New tax burdens for Swiss SMEs?

Switzerland's corporate tax law has made a major contribution to Switzerland's attractiveness as a business location and has persuaded a number of companies, some of them prominent, to relocate to Switzerland. For several years now, however, precisely this driving force behind Switzerland's attractiveness as a business location has been under enormous international pressure. The EU and the Organisation for Economic Co-operation and Development (OECD) in particular are pushing Switzerland to adopt international standards.

The discussions focus mainly on the cantonal tax privileges for holding, domiciliary and mixed companies, which in some cases treat domestic and foreign income unequally and thus create attractive tax conditions for multinational companies. At the political level and among business associations, discussions have been taking place for some time about possible and necessary adjustments to corporate tax law so that Switzerland's attractiveness as a tax location is maintained, internationally accepted and strengthened at the same time. On 5 June 2015, the Federal Council adopted the dispatch on the VAT Directive III, which means that the reform is now ready for parliamentary discussion.

Content of the Corporate Tax Reform III

The VAT Directive III focuses on three main objectives: Ensuring a continued competitive corporate tax burden, restoring international acceptance, and securing the financial yield of profit taxes for the Confederation, cantons and municipalities. In order to achieve these goals, the Federal Council proposes various measures. On the one hand, the special cantonal regulations for holding, domiciliary and mixed companies are to be abolished, and on the other hand, new attractive regulations for mobile income are to be introduced. In addition, cantonal profit tax rate reductions and various measures to improve the systematics of corporate tax law are planned. The three elements of the VAT Directive III are briefly summarised and explained below.

Patent box and promotion of research & development (R&D)

A patent box should be introduced at cantonal level for research-intensive companies. In addition, the cantons are to be enabled to provide for increased deductions for R&D expenses. The basic concept of the patent box provides for legal entities to deduct up to 90 percent of their results from patents owned or used by them.

Interest-adjusted profit tax did not make it into the dispatch on the UStR III.

The taxpayer is entitled to deduct income held as a usufruct from taxable income at the cantonal level. Thus, depending on the canton, an effective overall tax rate on such income of approximately 10 percent can be achieved. Unfortunately, the current draft law provides for a relatively narrow interpretation of the term "patents". It is intended that only income from registered patents qualifies. Other intangible assets such as trademark rights, trade names or unregistered inventions are excluded from the tax privilege. In addition to the patent box, the cantons are to be given the option of introducing an increased deduction for R&D expenses at the cantonal level. The parameters of such an increased R&D deduction are left to the cantons, with the subsidy being limited exclusively to R&D activities carried out domestically.

Profit tax rate reductions

The cantonal profit tax rate reductions are not formally part of the reform, as these fall within the competence of the cantons. However, the reform package of the UStR III provides for the Confederation to give the cantons room for manoeuvre in terms of fiscal policy by means of vertical equalisation measures, so that the cantons are in a position to reduce the ordinary profit tax rates to an average of 16 percent and thus compensate for the abolition of cantonal tax privileges.

Improving the systematics of corporate tax law

The third element of the reform is primarily aimed at harmonising existing rules and achieving a balanced tax burden in the area of capital income.

-introduction of a uniform rule for the disclosure of hidden reserves 

Now, hidden reserves are to be disclosed not only upon departure from or cessation of tax liability, but also upon entry into or commencement of Swiss tax liability. This means that hidden reserves (including self-created added value/goodwill) can be disclosed in the tax balance sheet at the beginning of the tax liability, irrespective of whether they can be capitalised under commercial law. The shares revalued for tax purposes must be depreciated in accordance with the usual depreciation rates, whereby the depreciation period for goodwill may not exceed ten years.

Attention should be paid to the new explicit mention that existing added value (e.g. in the case of relocation of sales or service functions abroad) will also be taxed if the Swiss tax liability ceases. For companies that are affected by the discontinuation of a cantonal tax privilege, corresponding relief will be created. The hidden reserves existing at the time of the discontinuation of such a tax privilege can be taxed separately and at a reduced rate for a period of five years, if realised. The applicable tax rates are determined by the cantons.

- Abolition of the issue tax on equity capital

- Adjustments to the partial taxation procedure

The privileged taxation of dividend income is to be standardised on a cantonal basis. On the one hand, relief will only be possible via the tax base (partial taxation procedure) and on the other hand, relief will be limited to a uniform 30 percent. The minimum participation level for claiming privileged dividend taxation has been left at 10 percent, after an extension to all participations was still envisaged in the consultation draft.

- Adjustments to the lump-sum tax credit (Pelli motion)

Swiss permanent establishments of foreign companies that are subject to ordinary taxation should be able to claim a lump-sum tax credit for income subject to foreign taxes under certain conditions.

The interest-adjusted profit tax, the planned adjustments to the capital tax and the tonnage tax, which was intended to promote ocean shipping from a tax perspective, were the subject of much discussion in the run-up but ultimately did not make it into the dispatch on VAT III. With regard to the tonnage tax, it was noted that this was not constitutional, as there was no explicit constitutional basis for promoting ocean shipping. Furthermore, the adjustments to the participation deduction (change from indirect to direct exemption) and to the offsetting of losses were not taken into account. It is particularly pleasing that the introduction of a capi

The introduction of a capital gains tax did not meet with approval in the consultation process.

tax was not well received in the consultation process and was also deleted without replacement.

Implications for Swiss SMEs

The abolition of cantonal tax privileges will not only affect multinational corporations, but also numerous Swiss SMEs with Swiss holding structures. If the holding status is fulfilled, then at the cantonal level the profit is not taxed. This means that not only dividend income, but also interest and royalty income, compensation for management functions, etc. are tax-exempt. The abolition of privileges will also remove the tax privilege on this non-dividend income. There is therefore a need for planning, in particular for holding structures that can currently take advantage of the reduced taxation of other (non-dividend) income. Pure dividend income will continue to be relieved by the participation deduction.

All in all, the VAT Directive III will not have any significant impact on SMEs operating exclusively in Switzerland. The most significant effects will be the reduction in profit tax rates and the deterioration in privileged dividend taxation. In any case, it should not be overlooked that the UStR III aims to promote investment activity in Switzerland in particular by means of a patent box and increased R&D expenditure. It is still uncertain when and in what form the VAT Directive III will finally be introduced. Nevertheless, Swiss SMEs should prepare for the changes and be able to rely on a tax advisor to guide them through this tax change.