordance with the OECD standard at cantonal level. This patent box, however, is more limited in scope than was the case with CTR III. Only income linked to an intellectual property right registered in a public register can benefit from the patent box. These rights include domestic and foreign patents and similar, narrowly defined rights. Copyright-protected software (not patented) is excluded from the patent box.
- Additional deduction for R&D expenses (maximum 50 percent of costs): The implementation of this measure is optional for each canton. The basis for the additional deduction is limited to personnel expenses plus 35 percent (for other R&D costs) or 80 percent of R&D expenses incurred and invoiced by third parties in Switzerland.
- Notional Interest Deduction (“NID”): This measure provides for a deduction of a notional interest on surplus equity. However, it is foreseen exclusively for cantons with high effective tax rates. According to current information only the canton of Zurich will meet the requirements for the implementation of the NID.
- Overall limitation: The tax relief on profit from the three instruments mentioned above as well as from a transitional measure may not exceed 70 percent. This limits the scope for relief compared with CTR III (80 percent).
- Restriction of the capital contribution principle: The currently applicable tax-exempt repayment of capital contribution reserves is also to be restricted. In future, companies listed on a Swiss stock exchange will have to comply with the repayment and partial liquidation rules when repaying capital contribution reserves. The repayment rule states that a tax-exempt repayment of capital contribution reserves can only take place if taxable dividends in the same amount are distributed. The same applies analogously to the issue of bonus shares and bonus nominal value increases from capital contribution reserves. The partial liquidation rule stipulates that at least half of the liquidation surplus must be charged to the capital contribution reserves when own shares are repurchased.
Cantonal Implementations and Developments
The main elements of the reform and in particular the intended reduction of corporate income tax rates are to be implemented on cantonal level. Accordingly, the implementation process is currently progressing in the various cantons. The canton of Vaud has already implemented a lower cantonal tax rate in force as from January 1, 2019.
The canton of Basel-Stadt has just accepted the cantonal implementation of the reform in a public vote on February 10, 2019 with a clear majority of 78.8 percent. In the canton of Fribourg, the implementation has been decided by the parliament and no referendum was called. In contrast to this the Bernese electorate rejected a reduction in the profit tax rate (antecedent to the main tax reform). In Zurich and Zug the cantonal implementation of the tax reform is still to be discussed by the respective cantonal parliaments. In other cantons, the official bill has still to be published by the government and to be sent to the cantonal parliament.
Timeline and Outlook
In the event of the Swiss public’s acceptance of the federal bill, the tax reform is scheduled to come into force on January 1, 2020. The transitional measure concerning a temporary special tax rate solution is to come into force immediately after the public vote. In order to mitigate the actual tax increase for those companies that wish to waive their cantonal tax status prematurely, the cantons are free to implement this measure already in 2019.
In case of a failure of the national reform package at the ballot box in May, the Swiss government would need to react quickly and work towards an abolition of the internationally criticized privileges (including some transitional rules and potentially increasing the cantonal share of federal tax revenue and adjusting the fiscal equalization system). However, in such a scenario likely no new tax privileges like the patent box or additional deductions for R&D expenses would be implemented. Without a quick abolition of the tax privileges, it would hardly be possible to prevent Switzerland from being blacklisted by the EU.
The rapid implementation of the new Swiss tax reform is no surprise and to be welcomed, as the need for a reform is urgent. The patent box and the additional R&D deduction are a clear commitment to Switzerland as a research and industrial location. The introduction of a notional interest deduction on surplus equity provides the canton of Zurich with a tailored instrument to implement the reform considering its local economy.
The OECD and the EU will continue to closely monitor the process in Switzerland and maintain their pressure to ensure that the legislative process does not take too long. It remains to be hoped that on May 19, 2019 the electorate will give the green light to the Swiss tax reform in order to eliminate the uncertain legal situation and in order that the objectives of the reform as stated above can be met.
- Companies with a privileged tax status in Switzerland should plan towards the loss of such status and to determine how such a change of status can be carried out in a tax-optimized manner with regard to existing hidden reserves. It is advisable to discuss the procedure with the cantonal tax authorities in advance.
- Furthermore, such companies should monitor and analyze developments in other countries with which they carry out transactions in a timely manner. Depending on the individual’s exposure to foreign regulations, an early waiver of a tax status may be beneficial.
- Companies should check the applicability of the new measures like the patent box or additional deductions for R&D expenses to their business activity.
- Due to these changing conditions and different implementations between the cantons, many companies cannot avoid revising the optimal location for their activities.
- In light of the OECD’s action plan to combat base erosion and profit shifting, it is recommended that the board of directors address tax planning—and in particular the use of soon to be phased out special tax regulations. Current structures must be regularly reviewed in light of ongoing international developments.
Sébastien Maury is Director at KPMG Switzerland.