Thursday, 14 July 2016

Switzerland passes final corporate tax reform package to enhance global competitiveness

The Swiss parliament on June 17, 2016, passed the final corporate tax reform package (CTR III) to strengthen Switzerland’s competitiveness as a business location. CTR III includes several notable tax reform measures related to federal and cantonal tax laws which may impact multinational enterprises (MNEs) doing business in Switzerland. Various cantons are also expected to reduce their cantonal corporate income tax rates.

CTR III includes significant changes to Swiss federal and cantonal taxation. The cantons will need to pass respective legislation at the cantonal level to determine which measures will be enacted. CTR III includes the following key changes to Swiss federal, cantonal, and communal tax law:

Notional Interest Deduction
CTR III introduces an interest deduction calculated based on equity exceeding a certain threshold (surplus equity), known as the notional interest deduction (NID). Parliament discussed this controversial measure at length and eventually passed it with the following terms:

  • The NID applies for direct federal income tax. 
  • The cantons have the option to introduce the NID for cantonal and communal income tax purposes. However, a canton may only introduce the NID if the canton taxes at least 60% of private individuals’ dividend income from investments greater than 10% of a company’s outstanding shares. To date, 16 out the 26 cantons tax only 50% or less of individuals’ dividend income and would need to increase this threshold in order to introduce the NID at the cantonal level. The remaining 10 cantons already meet the requirements to introduce the NID.
  • The interest rate used to calculate the NID is based on the long-term Swiss bond rate with no markup. For intergroup receivables of any kind, the applicable interest rate used to calculate the NID is based on the arm’s length principle which may be higher than the Swiss federal bond rate.

The legislature has instructed the Federal Department of Finance (FDF) to enact corresponding
implementation rules.

Disclosure of hidden reserves (Step up) 
CTR III introduces a systematic concept for the disclosure of hidden reserves − the difference between the recorded value and the fair market value of an asset – at the federal,
cantonal, and communal levels. When assets or functions are transferred from another country into
Switzerland, the hidden reserves and added values can be disclosed in the tax balance sheet. The disclosed hidden reserves can be deducted according to the applicable tax depreciation rates in subsequent years. Goodwill is to be amortized over 10 years. However, the hidden reserves and added values must also be accounted for at the end of the tax obligation, such as when the taxpayer leaves Switzerland or is transferring assets or functions abroad. This also applies to transfers of assets from
foreign branches into Switzerland or upon abolishment of direct federal tax regimes.

Abolishment of special cantonal tax regimes
CTR III eliminates the special cantonal tax regimes for holding, mixed, and auxiliary companies and
introduces a five-year transition period after the new law takes effect. During the transition period, the cantons can subject the realization of hidden reserves and goodwill to a separate lower special tax rate, provided such items would not have been taxable under prior law. This will prevent inconstitutional and sudden tax changes that could affect companies faced with elimination of a
cantonal special regime. The cantonal tax authorities, via formal decree, must assess the amount of hidden reserves and goodwill subject to this special lower tax rate. The cantonal legislature will determine the special tax rate.

Introduction of cantonal patent box
Under the patent box, the cantons can exempt the income derived from patent and similar intangible property rights from cantonal and communal corporate income tax up to a maximum of 90%. The design of the Swiss patent box aligns with the socalled ‘residual profit approach’, which incorporates the OECD’s modified nexus approach to determine the profit subject to, and benefit of, the patent box. Upon the effective date of the patent box, a canton must generally tax previously deducted research and development (R&D) expenditures. However, a canton can waive such tax if it ensures
that the R&D expenditures will be taxed by other means within five years. The legislature has instructed the Federal Council to enact the corresponding implementation rules.

Optional R&D deduction
CTR III introduces an optional deduction of 150% of R&D expenditures incurred in Switzerland.
The initial proposal to include foreign R&D expenditures borne by a Swiss company was dropped during the parliamentary process. The Federal Council will enact provisions that define qualifying R&D expenditures.

Overall restriction on tax relief
The benefits derived from the patent box, the special deduction for R&D expenditures, the NID, and
depreciation deductions for disclosed hidden reserves (step up) can only reduce a taxpayer’s total cantonal corporate income tax by up to 80%.
The cantons can choose to implement a lower maximum percentage. This measure is intended to ensure a minimum tax assessment at the cantonal level for companies that qualify for one or more of the new benefits.

Cantonal net wealth tax adjustment
In addition to the equity on investment rights, patents and comparable rights, the cantons may also implement a net wealth tax reduction for intercompany loans.

Cantonal share on federal tax income
The cantonal share of direct federal tax revenues will increase from 17% to 21.2%. As a result, the cantons will receive about CHF 1.1 billion more in federal support after the increase. The
federal government intends for the funds to partially support the reductions in the cantonal corporate
income tax rates.

Reduction of cantonal corporate income tax rates
Many cantons are planning to lower their corporate income tax rate.
Canton Vaud on March 20, 2016, passed a resolution to reduce the corporate tax rate to 13.78% overall.
Other cantons have communicated target tax rates between 12.5% and 14% but others, such as Canton Zurich, have not yet decided on their new rates. However, these cantons plan to make a decision and announce their decision within the next few months.

Postponed measures
The elimination of the issuance stamp tax and the introduction of a tonnage tax for shipping companies were postponed and moved to separate bills to be revisited at a later date.

Next steps
The referendum period of 100 days begins after the legislation’s official publication. If no referendum is requested, federal tax measures of CTR III could become effective as early as the beginning of 2017. The Federal Council determines when the reform measures will take effect. The cantons must then separately pass the measures related to the tax harmonization law as part of their cantonal tax legislation. Cantonal legislation changes, and any decision to reduce the cantonal corporate tax
rate, would require additional approval by the cantonal electorate if a cantonal referendum is also
A referendum opposing the federal government’s CTR III bill seems likely, as repeatedly announced by the country’s left parties. The Swiss electorate will likely have to vote on the bill in February 2017. If the vote passes, the reform could take effect at the federal and cantonal levels starting in 2019.

Source & more info: PwC