An excerpt from The Transfer Pricing Law Review, 5th Edition
overview
Switzerland is a federal democracy. The federal constitution thus grants both the federal government and the cantons the power to levy direct taxes. Federal income tax and corporation tax are levied in accordance with the Federal Income Tax Act (ESTG) of December 14, 1990. The cantons enact their own laws on cantonal income, wealth, corporation and corporation tax. These laws must comply with the Federal Tax Harmonization Act (ESTG) of December 14, 1990.
However, the Federal Tax Administration is responsible for collecting indirect taxes such as withholding tax, stamp duty and value added tax (VAT).
As a member of the Organization for Economic Cooperation and Development (OECD), Switzerland has accepted the transfer pricing guidelines developed by the OECD and is actively implementing the recommendations of the OECD project Base Erosion and Profit Shifting (BEPS).
Switzerland relies heavily on the Transfer Pricing Directives as it does not have any specific transfer pricing rules. Accordingly, the Federal Tax Administration has instructed the cantonal tax administrations to apply the OECD Transfer Pricing Guidelines directly to all transfer pricing issues
In Switzerland, the transfer price adjustment is based on the principle of prohibiting harmful profit shifts between related parties. According to the established case law of the Swiss Federal Court3, a transfer price can be adjusted if the following requirements are met:
- a company has provided a service without receiving adequate consideration for it;
- the benefit was granted to a shareholder or a related party;
- the benefit would not have been granted to a third party; and
- the disproportion between benefit and consideration was evident to society.
If all of these conditions are met, tax authorities will assume that harmful profit shifting has taken place. An adjustment would therefore be justified without demonstrating the parties’ intention to evade the payment of taxes.
As already mentioned, there is no specific legislation in Switzerland that defines and deals with transfer pricing. However, certain federal and cantonal tax laws deal with related issues such as the arm’s length principle and hidden equity. Such transfer price adjustment provisions are contained in most Swiss tax laws on income tax and corporation tax, 4 withholding tax5, stamp duties and value added tax
Article 58 FITA prohibits the deduction of unjustified expenses, ie all transactions with shareholders and related parties must comply with the arm’s length principle. For tax purposes, these unjustified expenses can be reintegrated into the company’s taxable profit and, due to inadequate transfer prices, realized profits can be reclassified as hidden dividend distributions. Shareholders are subject to income tax or corporation tax on any constructive dividends.
In addition, hidden dividend distributions carried out by a Swiss company trigger withholding tax of 35 percent (in accordance with Article 4 paragraph 1 letter b of the Withholding Tax Act of October 13, 1965); if the withholding tax is not borne by the beneficiary, the withholding tax is levied at the gross rate of 54 percent. Beneficiaries of the constructive dividends can nevertheless request a full or partial reimbursement under Swiss law (Art. 24 Paragraph 1 Withholding Tax Act of October 13, 1965) or an applicable double taxation agreement. Under certain conditions, a notification procedure for reporting can be provided instead of paying withholding tax.
In the case of a hidden capital contribution, the capital contribution can be subject to stamp duty of 1 percent (Art. 5, Paragraph 2, Letter a of the Stamp Duty Act of June 27, 1973).
The Federal Tax Administration also issues instructions in the form of circulars and circulars that provide guidance on transfer pricing and related topics. These include Saf Harbor rules (thinkapitalization and interest rates), 7 service companies, 8 evidence of economically justified expenses for foreign companies9 and restructuring. 10
The Sales Tax Act of June 12, 2009 is the only law that expressly requires that transactions between related parties take place on market terms. It also defines the term “related parties” for VAT purposes as follows: 11
- the owners of at least 20 percent of the share capital or share capital of a company or an equivalent participation in a partnership or persons closely related to them; or
- Foundations and associations with which there is a particularly close economic, contractual or personal relationship. Pension plans are not considered related parties.
The Federal Supreme Court defined the term “related parties” as corporations or persons with a close business or personal relationship12, which it interprets very broadly. In particular, the Court considers that the provision of a service on unusual terms or conditions that do not reflect the market is an indication that the parties are closely related.13 It is therefore crucial to determine whether the Transaction was conducted under certain conditions due to the close relationship between the parties or when the same conditions would have been required between independent parties.
Broader tax issues
i Inferred income tax, digital sales tax and other complementary measures
There are no special regulations on transfer pricing issues in Swiss tax law. However, the tax authorities should follow the OECD Transfer Pricing Guidelines as disclosed in Circular No. 4 of the Federal Tax Administration of 1997, revised in 2004. This circular provides for a general application of the arm’s length principle to determine taxable service income for companies. No other national regulation supplemented these general principles.
Switzerland takes an active part in the OECD discussions on the taxation of the digitized economy. The implementation of these future rules is currently unknown.
ii Tax challenges due to digitization
New rules for taxing the digitized economy discussed at OECD level include a change in the profit distribution mechanism (pillar 1) and a minimum tax rate for groups (pillar 2). The Swiss authorities prefer a multilateral approach to domestic measures that could create uncertainty in the taxation of digitized companies. In particular, it is to be expected that these new rules may reduce the profits allocated to Switzerland. While Switzerland supports the introduction of both pillars, it is therefore actively participating in the discussions to ensure that these new rules are applied fairly
As part of the first pillar and since profits can be shifted to the market regulations, the Swiss authorities have pointed out that the future regulations should be based on the arm’s length principle and should be geared towards value creation. With regard to the second pillar, a recommendation of a modest minimum rate would be acceptable to the Swiss authorities. With this new set of rules, however, the domestic tax rates must be taken into account, especially for small jurisdictions like Switzerland.
iii Effects of Covid-19 on Transfer Pricing
The Swiss authorities have not changed the current Swiss ordinance due to Covid-19. However, the cantonal and federal tax authorities have published a list of frequently asked questions on their respective websites to help taxpayers and explain the impact of Covid-19 on applicable tax law.
In principle, the tax authorities should follow the OECD guidelines and apply the updated OECD guidelines to the applications for tax treaties issued in December 2020. However, there is no certainty that these guidelines will be followed by the Swiss authorities, especially the cantonal tax authorities, as their practice may differ from case to case. However, exceptional circumstances should be taken into account when considering a possible tax liability.
Switzerland has 21 agreements with other countries such as France to curb the creation of permanent establishments by workers who work from home.
iv double taxation
Switzerland has double taxation agreements (DTAs) with over 90 countries. If double taxation occurs with a country with which Switzerland has signed a DTA, or if there is a risk of double taxation, taxpayers resident in Switzerland, both natural and legal persons, can apply to the Federal Department of Finance in Bern to initiate a mutual agreement procedure.
According to the OECD Model Tax Agreement on Income and Capital Taxes (OECD MC), taxpayers can initiate a mutual agreement procedure within three years of the first notification of the double taxation procedure (Art. 25 (1) OECD MC). Most of the DTAs concluded with Switzerland provide for this three-year period, but every double taxation agreement must first be checked.
Arbitration is also available under a number of double taxation agreements with Switzerland. In principle and contrary to the mutual agreement procedure, taxpayers can, for example, only apply for arbitration with one of the competent authorities if no agreement has been reached in the mutual agreement procedure after two years (Art. 25 (5) OECD.). MC).
In order to avoid double taxation, taxpayers can also apply for a ruling from the Swiss tax authorities prior to a transfer pricing transaction. Swiss taxpayers usually choose this route; However, if a foreign country decides to adjust a transfer pricing transaction, double taxation can still arise. In this respect, APAs can also be chosen by Swiss taxpayers in order to confirm the tax treatment under the relevant double taxation agreement and to reach an agreement between Swiss tax authorities and foreign tax authorities.
v Impact on other taxes
Adjustments to transfer prices are generally analyzed from the perspective of income tax and withholding tax, but the VAT consequences must also be taken into account. Under the Swiss Value Added Tax Act, the arm’s length principle also applies to transactions between related parties. As a result, an adjustment required by the tax authorities can affect the tax levied. Penalties and interest may also apply if an adjustment is found during an audit by the Federal Tax Administration.
Outlook and conclusions
Even if Switzerland does not have specific transfer pricing legislation, the Swiss authorities, both the administration and the courts, are increasingly influenced by the OECD, which, as mentioned, includes the BEPS project and the taxation of the digital economy. This means that any taxpayer operating in Switzerland should remain extremely cautious when dealing with transfer pricing issues and should always keep in mind the OECD Transfer Pricing Guidelines, including the latest OECD developments regarding Covid-19 or multilateral instruments aimed at curbing harmful profits shift .