SWITZERLAND: An Introduction to Tax

Switzerland consistently scores top marks in innovation and competitiveness, and this also applies to the general tax environment. International tax and economic developments have also impacted Switzerland and triggered several legislative changes in the past and for the upcoming years. The below outlines key trends in the Swiss tax landscape.

Impact of the OECD Pillar Two Proposal 

The OECD's Pillar Two proposal which aims to introduce a global 15% minimum tax rate prompted Switzerland to enact new measures. After a public referendum vote accepted the introduction of Pillar Two implementation legislation, the Swiss government introduced a Qualifying Domestic Minimum Top-up Tax (QDMTT) as per 1 January 2024. Other measures such as the Income Inclusion Rule (IIR) and the Undertaxed Payments Rule (UTPR) have been delayed likely for at least one year.

The Swiss government expects that its QDMTT will qualify for the QDMTT Safe Harbour and thus eliminate the need to calculate IIR or UTPR on Swiss companies and permanent establishments as Switzerland fully references the OECD Model Rules, the respective commentary as well as the administrative guidance – therefore especially alleviating administrative burden for foreign MNEs such as US and Canadian groups with Swiss operations.

Swiss-Specific Impacts of Pillar Two 

Pillar Two poses several interesting questions and issues for Swiss-based businesses as some Swiss cantons provide for an overall combined effective tax rate below the 15% threshold (and calculated on a tax basis different from GloBE):

• Jurisdictional blending: some Swiss cantons provide for tax rates in excess of 15% whereas some are below the GloBE threshold. Assuming there are no material changes in the tax basis for the purposes of Pillar Two, jurisdictional blending may result in Swiss operations not being subject to a top-up tax as the aggregate Swiss income is subject to an ETR higher than 15%.

• Participation reduction: Switzerland applies an indirect exemption to income from qualifying investments. Instead of excluding such income from the tax basis, Switzerland reduces the tax calculated on the total income by the ratio calculated from the net participation income to taxable profit. This also means that where there is substantial dividend income, the participation reduction would also exempt other income (interest, royalties, etc) from taxation. As Pillar Two applies a direct exemption method, Swiss holdings will almost certainly be faced with a higher cash tax expense and thus are required to review existing set-ups. This also applies if transfer pricing adjustments are eliminated under the Swiss participation reduction regime – thus incentivising a review of existing related party transactions with Swiss operations.

• Step-up in basis: With the recent corporate tax reform implemented as of 2020, Switzerland allowed for a tax-neutral step-up in basis for companies or permanent establishments which previously applied a tax regime (eg, mixed company regime, holding regime, principal regime and the Swiss finance branch). Similarly, Switzerland introduced the possibility of a tax-neutral step-up in basis upon migration or relocation of assets and functions to Switzerland. This step-up allows for the recognition of the fair value of the transferred assets or goodwill with a subsequent tax-effective amortisation. Under Pillar Two, these measures will be partially ineffective and Swiss operations may be impacted by a top-up tax depending on past choices made.

These aspects show that most of the companies that are active in Switzerland are substantially affected by Pillar Two.

Official New Transfer Pricing Publication 

On 23 January 2024, Swiss tax authorities issued a joint publication on transfer pricing aspects (TP Paper). Although these findings are not new practice and Switzerland already fully follows the OECD guidelines, it is a policy statement that transfer pricing aspects are increasingly in focus of audit.

As an example, Swiss tax authorities strongly rely on safe harbour interest rates applicable to related party loans. However, as such safe harbours may not result in an arm's length outcome taxpayers may increasingly have to safeguard their transfer pricing position with benchmarked rates.

The publication emphasises the trend to focus on transfer pricing aspects during Swiss tax audits and increasingly complex discussions (eg, on financial transactions, group synergies and reorganisation).

The TP Paper also reiterates that Swiss law – aside from CbCR – does not impose any Master or Local File obligations. Taxpayers are however required to evidence their transfer pricing position as part of the general obligation to cooperate with tax authorities. As such, it is recommended to have comprehensive transfer pricing documentation in place.

Acquisition Structures for Swiss M&A 

In past years, acquisition structures with Swiss acquisition vehicles saw an increased challenge notably with respect to alleged avoidance of Swiss dividend withholding tax. By way of context, Switzerland levies a 35% dividend withholding tax. An exemption at source can only be claimed (i) by Swiss corporate investors holding at least 10% in the target or (ii) non-Swiss corporate investors pursuant to an applicable double tax treaty or other international law instrument.

Certain direct investment jurisdictions would result in residual non-refundable withholding tax leakage (eg, US and Canada with 5%, Brazil with 10%).

Acquisition structures are however prone to challenges by Swiss federal tax administration under a very broad notion of anti-abuse rules in the following situations:

• Old-reserves doctrine: if a reorganisation or third-party sale results in a more beneficial withholding tax refund position (eg, switch from a residual withholding tax rate to a 0% rate), withholding tax is continued to be levied based on the previous residual rate until any distributable profits (tainted reserves) which existed at the time of such transaction have been fully distributed.

• International transposition: if a shareholder which has not been in a position to obtain a full refund of Swiss withholding tax sells or contributes a Swiss target into another Swiss entity against either debt or reserves from capital contributions, the repayment of which is not subject to withholding tax, dividend distributions of the target to the acquiring Swiss entity will be subject to a 35% non-refundable withholding tax.

• Extended international transposition: similar to the above, a non-refundable withholding tax leakage may also occur if a third-party acquirer which is not entitled to a full refund of Swiss withholding tax acquires a Swiss target through a Swiss acquisition vehicle which is financed in order to allow repatriation without Swiss withholding tax.

The SFTA has now introduced certain relaxation of these rules, notably if a transaction involves minority shareholders or includes external third-party financing and/or rollover structures for a Swiss acquisition vehicle.

In any event, the rules still generate complexity and require a thorough analysis for Swiss M&A structures (especially for private equity investments) prior to implementation.

Outlook – Swiss Tax Developments 

2024 will see the effects of the introduction of the Swiss Pillar Two implementation and will also require groups not yet in the scope of Pillar Two to review their position in view of the fact that the transitional rules apply to all taxpayers even if not yet in the scope of the QDMTT.