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As an academic and lawyer specializing in taxation, Pierre-Marie Glauser was closely involved in the corporate tax reform campaign in Switzerland that culminated in the referendum held on May 19th. An advocate of the proposed reforms, Glauser was a member of a number of working groups involved with the reforms and gave presentations at various conferences on the implications of accepting or refusing the reforms. Here he discusses the government backed provisions approved by 64.4% of Swiss voters on May 19th and their impact.
5 min read
Why abolish the privileged tax regimes that have helped to create Switzerland’s reputation as a low taxation destination for foreign multinationals?
Switzerland has been very attractive for both Swiss and foreign multinational companies. However, there has been international pressure for change, primarily concerning foreign entities, non-Swiss companies, that have incorporated their headquarters or significant aspects of their business in Switzerland. Due to the specific tax regimes, Switzerland was treating foreign sourced income, generated outside of Switzerland but repatriated to Switzerland and taxed there, at a better rate than Swiss sourced income. These tax regimes have been under great pressure from various institutions, including both the EU and the OECD.
The package of tax measures
What are the main provisions of the new tax reforms?
In Switzerland there are two levels of taxation: at the federal-state level – where these non-Swiss companies had no privileges, and were taxed like any other local business; and at cantonal level – which is where the privileges existed, mostly in the form of tax exemptions of a portion of profits.
At federal level, a law rules the framework of what the cantons must include in their legislation (although the federal state cannot set the level of tax rate which the individual cantons choose to apply).The main provision of the federal tax reform voted in on May 19th (and in which comes into effect January 1, 2020), is that the cantons are no longer able to grant the special tax regimes.
Previously a company fully exempted at cantonal level (so-called “holding companies”) only paid tax at the federal level at the effective tax rate of 7.8%. As of 2020, though, that company will be unable to obtain that exemption at cantonal level. Instead it must pay the full tax rate levied by the particular canton. In Geneva, for example, that would amount today to 24% (federal and cantonal).
Most companies concerned by the tax regimes have what is termed a “mixed company” regime. Currently, they are taxed ordinarily at federal level – 7.8% – with an exemption of that tax base at cantonal level giving in an overall total rate of about 10 or 11%. As of 2020 they will also pay the ordinary tax rate at cantonal level.
There are some new measures which may ease the tax burden for certain companies, though?
Yes, although special tax regimes are abolished at the cantonal level, the cantons are allowed to apply a number of new specific tax provisions in the future.
The cantons will newly allow companies to apply for what is known as the patent box, a measure accepted at international level. It may be of interest to certain R&D intensive companies, but the way it is drafted in law is fairly restrictive. There are strict conditions that must be complied with. A company can only apply the patent box to income linked to patents that are based on research in Switzerland. If you are a Swiss company, for example, and you acquire patents from abroad, you cannot claim for patent box.
Also, companies that already have patents, and have deducted R&D costs for developing their patents in Switzerland, would have to reimburse any tax savings made due to their R&D expenses in the past if they want to enter the patent box as of 2020. So there is a significant cost for entering into the system. In addition, the system is very complex and burdensome to manage, which is bad news for the corporations. I’ve heard from some executives, for example, that the tax savings would be less than the costs involved in making those savings.
What about the provisions relating to R&D expenditure and corporate financing?
With the enhanced R&D deduction, if the company has R&D expenses a canton can decide that for every one franc of expense in Switzerland, the company can deduct up to CHF 1.50. R&D deductions may encourage companies to engage in R&D costs, but this will not compensate for losing the benefits available under the previous tax regimes.
And then a third measure is the notional interest deduction (NID). Under the existing system firms using loans for financing are able to deduct interest payments as expenses. The new NID provision benefits firms that choose to self-finance, to borrow less and use their own assets to finance the business – by using equity, rather than maximizing debt leverage, for example. The NID entitles firms with a certain level of equity to deduct an amount notionally corresponding to the amount that might have been deducted if they had chosen to use more debt for financing.
Not all cantons will be able to apply this, as the federal law requires that the canton need to meet certain conditions relating to the tax rate level. For those cantons that do meet the conditions, they can choose whether to apply the NID or not. This provision is equally unlikely to compensate for the loss of the previous tax regimes.
In addition, it must be noted that the federal law requires that, after 2020, even if it applies all possible new tax instruments, a company will have to pay taxes at least on 30% of its profit (the cantons being entitled to increase this percentage). This means that a company that was previously benefiting from a privileged tax regime (with an exemption on 100% to 80% of its profit) will in any case be taxable on higher portion of its profit after the reform.
So if the new provisions are unlikely to compensate for the loss of the special tax regimes, where is the benefit?
The most important changes are not those determined directly by the vote on May 19. Instead, they are the individual decisions by the cantons to lower their corporate tax rates. If you are a canton like Geneva, with about one third of your corporate tax income coming from companies benefiting from privileged tax regimes, and representing over a billion a year of tax revenues paid by these companies and their employees, you cannot afford to impose tax increases up to the ordinary rate of 24% on companies currently paying the current 8 to 10%.
Most of the cantons have already announced that they will reduce the ordinary corporate tax rate for all companies. Geneva voted on May 19th to reduce its tax rate from 24% to 13.99%, with effect from 2020. The canton of Vaud, where the University of Lausanne is based, already reduced its tax rate to 13.79% as of January 1, 2019. This level of tax rate is probably acceptable to companies currently benefiting from a (due to be abolished) special tax regime and paying taxes at around 10%.
Nevertheless, the federal vote on the tax reform was also important in connection with the cantonal tax rate question. Indeed, the federal tax reform modified a provision at federal level that requires the federal state to pay approx. CHF 1 billion to the cantons, effectively helping the cantons to finance their tax rate reduction if they wish.
Benefits and risks
Which types of companies will benefit from the reforms?
I think all types of companies will benefit. Even those companies that were benefiting from the tax regimes in the past, in the future they may pay slightly more, but on the other hand the new measures simplify the tax system and companies know where they stand. It is important from the perspective of legal certainty. It’s also worth noting that not every corporation in Switzerland was benefiting from a special tax regime. All companies taxed ordinarily, in particular the local SME companies, for example, will benefit from the reduction in tax rate by the cantons.
Any company willing to move to Switzerland knows that it can benefit from an ordinary rate of approx. 14% in the lake of Geneva region, for example. And they may also benefit from the specific provisions I mentioned if they fulfil the necessary conditions. Overall, it probably means that Switzerland will be able to retain and attract multinationals, and also attract smaller R&D oriented companies, in biotech and IT, for example.
But isn’t there a risk of a negative impact to public services, for example, because of a lower corporate tax rate overall?
The income tax collected by the federal state from multinationals that benefitted from a special tax regime was approximately 50% of the total income from tax on profits. If these companies moved out of Switzerland because of changes in the tax regime the federal State would lose more than CHF 4 billion a year. It would be a terrible loss. But that’s not all. Those same multinational companies represent near 50% of the total of R&D expenditure in Switzerland.
The reform may lead to a reduction in corporate tax revenue, but they create the conditions that will enable both multinationals to remain in Switzerland and for Switzerland, therefore, to retain the source of those tax receipts, R&D expenditure, employment and taxes from employees, knowledge spillover and other benefits. Not to mention all the other elements of the supply chain and services connected to and supported by these multinationals.
Hopefully, a relatively standard, internationally accepted regime, and fairly low tax rate, will enable Switzerland to attract new businesses.
No major reforms are without complication. Where do you see the main challenges, gray areas, potential problems, emerging from the changes?
These reforms have taken very long time to develop and be accepted. Criticisms of the tax regime date back over two decades. The reforms have taken time due to the complexity and technical nature of the issues involved, and the complexity of the politics, at the different levels of authority.
There are a number of potential challenges in the future. At a political level, for example, in Switzerland, as with many other countries globally, there is increasing pressure to tackle income and wealth inequality. This was a popular discussion topic during the campaign. Interestingly, following the result some political parties were quick to suggest introducing a new law as a next step, forcing the cantons to harmonize the tax rates among the cantons. Currently there is competition between the cantons in terms of the tax rates imposed. Harmonizing rates would abolish inter-cantonal tax competition. Once harmonized there is every possibility that the tax rates may creep up again.
There is a significant role for academics here, to outline the full implications and consequences of such tax reforms, in terms of the impact of the various possible reforms on the tax system as a whole, for example.
In practice, regarding the corporations, one challenge will be managing the complexity of the instruments introduced by the federal vote. We will also discover whether having a simplified regime, with a fairly low rate, remains acceptable at the international level. While we may be compliant with OECD and EU guidelines following these reforms, what is regarded as acceptable now may change in the future. Is the discussion over? My fear is that, if companies continue to move operations and profit to lower tax jurisdictions like Switzerland, there will be pressure to make further changes, not least from countries and institutions that believe that they are disadvantaged.
From the way you describe it seems like a win-win package of tax reforms. Is it really possible that no one loses out?
During the campaign the opponents of the reform argued that the loss of tax revenue due to the reduction of the rates by the cantons will have an adverse effect on the provision of public and social services. Personally, though, I believe that rejecting the reform would have produced a worse outcome for the state and for public spending, because of the potential movement of multinationals out of Switzerland, as well as a decrease in the attractiveness of Switzerland as a destination.
That much is evident from the way cantons such as Vaud have flourished, over the last 20 years or so, as a result of the influx of international companies due to the beneficial tax regime. Many of the Swiss cantons have managed to create a virtuous circle of investment and growth; it is important that we do not ruin that.