Genesis of the reform
The Federal Tax Harmonisation Act in its article 28 provides for special tax regimes for companies subject to income tax. It allows for a very favorable tax treatment for companies that have little to no business activity within Switzerland, since their income deriving from foreign activity is largely exempted from taxation. This favorable treatment is a thorn for the EU, which has notified to the Swiss cabinet (Federal Council) that the special regimes were considered to be inconsistent with article 23, a provision in the EU-Switzerland free trade agreement of 1972 banning state aids. A second source of pressure is the OECD, which by means of its BEPS (base erosion and profit shifting) programme wants to put an end to international schemes allowing to shift profits to tax havens. This combined international pressure lead to an extensive corporate tax reform.
The reform’s main measure: abolishment of the special tax regimes and lowering of applicable tax rates by the cantons
The abolition concerns paragraphs 2 to 5 of article 28 of the Federal Tax Harmonisation Act. Therefore, the cantons will be prevented from applying special tax regimes and the regular rate will be applicable to all companies subject to income tax.
However, certain cantons, for example Vaud and Geneva, but as well Zug and Schwyz, have made extensive use of those preferential tax regimes, in the wake of which a dependency in terms of government revenue but also jobs has arisen. By reason of the absence of commercial activity in Switzerland, the concerned companies are very mobile and can therefore easily move, be it to another canton or abroad. With these constraints in mind, the challenge for legislators is to find a solution that will be in line with international constraints (EU, OECD), but that still allows to keep the affected companies. To that end, the majority of the cantons plans to lower their tax rate to around 13%.
Although 50% of the direct federal income tax derives from such specially taxed companies, in order to compensate the canton ‘s revenue losses, the reform foresees an accrued distribution of taxes from the Confederation to the cantons.
Additional measures foreseen in the draft legislation
- The ‘patent box’
Income from patents that can be linked to research expenses made by the entity subject to taxation is exempted up to 90% on cantonal and communal level (the cantons are free to determine an exemption rate lower than 90%). However, only income from patents and similar rights are eligible for the exemption. Other intellectual property rights like brands are not subject to it. This regime is fully in compliance with the BEPS rules, provided that the exemption is granted where the value is produced.
- The R&D ‘superdeduction’
The draft entitles the cantons to grant a deduction for R&D expenses that exceeds justified business expenditure. Again, it will be up to the cantons to legislate on the extent of the deduction. These measures aim at relieving fiscal costs during the entire life-cycle of scientific activity, that is from basic research (R&D) until market activity (patent), in order to attract high quality economic value added.
Furthermore, to keep Switzerland’s attractiveness for companies moving here from abroad, a ‘step-up’ will be introduced. It allows for a tax neutral declaration of hidden reserves. The same ‘step-up’ takes place in case of leaving Switzerland, but this time with tax consequences. Finally, a similar system should be put in place for companies that cease to benefit from the aforementioned special tax status during a limited period of five years.
- Abolition of the issuance stamp tax
Although this measure is extraneous to the motive of the reform, the issuance stamp tax is nonetheless planned to be abolished, since it penalises contributions of capital, whereas the interest rates for borrowings are deductible.
- Possible deduction of notional interests
Even though the federal council did not propose it in its last accompanying report, the deduction of notional interest rates is still desired, and fought for, by the business community.
The legislative process
The legislative process should come to an end in spring 2016. If no referendum takes place, the act could enter into force in January 2017 at the earliest. After a transitional period of two years, the cantons will need to have put implementing legislation in place. However, some notions, like the rights comparable to patents, need yet to be specified by the OECD itself.
For the time being, the amendment lies in the hands of the Swiss upper and lower chamber. Nonetheless, the reform already exerts influence, in the way that it creates legal uncertainty. Most cantons have not yet published a draft legislation. However, they have nearly unanimously committed to lower their tax rates for companies. Only Vaud has already finalised a draft implementing act, in order to counter the legal uncertainty and to maintain companies and jobs within the canton. Vaud plans to reduce its effective tax rate from now 22.33% to 13.79% (calculated on the average of all communes). Since the act is subject to a referendum, it will likely need to be voted. Generally, every canton can determine its (lowered) tax rate, and this amendment being incorporated in an act, a referendum can always be raised. Therefore, especially in high tax cantons, legal uncertainty persists. Some low tax cantons like Lucerne (12.6%) and Zug (14%) can be easy in their mind, since they are already very competitive and built up less dependency on such preferential regimes.
A lot at stake for Switzerland
For Switzerland, but even more for the cantons, the reform’s outcome is uncertain. The lowering of tax rates is a risky undertaking, since tax receipts will surely diminish, while retaining those specially taxed companies is unsure. In 2008, a national referendum on the corporate tax reform II was held, and got adopted only by an extremely narrow majority of 50.5%. With that in mind, and since the reform will shift the burden of financing the public sector more towards individuals, the political risk of a referendum should not be neglected. In the long term, however, the tax breaks for research-based activity and patents might render Switzerland attractive for all kinds of science-related businesses. Moreover, taking into account that the BEPS regime will bind all OECD members, taxation systems will subsequently become more transparent, and the stiff competition will henceforth be on the rates, where Switzerland is well placed compared to other countries.