Switzerland: Corporate Tax Reform III – Tax Project 17

Last Updated: 1 March 2018
Article by Michael Nordin and Julian Hodel
Most Read Contributor in Switzerland, August 2018

Following the voters' rejection of the corporate tax reform III at the beginning of this year, the federal council adopted the main parameters for the Tax Project 17 on 9 June 2017. The draft is very much in line with the concept of the corporate tax reform III. The implementation of first parts of the reform at the cantonal level is expected by 2020 at the earliest.

1 REJECTION OF CTR III

On 12 February 2017 Swiss voters unambiguously rejected the corporate tax reform III ("CTR III"). The reform would have abolished the internationally criticized taxation regimes for Swiss finance branches, principal companies, holding companies, mixed companies and domiciliary companies and would have replaced these privileges with internationally accepted measures. The solution was to provide the cantons with a module type catalog of substitution measures that would have been implemented according to the specific needs at the cantonal level. The bill aimed at reducing international pressure on Switzerland as a business location with regard to corporate taxation, without however reducing Switzerland's attractiveness as a business location.

The reasons for the rejection of the CTR III by Swiss voters are diverse. On the one hand the bill was considered to be overloaded and unbalanced. The notional interest deduction ("NID") for example was strongly criticized. Voters were of the impression that the bill mostly catered to the interests of internationally oriented large corporations. The bill entailed many uncertainties with regard to the financial impact on the confederation and the cantons as well as its specific implementation in the respective cantons.

In the international context Switzerland has made a commitment to abolish by 2019 all taxation regimes that are regarded to be harmful by the international community. If it fails to do so, Switzerland is threatened to be put on a black list of tax havens. This would not only compromise considerably Switzerland's image as a business location, but would entail serious repercussions from other countries. For example the potential termination of double tax treaties (rather unlikely), the levying of withholding taxes on payments to Swiss recipients benefiting from a tax privilege, the refusal of deductibility of expenditures paid to Swiss status companies, as well as other bureaucratic and administrative hurdles.

In addition, from 2018 certain tax rulings are exchanged with other States. This is expected to further increase the pressure on Swiss companies benefiting from privileged tax regimes. For reputational reasons and to prevent countermeasures from other countries, Swiss status companies may be forced to voluntarily give up their special tax status, before the entering into force of the Tax Project 17. Such a status change could potentially be bridged and softened with a so called step-up (a tax neutral disclosure of hidden reserves).

If, when, and to what extent Switzerland may be confronted with countermeasures from other countries is currently still unclear. In order to eliminate existing legal uncertainties and to preserve the attractiveness of Switzerland as a business location, Switzerland will draft a new bill capable to win majority support as soon as possible and will demonstrate to the international community its intention to cooperate in the fight against harmful tax practices.

2 TAX PROJECT 17

On 1 June 2017, roughly four months after the bill for the CTR III was rejected, the steering body presented, under the direction of the head of the federal department of finance, recommendations for the Tax Project 17 as a substitute bill for the CTR III. The Tax Project 17 bill was backed by wide support and drafted in collaboration with representatives of the confederation, the cantons and the communes as well as in consultation with the political parties and economic and labor associations. The bill follows a balanced approach, if not to say an approach aimed at political feasibility. According to the recommendation, the bill should achieve the following three objectives:

  1. securing the attractiveness of Switzerland as a business location;
  2. international acceptance; and
  3. sufficient tax revenues.

The Tax Project 17 is based on the CTR III and adopts its most important reform concepts. However, the reform concepts are envisaged to be implemented more restrictively than what had been intended by the rejected CTR III. The interests of the cantons and the communes are to carry more weight and cooperation shall be improved. The cantons should also be motivated to lower their tax rates in the framework of the Tax Project 17. Otherwise, certain privileged companies, which do not benefit from replacement measures and transitional arrangements, would be exposed to a massive increase in their tax burden. In order to ease the burden on the cantons, the vertical financial compensation therefore is to be adjusted. The cantons are encouraged to publish their implementation plans for the Tax Project 17 at the latest by its decision date and to advance their implementation projects in parallel to the implementation of the Tax Project 17. The improved predictability of revenue consequences in combination with an improved information strategy is expected to increase public acceptance of the Tax Project 17.

2.1 TIMELINE

On 9 June 2017 the federal council consulted and decided on the main parameters of the bill. The federal department of finance is now expected to prepare a consultation draft. The consultation procedure is scheduled to be completed by December 2017. Subsequently the federal law proposal could be dispatched for parliament in spring 2018 and parliament could pass the law in its summer or fall session 2018. First components of the bill could so enter into force as early as the beginning of 2019, provided of course that no referendum is called. The implementation at the cantonal level however will likely not take place before 2020.

The pursued timeline seems ambitious and will depend mainly on an agreement between the interest groups in parliament.

2.2 THE MEASURES OF THE TAX PROJECT 17 I N DETAIL

As previously noted, the Tax Project 17 adopts the concept and to a large extent the measures of the CTR III. The abolishment of the internationally criticized tax practices remains the key element and primary driver for the tax reform. Newly added elements include the increase of minimal child and educational allowances as well as the increase of partial taxation of dividends at the shareholder level. The widely criticized measure of the notional interest deduction has been removed. The aforementioned additional elements were added for the purpose of promoting political acceptance.

In addition, in order to preserve the attractiveness of Switzerland as a business location internationally, reductions of tax rates at the cantonal level are to be expected. However, the reductions of tax rates are decided autonomously by the cantons and independently from the reform at the confederation level. Various cantons had already announced reductions of tax rates in the context of CTR III (cf. table below):

Reduced profit tax rate incl. direct federal tax (current tax rates) Reduced capital tax rate (current ordinary tax rates)
Berne 16.37% (23.35%) 0.01% (0.03%)
Basle-Country 14% (20.7%) 0.155% (0.375%)
Basle-City approx. 13% (22.18%) 0.1% (0.525%)
Fribourg 13.72% (20.85%) 0.04% (0.16&)
Geneva 13.49% (24.2%) no reduction
Soleure 12.9% (21.8%) 0.02% (0.08%)
Zug approx. 12% (14.6%) no reduction
Zurich 18.2% (21.1%) no reduction
Lucerne 12.32% 0.185%

Hereafter the main measures of the Tax Project 17 are listed and their content explained:

  1. Patent box
    The Tax Project 17 stipulates the introduction of an OECD conform patent box at the cantonal level. While the patent box was planned as an optional measure within the CTR III, the Tax Project 17 suggests it shall be a mandatory measure. A more restrictively designed patent box is envisaged as compared to that under CTR III. In particular, there would be no privileged taxation of income deriving from copyright protected software.

    Patent boxes aim at achieving separate and privileged taxation of income deriving from patents and comparable rights. With the assignment of income to a patent box, it is subject to a lower tax rate than the residual income of the company. The tax burden of companies that hold and administer qualified patents (and comparable rights) `will as a result be reduced.

    In the same way as deductions for research and development costs (so called input incentives) patent boxes (so called output incentives) are instruments to promote research and development ("R&D") and serve to strengthen Switzerland as an industrial and research location.
  2. Super deductibility of research and development costs
    Furthermore in order to promote R&D, cantons shall have the option of instituting a super deduction on R&D costs (a so-called input incentive). Thus companies would be allowed to claim deductions for R&D costs of up to a maximum of 50% above their effectively incurred costs. Contrary to the CTR III the possibility of higher deductibility shall generally be limited to labor costs. Therefore third-party costs incurred in Switzerland would not qualify for a super deduction.
  3. Mandatory limitation of tax relief
    The total tax relief on profits arising from the two aforementioned instruments – the patent box and the super deduction – shall be limited by a mandatory limitation of tax relief. While the CTR III stipulated a maximum tax relief of 80%, according to the Tax Project 17the total tax burden may only be reduced by a maximum of 70%.
  4. Increase of partial taxation of dividends
    In order to compensate for potential financial losses due to cantonal tax rate reductions and the measures of the Tax Project 17, the partial taxation of dividends deriving from qualified participations that are privately held (stakes of at least 10% of the capital of a company) shall be increased from 60% to 70% at the federal level, and a partial taxation of at least 70% shall be stipulated at the cantonal level.

    Small and medium sized enterprises will find themselves particularly affected by the increase of partial taxation of dividends. From their perspective the measure may result in a tax increase for local shareholders. On the other hand it needs to be noted that local small- and medium-sized enterprises will benefit considerably from the tax rate reductions at the cantonal level.
  5. Vertical financial equalization procedure
    As with the CTR III, the Tax Project 17 also include the adjustment of the vertical financial equalization procedure between the confederation and the cantons in order to reduce the burden on the cantons' finances due to tax shortfalls in connection with the proposed measures (in particular the cantonal reduction of tax rates). Within the Tax Project 17 it was suggested that the canton's portion of the direct federal tax revenue is increased from 17% to 21.2%. The federal council however reduced the originally proposed share of the cantons to 20.5%.
  6. Increase of child and educational allowances
    A 30% increase of the minimum amount of child and educational allowances was added to the catalog of measures (to at least CHF 230 and CHF 280, respectively) . This measure is neither related in substance to the concerns of the company tax reform nor to the other proposed measures of the Tax Project 17 and serves merely to increase the chances of passing the bill.

3 OUTLOOK AND RECOMMENDATIONS

Even though the suggested measures of the Tax Project 17 seem clear and tangible at first sight, many questions still remain unanswered.

With the removal of the notional interest deduction measure and with the additionally proposed compensation measures (increase of the partial taxation of dividends, increase of the minimal amount of child and educational allowances, reduction of the limitation of tax relief) the steering committee has drawn on the consequences from the CTR III vote and has made significant concessions.

It is however possible that the federal council after the consultation procedure, or the parliament in their discussions, will decide to modify the bill, to strike suggested measures or to add further measures. Various political parties have already signaled their discontent with some of the suggested measures. It is hoped that there will soon be a consensus regarding a draft bill capable of winning majority support of the voters in order to eliminate fiscal uncertainties with regard to Switzerland as a business location.

Open questions remain with regard to the design of individual measures (especially concerning the efficient implementation of a patent box in line with OECD requirements) as well as the implementation to be made at the cantonal level. In order to guarantee transparency and to boost public acceptance a timely announcement of the cantonal strategies with regard to the implementation of the bill is desirable.

The further developments at the federal level as well as the cantonal level should in any case be followed closely, in order to take any necessary steps at an early stage. Particularly internationally oriented companies may need to envisage the early abolishment of taxation regimes and adopt appropriate measures. Furthermore, the possibility of balancing the abolishment of the taxation regimes with interim solutions (step-up) or the new tax relief measures (super deduction/patent box) should be analyzed. The balancing measures may also be relevant for companies that have not benefited from a tax regime to date.

Originally published August 2017

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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