In the realm of multinational corporate tax planning, Switzerland has long been a key jurisdiction due to its generally attractive business attributes (solid infrastructure and multilingual, skilled workforce) and competitive corporate tax regime. 

But in recent months, in response to mounting international pressure brought to bear by both the European Union and the Organisation for Economic Cooperation and Development (OECD), the Swiss federal and cantonal governments are contemplating significant tax reform proposals.  The Swiss government has signaled that it intends to address concerns expressed by the EU and the OECD while strengthening the future competitiveness of the Swiss tax system. 

That is, the Swiss tax landscape is in the throes of change. It seems inevitable that certain beneficial tax models will be abolished in the next few years. 

This article outlines key, high-level takeaways based on recent meetings and discussions surveying ongoing Swiss tax developments. In addition to ongoing monitoring of the evolving situation, a high-level analysis of the proposed changes’ impact to existing business models may be useful for strategic planning purposes.

Background

Switzerland has three levels of taxation:  federal, cantonal and municipal.  Under ordinary circumstances, Swiss tax rates historically ranged from 11.5 percent -24 percent, depending upon the canton.  Pursuant to certain beneficial federal and cantonal tax regimes, however, the effective tax rate (ETR) for a foreign multinational could be as low as 0 percent – 10 percent.

In recent years, international developments have impacted the Swiss tax environment.  Although Switzerland is not part of the EU, in 2005, the EU Commission began looking into whether the beneficial cantonal regimes were aligned with international taxation standards.  The dispute escalated until June 2012, when both the Swiss federation and the cantons agreed to negotiate regarding the elimination of certain taxation models. 

In February 2013, further intensifying the focus on the Swiss taxation framework, the OECD published its report Addressing Base Erosion and Profit Shifting (“BEPS”).  In July 2013, the OECD launched the BEPS Action Plan, which detailed 15 actions to address profit shifting, including Action 5 (i.e., “Counter Harmful Tax Practices”).  Pursuant to Action 5, certain Swiss tax models were identified as potentially harmful.

After lengthy negotiations and discussions between the EU and Switzerland, the parties signed a Memorandum of Understanding on July 1, 2014, in which Switzerland agreed to abolish certain tax regimes.

Likely impact of reform on present Swiss tax regimes

The chart below summarizes Switzerland’s present tax regime and the changes likely to arise in response to pressure from the EU Commission and the OECD.  Importantly, administrative tax rulings are unlikely to be available in the future, although existing rulings are expected to be grandfathered for some yet-to-be determined period.

At a Glance:  High-Level Summary of Present Swiss Tax Regimes and Likely Fate as a Result of Swiss Tax Reform
Model	Authority	General Description	Current Tax Features	EU Commission View	OECD View	Likely Effect of Swiss Tax Reform
Holding Company	Cantonal	Company or Swiss branch of a foreign company engaged in long term holding and administration of certain qualifying participations; no Swiss business activities	Federal participation exemption on certain dividends and capital gains income; cantonal tax exemption; ETR ~0% for income from qualifying investments and 7.8% on other activities	Alleged to constitute unlawful state aid because income from certain activities is taxed solely at the federal level	Pursuant to BEPS Action 5 - “Counter Harmful Tax Practices,” identified as potentially harmful	To be abolished
Domiciliary Company	Cantonal	Company limited to the performance of administrative functions in Switzerland	Beneficial tax rates on qualifying participations and certain foreign source income; ETR ranges from 0%-10% depending upon  type of income	Criticized because it may result in unequal treatment of domestic versus foreign sourced income	Pursuant to BEPS Action 5, identified as potentially harmful	To be abolished
Mixed Company	Cantonal	Corporations primary business is abroad (i.e., 80% or more of income foreign source / 80% or more expenses are paid outside Switzerland)	Beneficial tax rates on qualifying participations and certain foreign income and partial tax relief based on cantonal benefits; ETR 0%-11% depending upon type of income	Concern that home country profits are shifted to Switzerland	Pursuant to BEPS Action 5, identified as potentially harmful	To be abolished
Nidwalden IP Box	Nidwalden Canton only	Available to companies resident in the canton and which own IP	Reduced ETR of 8.84% on net royalty income	IP Boxes in general are suspected by EU Commission of unfairly benefiting mobile businesses without creating corresponding research and development activities; the Commission’s general probe of patent box regimes is ongoing.		Assuming that patent boxes are ultimately determined to comply with EU rules this regime may survive
Principal Company	Federal	Available to companies that meet either the Domiciliary or Mixed Company status at cantonal level but that also sell through an affiliated company commissionaire or limited risk distributor	Certain income exempt from tax; ETR can be as low as 0%-9%		Pursuant to BEPS Action 5, identified as potentially harmful	To be abolished
Swiss Finance Branch	Federal	Company acting as internal affiliate group “bank” due to the volume of financing including loans, hedging and cash pooling	Certain beneficial deductions are permitted and the company can also apply for Domiciliary or Mixed Company regimes; ETR 3%-4%	Currently N/A	Certain financial instruments and interest deductions have been identified as problematic in BEPS Action 2 - “Neutralize the effect of hybrid mismatch arrangements” and Action 4 - “Limit Base Erosion via Interest Deductions and Other Financial Payments”	To be abolished

 

What will replace the former tax regimes? Potential proposals

As a result of growing international pressure, the Swiss government will likely be compelled to introduce new tax regimes that are viewed as compatible with EU and OECD standards, while enhancing and maintaining Switzerland’s competitive position. 

Potential proposals under discussion include:

• General lowering of the corporate tax rate
  • Flat rate tax at each of the three levels
    • Anticipated combined flat ETR of ~11.5 percent -15 percent
    • No substance required for flat rate tax
    • No ruling required
    • New Swiss IP / License Box
      • Still undetermined: the breadth of qualifying IP and Swiss substance requirements
      • Most substantial benefit is likely if legal and economic IP ownership is in Switzerland
      • Accounting divided between IP Division Income and Operating Division Income
      • Combined ETR of ~ 10 percent -12 percent
      • Interest-adjusted corporate income tax / notional interest payable on equity
        • This proposal does not enjoy broad support by the cantons
        • Elimination of share issuance tax / stamp duty
        • Re-valuation of assets relocated to Switzerland
        • Participation exemption mechanism adjustments
        • Lump-sum tax foreign tax credit system adjustments
        • Canton-specific tax holidays
          • As opposed to tax rulings, tax holidays are granted as part of a political, rather than an administrative, process; as such, it is contemplated tax holidays may still be permissible
          • It is likely that tax holidays would require a commitment to canton-specific substance (i.e., 20-25 employees and a guaranteed profit level)

Assessing the risks and opportunities of potential proposals

Although the proposals are not yet final, for strategic planning purposes it may be possible to do a high-level risk / opportunity analysis based on certain business models.  For example:

Holding company =  Dividend Withholding Tax (WHT) will likely be relatively unchanged; i.e., ~0 percent -10 percent based on treaties and EU directives; management fees, currently subject to ETR of 7.83 percent; will  likely  be subject post-reform to ordinary corporate income tax  rates (CIT), estimated at a minimum of 11.5 percent, depending upon final ordinary rate implemented

IP company = Likely ETR with use of IP / License Box~ 8.8 percent – 12 percent; combined ETR based on reduced rate applied to IP profits and ordinary CIT rate on routine operating profits

Trading company = ETR likely to be minimum of 11.5 percent; if the trading company owns the economic rights to IP, then License Box may be applied to product embedded IP, potentially  reducing ETR

Timing

Timing of implementation and the length of any grandfathering period is not yet certain.  The Swiss government anticipates completing the first draft of the legislation, as well as the consultation process, by the end of 2014.  Indications are that entry into force will occur sometime after 2018, following parliamentary debate and the requisite referendums.  At present, the grandfathering period is estimated to last from 2018-2020.

Modifications are coming

The Swiss tax landscape is currently evolving in response to international developments.  While the outcome of tax reform proposals is not yet established, the Swiss government has expressed its intention that any modifications strengthen Switzerland’s corporate tax competitiveness. 

For more information about ongoing developments related to Switzerland’s tax regimes, please contact the author.