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New Swiss Corporate Tax Reform Requires Public Approval

Tuesday, February 5, 2019

A federal referendum will be held on May 19, 2019, in Switzerland on an overhaul to the corporate tax code, to bring it into line with international standards.

The referendum will decide the fate of the Federal Act on Tax reform and AHV Financing (TRAF), which was drafted after the earlier corporate tax reform III package, discussed below, was rejected.

The TRAF legislation is due to enter into force on January 1, 2020. It will abolish the special arrangements for cantonal status companies, along with the federal practices on tax allocation for principal companies and Swiss finance branches. The legislation will also introduce a mandatory patent box regime for all cantons, provide a relief restriction, and reform the taxation of dividends from qualified participations.

The Swiss Federal Council has announced that, from 2019, the Federal Tax Administration (FTA) will no longer apply the federal practices concerning principal companies and Swiss finance branches to new companies.

Companies operating internationally often group their structures into larger units and centralize functions, responsibilities, and risks within the group in so-called principal companies. Under the current Swiss rules, if a principal company is located in Switzerland, some of the net profit is exempt from taxation in the country.

Swiss finance branches are Swiss financial permanent establishments of foreign companies and are responsible for lending within foreign groups. Currently, the calculation of a usage fee for the capital made available to the Swiss permanent establishment reduces the taxable net profit of the Swiss finance branch in Switzerland.

Unlike the rules on cantonal status companies, the abolition of the federal practices does not require any legislative amendment. As a first step, the FTA will ensure that the federal practices are from 2019 no longer applied to new companies. Then, with the entry into force of TRAF in 2020, the federal practices for existing principal companies and finance branches will be abolished.

Why is Switzerland's tax regime changing?

Switzerland was obligated to change its corporate tax regime after long-standing pressure from the European Union, which led to the country accepting the EU Code of Conduct on Business Taxation in June 2014. Jurisdictions recognizing the Code must, among other things, roll back tax measures deemed "harmful" and commit not to introduce new ones.

Consequently, tax reform proposals were drawn up to abolish special tax arrangements at cantonal level, namely holding, domiciliary, and mixed company formats, which allow foreign companies to pay little or no corporate tax. These regimes have long been criticized by the EU for facilitating the shifting of profits from EU member states to Switzerland.

CTRIII

However, the Swiss Government wasn't content with merely sweeping away the cantonal tax regimes. It is estimated that cantonal status companies employ around 150,000 people and contribute about 20 percent to total cantonal and communal revenues. Therefore, a major goal of the earlier tax reform, which came to be known as Corporate Tax Reform III (CTRIII), was the introduction of more internationally accepted tax incentives, designed to both maintain Switzerland's international tax competitiveness and ensure the corporate tax regime adhered to international standards.

As such, CTRIII would have included the following changes:

  • As such, CTRIII also included the following changes:
  • A patent box at cantonal level (but not at federal level), offering preferential treatment for revenue from patents and similar rights associated with research and development (R&D) in Switzerland;
  • A super deduction for research and development expenses of up to 150 percent of qualifying R&D expenditure incurred in Switzerland, which would have been optional for cantons. This was not be applied at federal level;
  • A notional interest deduction on "surplus equity," intended to align the tax treatment of debt and equity financing, and replacing initial proposals for an interest-adjusted corporate income tax;
  • A provision allowing cantons more flexibility over corporate tax;
  • Targeted capital tax deductions at cantonal level; and
  • The abolition of issue tax on equity capital.

CTRIII made steady progress through Switzerland's often laborious legislative process. It was approved by the Swiss Federal Council, the seven-member executive council that constitutes the federal government of Switzerland, on April 2, 2014, and by parliament in June 2016. However, the measures were rejected by voters at a referendum in February 2017, effectively consigning the reforms to the legislative waste bin.

Campaigners have reportedly said that the new proposals seek to do away with tax privileges for companies but replace them with equally unacceptable tax breaks.