The demands on Switzerland
Conformity with the OECD and EU standards. That means inter alia equal treatment of domestic and foreign income and therefore abolition of five special forms of corporate taxation (“tax regimes”), which are subject to international criticism:
- Holding company,
- domicile company,
- and mixed company at cantonal level,
- principal taxation,
- and regime for Swiss Finance Branches at federal level.
On 14 October 2014, Switzerland assured the EU that it would abolish tax regimes considered by the EU to be harmful. In turn, the EU undertook to abolish in parallel existing measures of individual EU states against Switzerland. On 12 February 2017 Corporate Tax Reform III (CTR III) was presented to the sovereign and rejected with a resounding “No”.
Given the existing international pressure, the Federal Council had to act quickly and therefore launched the draft of a new tax proposal (known as Tax Proposal 17; TP 17). The consultation process on the Federal Council’s revised proposal was concluded on 6 December 2017.
The objectives of TP 17 are the same as for CTR III
The following target triangle is to be achieved in the best possible way:
- Restore international acceptance of the Swiss tax system,
- maintain its attractiveness as a business location and
- secure appropriate tax revenues for confederation, cantons and communities.
The new corporate tax system should strengthen Switzerland as a competitive tax location and reliable value-adding partner for domestic and foreign groups and for Swiss SMEs. Attractive jobs should be created and retained and social prosperity consolidated. In addition, international conformity is strived for and a balanced corporate tax substrate ensured. It is the intention that TP 17 is more balanced, more comprehensible and politically more widely accepted, as the call for an acceptable solution and a suitable balance is becoming louder.
For those involved in the political process it is now a question of giving up their extreme positions and to come together to reach an agreement.
The basic concept
In order, to achieve the above-mentioned target triangle in the best possible way, the cantons must be permitted a high degree of flexibility in structuring their regimes. Rigid regulation with enforced conformity regardless of the cantonal characteristics would inhibit successful realisation and contradict Switzerland’s federalist concept. The reform package is therefore still based on modules and allows the cantons certain range of options in the realisation. The Helvetic success model, which in the last 30 years has brought Switzerland numerous corporate relocations and prosperity, should be retained this way.
During the CTR III referendum campaign it was frequently unclear, to what extent one would gain effective advantages and suffer disadvantages. The fact is: In the past, the Confederation has benefited from the regime companies to a much greater extent than the cantons. The substrate for these taxation forms represents about half of the corporate income tax revenues from Direct Federal Tax and, together with the cantonal corporate income taxes, amounts annually to about five billion Swiss francs. An exodus of the regime companies, which up to now have enjoyed privileged cantonal taxation, would therefore seriously damage not only the cantons, but also the Confederation. The measures foreseen by the Federal Council are intended to avoid this as far as possible and to ensure, that Switzerland will remain fiscally attractive for the location of companies in the future.
The prospective tax charge for those companies, which up to now have been taxed under the rules of the regimes being abolished, depends on how much the canton, in which they carry on their activities, will reduce the standard corporate income tax rate and whether they carry on research and development in Switzerland. In any event, previous regime companies will, after the reform becomes effective, at first pay the same or somewhat higher taxes and, after the expiry of a transitional period, depending on the canton pay a little or substantially higher taxes.
The proposed relief measures and cantonal reduction of the ordinary corporate income tax rates will benefit in particular Swiss SMEs. The increased partial taxation of dividend income at owner level will compensate this benefit to some extent. The total effect depends on the characteristics of a SME, and where in Switzerland the company and its owners carry on their activities or have their residence. In cantons, which reduce the corporate income tax rates significantly, SMEs will in spite of higher partial taxation overall be the winners. This in contrast to cantons, which cannot, or only marginally, reduce the corporate income tax rate.
Overview of the most important reform measures and their effects on the corporate location Switzerland:
- Introduction of internationally accepted reliefs for all Swiss companies with research and development activities in Switzerland (including those that have previously not benefited from a tax regime);
- Increase of financial contribution from the Confederation to the cantons, to finance the cantonal different potential for reduction of the corporate income tax rates for all companies;
- Alleviation of the increase in the cantonal corporate income tax charge for international corporate activities, which previously benefited from a tax regime now being abolished, for a transitional period of five years;
- Retention of taxation independently of the legal form by means of a moderate counter-correction in the partial taxation of private dividend income;
- In comparison with CTR III reduced losses of tax revenues, with the aim of nevertheless keeping the business and tax location Switzerland internationally attractive and reliable.
- the introduction of an incentive to create more equity by a deduction for secure financing (formerly interest adjusted corporate income tax) at least optionally for the cantons for the purpose of motivating greater self-financing and reducing the present tax motivation of higher debt. This would contribute to the stability of Swiss companies and job security, even in times of crisis.
Selected measures in detail:
- Patent box profits, more precisely from patents and comparable rights are beneficially treated for tax purposes. They are intended to promote research and development activities and their value creation in groups and SMEs. At cantonal level – as previously proposed in CTR III – a patent box meeting the OECD requirements is foreseen as compulsory. It is, however, more narrowly defined in TP 17. For example, income from Copyrighted Software shall be excluded from the tax benefit.
- Increased deductions for R&D expenditure: because the nexus approach reduces the effect of the patent box, optionally the cantons may supplement the patent box with an input oriented special deduction in the additional amount of at most 50 % of own research and development costs and of 40% of R&D costs purchased in Switzerland.
- Deduction for secure financing: the so-called interest adjusted corporate income tax, also known as Notional Interest Deduction (NID) on excess equity has been struck out of TP 17 by the Federal Council. Interestingly, in the meantime the EU has published a proposed guideline for measurement common corporate tax base in the EU. Included in this proposal is also a so-called deduction for growth and investment, which is very similar to the Notional Interest Deduction. The aims of this rule were twofold: firstly, one wanted to give companies a fiscal incentive to create higher equity financing and, associated with this, greater resistance to a crisis. On the other hand, one wanted to retain highly mobile financing activities existing in Switzerland. Presumably this objective was not recognised by wide circles during the CTR III referendum campaign, not least because of the badly chosen expression “interest adjusted corporate income tax”. Being a sensible measure, it should nonetheless be permitted optionally at least at cantonal level under the positive labelling, “Deduction for secure financing“.
- Step-up of hidden reserves: 18 of 26 cantons already permit under current law the change from a privileged tax status to ordinary taxation through the tax-free step-up of the hidden reserves that arose under the special regime. With the transitional rule under TP 17 the increase, mentioned at the beginning in the tax charge on the abolition of the current tax status, is to be cushioned for the first five years after enactment of TP 17. The cantons may tax the hidden reserves, hitherto tax free, at a special (low) rate to be fixed by the canton.
- Reduction of the ordinary cantonal corporate tax rate for all companies: in order to avoid a fiscal shock after expiry of the transitional rules on the taxation of hidden reserves, the cantons want to reduce their cantonal corporate income tax rates as far as possible. Depending on the cantonal tax level, this reduction, which would be effective for all companies operating profitably, would be in the range between negligible and a substantial number of percentage points. This measure is not formally part of TP 17. Each canton must have such a measure approved in the normal cantonal legislative manner.
- Revision of the capital tax: for companies under a tax regime, today the capital tax is applied more favourably than for companies without special tax treatment. Therefore, the cantons should be able to reduce the cantonal capital tax, to the extent the taxable capital is attributable to patents and participations. Here, too, consonant with the introduction of a deduction for secure financing optional for the cantons, the capital tax relief is also to be permitted, to the extent the equity is attributable to group loans.
- The partial taxation of dividend income for income tax purposes of private investment holders was adopted in 2008 together with CTR II. This income is to be taxed at 70% in future. Compared with today this is higher. In various cantons this increase will be compensated respectively over-compensated, by the expected reduction of ordinary corporate income tax rates, which in future will apply to distributed profits. However, depending on the constellation, the situation is not consistent and can result in a higher charge for private company owners. Therefore, in order to avoid false incentives and distortions, it would be preferable, if the cantons could set the partial taxation percentage autonomously.
- The overall limitation of reliefs was reduced from 80% to 70%. The cantonal minimum charge to income tax will be at least 30% (CTR III: 20%) of profits in the future. This limit is effective in those cases, in which the measures being newly introduced would provide greater relief.
- The minimum children’s and education allowances shall be increased by CHF 30, following the example of Canton Vaud. As a reminder: children’s allowances are funded by the companies dependent on the number of jobs. This element is irrelevant and has nothing to do with corporate taxation. It should therefore be struck from the bill.
Based on the consultation replies received, the Federal Council will draw up the final bill and forward it to Parliament for discussion in spring 2018. If the reform proposal can be dealt with in Parliament expeditiously and without referendum, it is anticipated that the package can become effective on 1 January 2020.
Companies are well advised to prepare in good time for the changing conditions and to draw up alternative actions with a scenario planning. In a first step, they should review the overall tax effects. These include possible benefits from the Step-up practice, benefits from relief measures, such as the research and development deduction or the patent box and effects on the valuation of deferred taxes in the group financial accounts. And of course, it is worthwhile comparing their different possibilities in the various cantons.
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Information on Tax Proposal 17
The most up-to-date information on and changes to the Tax Proposal 17 can be found at any time online.