Switzerland has been under pressure by the European Union ("EU") and the OECD with regards to tax regimes for holding, domicile, mixed and principal companies as well as "Swiss Finance Branches". The international pressure also led Switzerland to be listed in the OECD report on "Base Erosion and Profit Shifting" (BEPS) action nr. 5 regarding harmful tax practices. In the framework of the CTR III, the cantonal tax regimes will be abolished, substituted by new internationally accepted measures.
On June 17, 2016 the Swiss Parliament approved the tax bill which introduces new tax instruments. The proposed measures will strengthen Switzerland as a tax and business location. The new legislation will probably be subject to a referendum, which has already been announced by the Socialist Party. If so, a public vote would take place in February 2017. In addition most cantons plan to reduce their corporate tax rates.
Key features of the CTR III
Considering the changing Swiss (and international) tax landscape, companies which benefit from the current tax privileges and/or carry on licensing, financing or R&D activities should address key considerations such as:
- Assess whether the company should voluntarily exit from the privileged tax regime at the present stage or keep it until the CTR III becomes into force. The assessment will require a thorough case-by-case analysis which should consider amongst other the impact of a possible step-up in the course of the change from privileged to ordinary taxation, the fact that tax rulings (on preferred tax regimes) will be exchanged spontaneously between tax authorities under specific conditions from 2018 onward.
- Assess whether the company will be able to take advantage of the measures proposed in the CTR III bill including the patent box, the NID and/or the R&D super deduction. The assessment should not only consider whether the company would be eligible for a new measure but also related BEPS challenges.
Wrap up of the main measures of the CTR III
Abolition of existing preferred tax regimes
The current provisions which rule the preferred regimes for holding, domicile and mixed companies at cantonal and communal tax level will be abolished. The same will occur for ruling based Principal company status and Swiss Finance branches.
The holding, domicile and mixed company regimes should be grandfathered during a period of five years after the CRT III bill comes into effect. The cantons can enact a (lower) special tax rate to capture hidden reserves and goodwill disclosed in the tax balance sheet during the grandfathering period, provided these items would not have been taxable under prior law. The amount of hidden reserves and goodwill subject to the (lower) special tax rate must be confirmed through a ruling application with the relevant cantonal tax authorities. During the grandfathering period a respective company will apply an ordinary and “special” tax rate. Considering that no tax values will be adjusted, no deferred tax adjustment (asset) will be required.
Reduction of cantonal corporate tax rates
As part of the CTR III some cantons are challenged to reduce their corporate tax rates. The funding of the CTR III is a major issue for these cantons. In order to limit the tax burden of the cantons related to the CTR III the Swiss parliament decided to increase the share of the cantons related to the Direct Federal Tax from 17% to 21.2%.
The status of the political process for a tax rate reduction varies among the cantons. The Canton of Vaud already passed a resolution on March 20, 2016 to reduce the cantonal and communal corporate tax rate. Other cantons have communicated the target tax rates or have not yet taken position in this respect.
Notional Interest Deduction
The CTR III bill provides for a deduction of a deemed interest calculated on excess equity, known as the Notional Interest Deduction (“NID”). Basically the applicable interest rate to calculate the NID on the excess equity shall be equal to the long-term Swiss bond rate. However for intercompany receivables, the applicable interest rate is based on the arm’s-length principle.
The NID is applicable at Federal, Cantonal and Communal level.
However a canton can only introduce the NID provided that the partial taxation of dividend income from qualifying participations earned by individuals is at least 60%. In 16 out of 26 cantons the applicable partial taxation is below the 60% threshold. These cantons would need to increase the threshold in order to introduce a NID in the cantonal tax laws.
The patent box concept contained in the CTR III bill follows closely the “modified nexus approach” agreed between the OECD and the G20 countries. The cantons can relief the profit, to the extent derived from patents and similar intangible rights, from cantonal and communal corporate income tax up to a maximum of 90%. The extend of profit relief will be driven by the actual level of research and development expenditure incurred in Switzerland. The Swiss government is in charge to enact the corresponding implementation provisions in an Ordinance.
The patent box is applicable at Cantonal and Communal level.
R&D super deduction
The CTR III bill provides for an optional deduction of 150% of research and development (R&D) costs incurred in Switzerland. The cantons can foresee a lower exemption in their tax laws. The Swiss government is in charge to enact the corresponding implementation provisions in an Ordinance.
The R&D super deduction is applicable at Cantonal and Communal level.
“Step-up” of hidden reserves when a tax liability starts
The step-up mechanism foreseen in the CTR III bill provides for a disclosure of hidden reserves in the tax balance sheet at the beginning and the end of the tax liability. It will ensure a consistent tax treatment when companies transfer assets or functions to or from Switzerland or enter or leave a patent box or other potential tax exemption schemes.
The hidden reserves disclosed in the tax balance sheet at the beginning of the tax liability are not subject to taxation and can be depreciated in subsequent years according to the applicable tax depreciation rates. The depreciation period for goodwill is limited to 10 years. Hidden reserves which exist at the end of the tax liability and were not taxed will be subject to exit tax.
The step-up is applicable at Federal, Cantonal and Communal level.
Limitation of the combined tax relief
The combined tax relief resulting from the patent box, the NID, the R&D super deduction and the step-up will be limited to 80% of the taxable profit on cantonal and communal level (before such deductions, loss carry forward and excluding participation income). The cantons can foresee a lower limit in their tax laws.
The limitation of the combined tax relief is applicable at Cantonal and Communal level.
Lowering of equity tax on patents, participations and on intra-group loans
Under current legislation companies are subject to equity tax (net wealth tax) at cantonal and communal level. The cantons will be entitled to foresee a reduction of capital tax based on patents, participations as well as intra-group loans.
What’s next ?
- The Swiss government is in charge to set the effective date of the CTR III bill.
- The CTR III bill is currently subject to the mandatory 100 days referendum period. The Swiss socialist party announced the launch of a referendum procedure. Therefore it seems likely that the CTR III bill will be subject to a public vote in February 2017 and should enter into force earliest in January 2019.