Corporate Tax Relief in Switzerland Tax Relief in Switzerland.pdfCORPORATE TAX RELIEF IN SWITZERLAND...

C O R P O R A T E T A X R E L I E F I N S W I T Z E R L A N D

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INTERNATIONAL TAX

Corporate Tax Relief in Switzerland

Year 2003


Table of contents

NEWLY ESTABLISHED COMPANIES........................................................3

QUALIFYING DIVIDENDS AND CAPITAL GAINS ..................................4

HOLDING COMPANIES................................................................................5

INTERNATIONAL COMMERCIAL COMPANIES (DOMICILIARY) .......6

SERVICE COMPANIES..................................................................................7

INTERNATIONAL SALES COMPANIES (50/50 RULING)........................8

FINANCE BRANCHES...................................................................................9

PRINCIPAL COMPANIES............................................................................10

OUR OFFICES IN SWITZERLAND ............................................................11

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Newly established companies

For some years, relief has been granted to new businesses as an incentive for investment in Switzerland. Whilst the Swiss Federal Government has a less generous approach to tax relief, nearly all cantons encourage the establishment of new industries within their territories by granting tax privileges to new active business enterprises.

These incentives include exemptions from cantonal and communal income and capital taxes for periods of up to ten years after inception of business. They depend upon the type and amount of investment, the number of jobs created, the regional economic planning aspects, etc.. Companies not receiving the maximum relief can expect tax reductions of 30-40% over varying periods of up to 10 years.

The setting up or restructuring of a business must be in the interests of the economy of the canton concerned in order to qualify for relief. This depends on the appreciation of the competent authorities. The following criteria are usually taken into consideration:

• Creation of new jobs,

• Technological development,

• Opening of new markets,

• Production of new goods or production of goods that are complementary to existing products.

Relief is primarily aimed at businesses in the secondary sector, typically in manufacturing. However, commercial, financial and or service related businesses may also qualify if they are deemed to be complementary to the local and regional industrial sectors or other sectors which are essential to the economic development of the canton.

The nature of the tax relief granted comes in different forms of which include the following which can be cumulative:

• Exemption from corporate income and capital taxes for five or ten years. In such cases, the exemption is progressively reduced with time.

• Constitution of tax-free reserves for future investments.

• Loss carryforward possible on all losses incurred during the period of tax relief.

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Qualifying Dividends and Capital gains

Switzerland has adopted a system whereby a company receiving dividends or capital gains derived from qualifying holdings may file for tax relief.

Tax relief comes in the form of a reduction of corporate income taxes. It is computed based on the ratio that the net qualifying dividend income (or capital gains) bears to the total net profits of the recipient company.

To qualify for relief on dividend income, a Swiss company must own at least 20 percent of the registered capital of another company, or a participation the value of which exceeds CHF 2 million.

To qualify for relief on capital gains, a Swiss company must make a profit on the sale of a participation which represents at least 20 percent of the share capital of another company which it has held for at least one year and which does not result in an unjustified tax saving by a group. Losses incurred as a result of the sale of qualifying participations remain tax deductible. As a rule, this relief is applicable to all qualifying participations acquired after 1 January 1997 and only to those acquired previously if they are sold after 1 January 2007. International share transfers to group companies constitutes an exception to this rule.

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Holding companies

Holding companies may obtain relief on qualifying dividend income for Swiss federal tax purposes (see paragraph 2). Consequently, a pure holding company (i.e. a company whose income is entirely generated by qualifying dividend income or capital gains) is totally exempt from Swiss federal taxes. However, relief for qualifying dividend income and capital gains is subject to conditions. In addition, the relief does not apply to other income such as interest on loans to affiliates.

In an attempt to attract both foreign and domestic investment, cantonal tax laws have the possibility of offering much more generous relief to holding companies. Indeed, companies which qualify for holding company status are completely tax exempt.

• The main purpose of the Holding company (as per its charter of incorporation) must be the management of long-term financial investments in affiliated companies,

• At least two thirds of the assets (or income) must be derived from long term participations, and

• A Holding company may not be actively engaged in commercial activity in Switzerland.

Holding companies are exempt from cantonal and communal corporate income tax. This is the case irrespective of whether the income is derived from long term investments or otherwise, or whether the income is generated abroad or in Switzerland.

This general rule suffers a few exceptions. Holding companies may own real estate in Switzerland, however, any income or capital gains generated from such real estate is subject to ordinary taxation. Income for which treaty relief is obtained must be subject to ordinary taxation if required by the relevant tax treaty. Income earned from services rendered to Swiss based affiliates may also be subject to ordinary taxation.

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International commercial companies (domiciliary)

Domiciliary companies are those which have administrative activities in Switzerland but which are engaged in commercial activities primarily abroad. They can range from small letter-box companies with no personnel or infrastructure of any kind, to trading activities and the large operational headquarters of multinational companies. Although Swiss federal tax law does not provide any particular relief for Domiciliary companies, there are special rules for cantonal and communal income tax purposes, which lead to a combined effective corporate income tax rate of between 10 and 14%. These rules have been designed to attract foreign investors interested in sales, financing, intellectual property or other operations outside Switzerland.

Each canton has its own particular interpretation of the law. The following example relates to the general situation. However other types of relief may be granted depending upon facts and circumstances.

• Income from qualifying participations:

• Dividend income: tax exempt.

• Capital gains realized on the disposal of long-term investments: tax exempt (provided the gain does not arise on the sale of a real estate company which owns real estate in Switzerland).

• Other Swiss source income:

• Other Swiss source income is taxed at ordinary rates.

• Other foreign source income:

• Foreign interest income from group companies: 2.5 percent of such income is taxed at ordinary rates (97,5% exemption).

• Other foreign interest income: 15 percent of such income is taxed at ordinary rates (85% exemption).

• Other foreign source income: 20 percent of such income is taxed at ordinary rates (80% exemption).

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Service companies

Service companies generally provide technical, administrative or scientific assistance including research and promotional activities. When such services are provided to group companies, it is very difficult to determine the taxable income generated by the service company i.e. the extent of the contribution of the Swiss resident company to the total profits of the group. In order to limit the number of litigious cases, the Swiss Tax Administration commonly attributes to service companies a notional profit upon which tax is levied.

Profit assessable in Switzerland is generally deemed to be at least 5% of total expenses incurred or one twelfth (8.33%) of total local payroll costs.

This service company ruling merely indicates the method of calculating the taxable income. For cantonal and communal tax purposes it may be combined with the rules applicable to domiciliary companies (see paragraph 4). The following relates to the situation in certain cantons: • Services provided in Switzerland are subject to ordinary taxation i.e. 5%

of expenses are taxed at ordinary rates.

• In situations where a group service company employs non resident personnel to provide services abroad to non resident affiliates, 80% of the notional income is exempt. The remaining 20 % is subject to ordinary rates.

• Where Swiss resident personnel is employed to provide services abroad to non resident affiliates, 50 % of the notional income is subject to the above mentioned preferential regime (i.e. 80 % exemption). The remaining 50 % is subject to ordinary rates.

• If Swiss resident employees work abroad for short periods of time, any costs related to such activity is broken down between a) and c) in proportion to the number of days worked in Switzerland and abroad.

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International sales companies (50/50 ruling)

International sales companies are set up in Switzerland for the specific aim of trading outside Switzerland. They are particularly interesting for companies where business practice requires the payment of commissions to related parties or commercial partners. Indeed, international sales companies often incur costs which are difficult to justify. To simplify matters, a Swiss company whose activities are managed from abroad and which (in principle) has no commercial or technical organization in Switzerland may distribute 50 percent of its gross income without any form of substantiation.

The following conditions must be satisfied in order to qualify for the 50/50 ruling:

• (1) Foreign activity: commercial activity for which the ruling is requested must be generated outside Switzerland;

• (2) Swiss activity restricted: there may not be any commercial activity in Switzerland (non-substantial Swiss activity or parallel Swiss activity outside the field of business for which the ruling is requested may be possible - this Swiss source income would however not qualify for the 50/50 relief);

• (3) Foreign infrastructure: there may not be any commercial infrastructure in Switzerland (except to support the abovementioned limited Swiss activity);

• (4) Foreign operations: activities of the Swiss company for which the ruling is requested must be undertaken outside Switzerland by foreign shareholders or other foreign individuals/corporations in a business relationship with the company;

• (5) Swiss beneficiaries rights restricted: no Swiss shareholders, related party or third party may benefit (directly of indirectly) from commissions or other non-justified payments;

Under the 50/50 ruling, a company is entitled to deduct 50% of its gross profits in the form of a commission, management fee or a royalty to a non-resident entity.

From the remaining income, only administrative expenses, and direct taxes may be deducted. The difference is usually taxable at ordinary tax rates. However, for cantonal and communal tax purposes, the 50/50 ruling may be combined with the rules applicable to Domiciliary companies. In certain cantons, this implies that the net taxable foreign source income is reduced by a further 80 percent (i.e. only 20 percent of taxable income is taxed at ordinary rates).

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Finance branches

Finance branches may take advantage of a very favorable tax ruling whereby foreign source income is taxable in Switzerland at rates between 1 and 5%.

Special relief is granted to finance branches who have a bank-like activity. According to guidelines issued by the Federal Tax Administration, the conditions required to be treated as a Finance Branch are as follows:

• The assets of the branch should amount to at least CHF 100 million (lower if justified by circumstances).

• The activity of the branch should be primarily a financing activity. Indeed, 3/4 of its gross profits should be derived from financing activities and 3/4 of its assets should be invested in financing activities.

• Loans or advances granted by the branch to any Swiss subsidiary may not exceed 10% of the total assets of the branch.

For Swiss federal and cantonal/communal tax purposes, it is possible to deduct a significant portion of accounting profits on a notional basis. The underlying assumption behind this deduction is that, if the branch was a bank, it would be able to be capitalized in such a manner as to allow for a significant interest deduction. For purposes of calculating the notional interest deduction of the branch, the branch is deemed to have a notional share capital equal to 1/11th of its total assets. Accordingly, the notional interest is calculated on the balance of 10/11ths of the assets, which is deemed to be financed by a loan from the head office (less a commission). A further 10% (approx.) is deducted by way of a praecipuum (allocation to head office) to determine the net taxable income. Other more beneficial methods of calculating the national interest deduction may also be possible depending on cantonal administrative practice.

Net income is subject to Swiss Federal income tax at ordinary rates. However, for cantonal and communal tax purposes, net income as defined may often be further reduced depending on the type and source of income. Indeed, in certain cantons, although Swiss source income is fully taxable, 85% of third party foreign financial income is tax exempt (15% is taxable). In addition, 97.5% of foreign financial income from other entities within the group is tax exempt (2.5% is taxable).

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Principal companies

In a typical Cost Sharing Structure, in which a Swiss company is to be the principal in foreign manufacturing and sales, the Swiss company will usually contract with manufacturing companies within or outside the group.

These so-called "Contract Manufactures" will be provided with the raw material by the Swiss Principal and will only be charged with the pure production of the goods. During the entire manufacturing process the goods remain the property of the Swiss Principal and the Contract Manufacturers are usually remunerated for their service on a cost-plus basis.

In order to license technology or to sell the finished goods, the Swiss Principal can enter into "commissionaire" arrangements with group companies in the jurisdiction into which the products are to be sold. According to these commissionaire arrangements, the local sales companies will sell the products to the local customers in their own name on behalf of the Swiss Principal. The Swiss Principal will retain ownership over the goods until they are sold to the customer. The Sales companies will not bear any risk associated to the product sales. Consequently, the entire sales proceeds flow directly to the Swiss Principal. The Sales companies are usually reimbursed for their marketing efforts on a cost-plus basis.

In countries such as the U.K. whose domestic commercial law does not provide for commissionaire arrangements, so called "stripped buy-sell" agreements are entered into with very similar results.

Typically in such structures, the bulk of the profit of the non-Swiss sales will remain with the Swiss Principal where there are very favorable tax incentives. Indeed, if correctly structured, a substantial portion of income can be deemed to be allocated to non-Swiss activities and can therefore be taken out of the Swiss tax net for both Swiss federal and Geneva cantonal and communal tax purposes (factual branch exemption). This can lead to a total combined corporate income tax rate of between 5 and 9% on non-Swiss sales income.

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