Switzerland: Tax Summer Update: Revised Swiss Corporate Tax Reform And Required Actions To Benefit

Background to the revised tax reform

Swiss corporate tax reforms I and II In the first iteration of its corporate tax overhaul (CTR I), Switzerland introduced various measures to improve its reputation as an attractive jurisdiction for corporate tax. Included in the CTR I were measures such as a comprehensive exemption for participation income and participation profits of holding, mixed, and principal companies and finance branches (status privilege). These measures resulted in a substantial or complete exemption from income tax on the cantonal and communal levels for status privilege companies.

After the implementation of CTR I, Switzerland experienced an influx of holding companies and companies qualifying for status privilege, which prompted a new corporate tax reform in 2007 (CTR II). CTR II was intended to improve on CTR I and to further promote Switzerland as a top holding company location. Notably, CTR II included a partial tax exemption for qualifying participations in order to prevent double taxation on dividends for substantial shareholders, and also provided for the implementation of the capital contribution principle.

International pressure on the Swiss corporate tax system Simultaneously, Switzerland's corporate tax law became the focus of attention from the OECD, the G20, and the EU. The main criticism of these international institutions was that Switzerland enabled multinational companies with status privilege to shift profits globally without being taxed at the base where the income was generated. At the peak of the tax dispute, the OECD put Switzerland on a 'grey list' of countries that were not compliant with commonly agreed OECD standards.

Rejection of Swiss corporate tax reform III In view of this international pressure and Switzerland's desire to regain its position as a fair and attractive tax location, the Federal Council (government) and the Federal Assembly (parliament) drafted a new corporate tax reform that was introduced initially in 2015 (CTR III). The initial version of CTR III was compliant with international tax standards, including the OECD's base erosion and profit shifting (BEPS) project, and entailed, among other things, the abolition of the heavily criticised status privilege. At the same time, the reform proposal would have enabled Switzerland to remain competitive from an international tax perspective.

Nevertheless, Swiss left-wing parties did not agree with CTR III and launched a referendum to prevent its adoption. With its many direct democratic instruments, Switzerland has a long history of placing certain legislative proposals to a public vote as a means of enhancing participatory democracy. Ultimately, Swiss voters rejected the CTR III in a referendum held in February 2017.

As a consequence, the status privilege remained in force, despite international pressure. For companies that were active on a cross-border basis, this situation inevitably led to legal and planning uncertainties.

TP 17 and TRAF After the rejection of CTR III, the Federal Council released a revised corporate tax reform called Tax Proposal 17 (TP 17) on March 21 2018. The majority of the measures in TP 17 corresponded to the measures already included in the CTR III. However, the make-up of the TP 17 was more balanced, hoping to ensure political consensus. Nonetheless, before TP 17 reached a vote in the Federal Assembly, it was unclear whether the political parties would reach an agreement on the matter.

For this reason, a new CHF 2 billion ($2 billion) per year subsidy for the Federal Social Security Scheme (AHV) was added to the TP 17 proposal as a form of socio-political compensation. With this addition, the new corporate tax reform, now called the Federal Act on Tax Reform and AHV financing (TRAF), was eventually adopted by a clear majority by the Swiss Federal Assembly on September 28 2018.

Some smaller parties called for a popular referendum against TRAF and it was put to the people's vote on 19 May 2019. TRAF was approved by a large majority of the Swiss electorate, and will accordingly be implemented as of January 1 2020.

Revocation of status privilege One of the most important consequences of TRAF is the abolition of the status privilege at a cantonal level, thus ensuring that the Swiss tax jurisdiction is again compliant with international tax standards (e.g. BEPS). As a result, holding companies will in future also be taxed on their income on a cantonal level.

Depending on the generated income of the holding company, the new dispensation must not necessarily lead to any or a significant increase of the holding's income tax burden. If a holding company receives primarily dividend income it would face no or only a small increase of its tax burden, as the cantons have already introduced a partial tax exemption for qualifying participations in order to prevent double taxation on dividends for substantial shareholders.

In addition, the cantons will lower their income tax rate in the course of the TRAF implementation which will further lower the tax burden of holding companies. However, should a holding company mainly generate interest or royalty income, this would result in a higher taxation as the partial tax exemption for dividend income would not be applicable. In summary, this means that the establishment of a holding company can still be very attractive from a tax point of view, provided the holding company mainly generates dividend income.

Disclosure of hidden reserves for status privilege companies As a result of the revocation of status privilege, companies remaining in Switzerland will be forced to transition from privileged to ordinary taxation. In such a case, a so-called two-rate system is applicable. Profits relating to hidden reserves obtained under the previous status privilege will be subject to a five-year limited special tax rate. Cantons will be free to determine this special rate. Alternatively, status privilege companies have the opportunity to disclose hidden reserves taxneutrally during a five to ten-year period (depending on the canton) and to amortise the tax-free disclosed hidden reserves (so called step-up). The disclosure of hidden reserves ensures a competitive income tax burden and is intended to encourage current status privilege companies to remain in Switzerland.

The canton of Zurich (ZH) plans to introduce a five-year limited special rate of 0.5% and a ten-year period for the step-up of disclosed hidden reserves. The cantons of Lucerne (LU) and Aargau (AG) have chosen a similar approach and plan to introduce a five-year limited special rate of 0.5% (LU) and 2.4% (AG), as well as a ten-year period both for the step-up of disclosed hidden reserves. The canton of Zug (ZG) fixes the five-year limited special rate at 0.8 – 1.6% and provides for a step-up period of five years in its revised cantonal tax act. Basel-Stadt (BS) uses its own tax practice for the step-up of hidden reserves and levies three percent (two-rate system). Geneva (GE) will introduce a five-year limited special rate of 13% for disclosed hidden reserves. The canton of Vaud (VD) has not implemented the possibility of disclosure of hidden reserves in its revised cantonal tax act.

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