As a preliminary remark, it should be emphasised that taxes in Switzerland are levied at three different levels: federal, cantonal and municipal. Certain taxes are only levied at the federal level (eg, withholding tax, stamp duties or VAT) while some other taxes are only levied at cantonal levels (eg, gift tax, inheritance tax or wealth tax). As cantons still have a high level of independence regarding tax matters, this can result in significant differences in the handling of tax controversies between the various cantonal and federal tax authorities.
Tax controversies usually arise by way of a formal complaint filed by the taxpayer against a tax assessment decision rendered by a tax authority. In the fields of withholding tax, stamp duties and VAT, where the principle of spontaneous taxation applies (meaning that taxpayers themselves calculate the amount of tax due, declare it and pay said amount to tax authorities), controversies usually start as a result of a tax audit conducted by the Swiss Federal Tax Administration (SFTA).
All tax matters may give rise to tax controversies, regardless of the type of tax or of the values involved.
Broadly speaking, Swiss tax authorities are quite open to discussion with taxpayers, which serves to mitigate the possibility of tax controversies further down the line. In particular, tax rulings (see 6.4 Avoiding Disputes by Means of Binding Advance Information and Ruling Requests) provide a powerful tool to ensure certainty and avoid ulterior disputes.
In an effort to comply with the Base Erosion and Profit Shifting (BEPS) Recommendations of the OECD, as well as with the EU's various measures to combat tax avoidance, Swiss tax authorities have taken, over the years, an increasingly strict approach in many tax matters. This has led to a growing number of tax controversies in Switzerland, with, for instance, offshore structures being increasingly challenged.
When faced with an additional tax assessment, the taxpayer is not obliged to pay or guarantee the tax assessed in order to be able to lodge a formal complaint, and subsequently an appeal, against it.
Alongside the additional tax assessment, Swiss tax authorities will typically open criminal proceedings against the taxpayer; for instance, due to the misdemeanour of not having declared a taxable event to the tax authorities.
It is currently rather difficult to evaluate the impact of COVID-19 on pending tax controversies. Some tax authorities, as well as judicial authorities, have automatically extended deadlines granted to taxpayers or claimants under pending procedures while legal deadlines, as provided by Swiss law, could not be extended. In particular, tax authorities and judicial authorities have not closed theirs offices and continue to be easily reachable. COVID-19 may have slowed tax procedures in recent months but a major impact on the time taken to obtain justice is not currently expected.
Regarding payment obligations, no specific measures were adopted to relieve taxpayers of their tax obligations. The tax authorities, competent to require tax obligations' payment and sue if necessary, are expected to become more likely to grant extended terms of payment in the medium term. Additionally, no late interest fees will be due until the end of fiscal year 2020 for certain taxes in cases of a late payment (VAT and direct taxes at the federal level).
Internationally, there will certainly be increased pressure from the Swiss tax authorities, eager to retrieve taxes in Switzerland. It is, however, difficult to apprehend an increase of tax controversies in the medium term. This may, however, lead to a new pressure in pending cases.
Nationally, new harsh tax audits are not expected to be launched in the coming months. In our practice, we have even experienced that tax authorities have been more prompt to reach agreements by means of ruling requests in recent months.
The Swiss tax authorities do not share the criteria on which they base their decisions to perform a tax audit. The various tax authorities have a certain flexibility in this matter. Some tax authorities set year-to-year variation thresholds regarding the taxable amounts reported, which can trigger a verification process.
Tax authorities may initiate tax audits as soon as they receive any relevant information for taxation that was previously unknown to them.
The statutory limitation on initiating a procedure for the collection of back taxes is ten years after the end of the tax period for which the tax has not been levied, preventing any such procedure afterwards. For withholding tax, stamp duties and VAT, this statutory limitation is five years after the end of the relevant tax period.
Once the procedure has been initiated, the statutory limitation on determining a supplementary tax is 15 years after the end of the tax period to which the procedure relates, preventing any levy of tax afterwards, even if a back-taxes procedure has been opened. For VAT, this statutory limitation is ten years. Withholding tax and stamp duties, however, benefit from a specific status as no statutory limitation applies anymore if a procedure has been initiated.
As a rule, tax authorities in Switzerland, whether cantonal or federal, have an audit department with an internal and an external unit. The latter can visit the taxpayer's premises.
These audits are only based on printed documents. Data made available electronically fur such purpose is not available in Switzerland yet.
Tax inspectors may be interested in all aspects of taxation. Regarding companies, compliance of the accounts with accounting and tax rules is the most important aspect for legal entities examined by tax auditors. Whereas, for natural persons, justification of the deductions claimed and the existence of unlimited liability are frequently examined.
Exchange of information, mutual assistance between tax authorities as well as constant development of international tax rules have certainly led to an increase of tax audits in Switzerland.
Assisting clients targeted by requests for information from foreign countries in the context of a foreign tax audit is a frequent activity of this firm.
One unique feature of the Swiss tax authorities is their willingness to discuss tax matters with taxpayers openly. In the context of a tax audit, the best strategy is often to demonstrate transparency regarding the facts and technical accuracy regarding the legal analysis.
If a taxpayer disagrees with an assessment decision made by a tax authority, they may submit a formal complaint to the tax authority that has issued the assessment decision, within 30 days as from notification. The formal complaint procedure is an official appeal procedure that forces the tax authority to issue a new decision subsequently.
Such a formal complaint must be filed in writing. With regard to income tax, the complaint does not need to be substantially motivated (except if the complaint is made following a discretionary assessment decision). The taxpayer only has to express their unquestionable disagreement with the assessment decision. Formal complaints in the field of other taxes must be sufficiently motivated, meaning that the taxpayer has to demonstrate that the assessment decision is obviously inaccurate.
If the formal requirements are met, the tax authority has to re-examine the tax assessment decision and may modify, in whole or in part, the first decision or reject the taxpayer's formal complaint.
While Swiss tax law does not provide for a particular deadline for the tax authorities to respond to a formal complaint lodged by a taxpayer, they have a constitutional obligation to process the claim within a reasonable time. The meaning of "reasonable time" is not clearly defined and depends on the specific circumstances of the case at hand. The taxpayer can lodge a judicial claim if a tax authority does not process their formal complaint within a reasonable timeframe. Such situation rarely occurs in practice.
If the taxpayer is not satisfied with the decision of the tax authority on their formal complaint, they have the ability to lodge an appeal with a first-instance cantonal court or, in matters falling under the authority of the SFTA, with the Swiss Federal Administrative Court. The deadline to lodge an appeal is 30 days as from notification of the contested decision on formal complaint.
Swiss administrative procedure rules, including tax procedure rules, provide for an essentially written litigation process and imply few or no investigative acts such as hearings, due to the technical nature of tax law and the generally numerical content of litigation.
Following the taxpayer's appeal, the tax administration files a reply before the court, supporting the position of its tax decision. Usually, an additional exchange of replies is allowed, before the case is kept to be judged by the court until the judgment is rendered.
Evidence must be provided at the time of lodging the appeal and is particularly important because of the burden of proof in Swiss tax litigation (see 4.4 Burden of Proof in Judicial Tax Litigation).
Regarding tax matters in general, as well as within the context of judicial tax litigation, the tax authority must establish the facts upon which the tax liability is based, while the taxpayer has to prove the facts that reduce or eliminate that liability.
If the elements gathered by the tax authority provide enough evidence of the existence of taxable items, it also falls upon the taxpayer to establish the truth of their own claims and to bear the burden of proof regarding elements that justify their exemption.
Legal analysis and reassessment of the tax administration's position is the most important aspect of tax litigation. Settlements with the tax administration are still possible but less likely once the dispute has begun, as tax authorities sometimes have an interest in having their practice confirmed by courts.
With the exception of a back-taxes procedure, which often covers the previous ten years and where statutes of limitation may play a minor role for the earliest years depending on the case at hand, timing is generally not an efficient strategy.
Statutes and case law are the most important sources for Swiss tax courts. The ECHR's case law is also taken into account, in particular within criminal tax procedures. International guidelines are also elements of interpretation on which the courts occasionally rely. Tax doctrine is a source of interpretation used by courts, but they are not bound by the doctrine.
Appeal Before a Second-Instance Court
Any tax decision previously challenged before a first-instance court may be appealed. There is no limit based on the value of the dispute. A decision of a first-instance court can be appealed to a second-instance cantonal court within 30 days of service of the first-instance court's decision. The tax authority or the taxpayer, or both, can lodge an appeal.
The procedural principles are the same as those applying before the first-instance court. Judgments of a second-instance court may be appealed to the Federal Supreme Court.
Appeal Before the Federal Administrative Court
The Federal Administrative Court is the ordinary administrative tribunal of the Swiss Confederation. The main role of the Federal Administrative Court is to examine the legality of decisions in matters falling under the authority of the Federal Administration.
Lower instances are mainly the federal departments and subordinate federal offices. The Federal Administrative Court hears appeals against decisions of federal authorities, in the fields of withholding tax, stamp duties and VAT in particular.
A decision of the Federal Administrative Court can be appealed to a second-instance cantonal court within 30 days following the first-instance court's decision. The appeal can also be lodged by the tax authority or the taxpayer, or both. Its judgments may be appealed to the Federal Supreme Court.
Appeal Before the Federal Supreme Court
If the taxpayer considers that the final decision of the second-instance cantonal court or of the Federal Administrative Court violates his or her rights, he or she may lodge an appeal before the Federal Supreme Court. Such an appeal must be lodged within 30 days of notification of said contested decision.
The Federal Supreme Court is the highest judicial authority within the federal state. It issues final rulings in tax matters.
For the different stages in tax appeal procedures before all Swiss courts, see 4.2 Procedure of Judicial Tax Litigation regarding the first-instance cantonal court, given that the procedure is essentially the same.
However, it should be noted that the Federal Supreme Court does not re-establish the relevant facts of the case. These facts may only be corrected by the Federal Supreme Court if it finds that they have been blatantly incorrectly established by a lower court, or that they have been based on a violation of law. This means that the Federal Supreme Court takes its decisions solely by applying the law to facts that have already been determined.
In the canton of Geneva, before the first instance of appeal, a judge usually renders his or her decision with the help of two associate judges specialised in tax law. The second instance of appeal is usually composed of three professional judges.
The Federal Administrative Court and the Federal Supreme Court are, as a rule, composed of three judges but may be composed of five judges in special cases. Before these courts, a single judge may render a judgment for clearly inadmissible or insufficiently motivated cases.
Swiss tax law does not provide for national mediation or arbitration procedures.
With regard to forms of alternative dispute resolution (ADR), double taxation treaties concluded by Switzerland usually refer to a mutual agreement procedure (MAP), which is independent of Swiss domestic law procedures. Thus, the time limits provided for by domestic law have no influence on the MAP and vice versa. In particular, the 30-day deadline to file a claim against a tax assessment decision is not suspended by a request for a MAP. In order to save their rights according to Swiss tax law, taxpayers should file a complaint against the relevant tax authority, which will be suspended during the MAP.
In international tax matters, a MAP is carried out if the procedure set out between the competent Swiss and foreign authorities is unsuccessful.
The MAP is initiated at the taxpayer's request, before the competent authority in the taxpayer's country of residence. However, the taxpayer itself is not a party since the MAP is a procedure between one state and another.
In Switzerland, the competent authority for MAPs is the State Secretariat for International Financial Matters (SIF). There is no obligation of result between Switzerland and the relevant other state.
Swiss tax law does not have national mediation or arbitration procedures.
Given the overall complexity of taxation in Switzerland, taxpayers have an interest in discussing the more complex cases with the tax authorities at an early stage; for instance, in the case of international corporations considering moving to Switzerland, so they can obtain confirmation of their future taxation. The same applies to individuals.
In this regard, tax rulings are commonly used in Swiss tax practice, although Swiss tax law does not expressly refer to rulings. It should be noted that a tax ruling does not provide any preferential taxation over the applicable law. It constitutes, instead, a quicker and more efficient way to provide clarity with regard to taxation questions.
In order to obtain a ruling, the taxpayer has to disclose all relevant information, usually in the form of a letter. If the competent tax authority agrees with the taxpayer, the ruling request is sent back to the taxpayer with the stamp of the authority, which provides the taxpayer with confirmation from the State on the tax treatment of a transaction or a situation. Tax rulings are not public.
Regarding the binding effect of such rulings, the taxpayer is protected by the constitutional principle of good faith as far as he or she relies on the information received by the competent tax authority. Swiss case law also especially emphasises the importance of implementing the facts precisely described in the ruling.
There is no legal entitlement for a taxpayer to obtain a binding ruling, even though tax authorities are mostly willing to deal with ruling requests. This means that taxpayers cannot contest a refusal to give a ruling request.
As mentioned in 6.2 Settlement of Tax Disputes by Means of ADR, the MAP, in the case of double taxation with a country with which Switzerland has signed a double taxation agreement, requires that all relevant steps between the relevant Swiss and foreign entities be respected.
There is no limit value of the claim. According to the OECD Model Tax Convention on Income and on Capital of 2017, the taxpayer has to request the initiation of a MAP within three years from the first notification of the action resulting in double taxation.
There is no appeal possible against the outcome of the MAP.
ADR is mostly used in transfer pricing cases. With regard to MAPs, and according to the 2018 statistical report of the competent authority, out of 257 cases filed, 70 related to transfer pricing issues.
As a preliminary remark regarding direct taxes, it should be underlined that a taxpayer seeking to limit the amount of tax it pays is not acting in a criminally punishable manner. Furthermore, in Switzerland, anti-avoidance rules are not contained in one specific piece of legislation; they actually take different forms.
Swiss tax law includes a purely administrative procedure, the back-taxes procedure, which aims at recovering amounts not dutifully declared by the taxpayer.
Swiss criminal tax law deals with misdemeanours (or "contraventions"), which lead to a fine, and tax offences, which may imply imprisonment.
Breach of procedural obligations, tax evasion and attempted tax evasion are the main misdemeanours.
Breach of procedural obligations refers to situations where, for example, the taxpayer fails to file a tax return or does not comply with a duty to provide information. Regarding the sanction, for income and equity taxes, the penalty is limited to CHF10,000. For other types of tax, the limit varies.
Tax evasion is where the taxpayer, with intent or through negligence, omits certain items in their tax return, or causes a final assessment to be incomplete. The fine may vary from one third to three times the amount of tax evaded. The statute of limitations is ten years. Regarding attempted tax evasion, the fine amounts to two thirds of the amount determined for complete evasion. The statute of limitations is six years.
A back-taxes procedure, which aims at recovering amounts not dutifully declared by the taxpayer, generally triggers a tax evasion procedure. Forgery and withholding tax at source diversion are the main tax offences.
Forgery is the use of fraudulent documents (eg, false financial statements or salary certificates) and is a qualified tax offence with a maximum penalty of imprisonment for up to three years and a minimum fine of CHF10,000. Tax at source diversion is where a person required to collect tax at source misappropriates the amounts collected for their own benefit or for that of a third party. The maximum penalty is imprisonment for up to three years.
In tax offences, the payment of back taxes is always due.
For tax misdemeanours, the competent authority for the processing of back taxes and for tax-evasion procedures is the same authority, namely the cantonal tax authorities or the SFTA for federal taxes and then the courts. As a rule, these two procedures are conducted simultaneously and set by tax law.
For tax offences, the Public Prosecutor is competent. In such cases, the tax or criminal authority, depending on the case, may decide to suspend one procedure during the settlement of the other. The procedure is set by criminal law. The criminal procedure is generally more elaborate than the tax procedure and leaves more room for investigative acts.
The Public Prosecutor is only competent regarding the criminal part of the tax offence. The calculation of the amount of taxes due remains under the tax authorities' competence.
Tax authorities initiate such proceedings when they suspect that a tax return or final assessment is incomplete. As mentioned (see 7.1 Interaction of Tax Assessments with Tax Infringements), a back-taxes procedure generally implies a tax evasion procedure, which is of a criminal nature.
Depending on the case at hand, the case may evolve into a more serious offence, but most cases develop into a two-way procedure of back taxes and tax evasion.
For tax misdemeanours, as the tax authority establishing the back taxes also establishes the criminal tax penalty, the process is treated by the relevant authority, whether it is the tax authority or the relevant administrative court.
For tax offences, while the back-taxes procedure will still be treated by the tax authority or the relevant administrative court, the Public Prosecutor is competent regarding the criminal aspect.
In cases of tax evasion, the good co-operation of the taxpayer makes it possible to reduce the amount of the fine within the framework of the law.
However, the amount of taxes due, which relates to the back-taxes procedure, cannot be amended.
For tax misdemeanours, if the taxpayer does not challenge the decision of the tax administration, the procedure is not pursued before the administrative courts, but the payment of the fine remains due. Before the administrative courts, full payment of the tax and fine, and withdrawal of the appeal, are also possible. However, this does not change the criminal tax qualification of the procedure.
For tax offences, the issue is a matter for the criminal courts and the mere payment of the tax due is not enough to stop the procedure, since the issue of tax payments is not addressed by the Public Prosecutor.
Where the taxpayer acknowledges the material facts, a simplified procedure may be possible before the Public Prosecutor under certain conditions. The Public Prosecutor prepares an indictment that the taxpayer may accept or refuse.
For misdemeanours, appeal possibilities are the same as explained above 7.4 Stages of Administrative Processes and Criminal Cases and 7.5 Possibility of Fine Reductions.
For criminal offences, an appeal to the second instance and then to the criminal chamber of the Federal Court is possible, if specific deadlines are observed.
As a rule, transactions and operations challenged under transfer pricing rules or general anti-avoidance rules have resulted in two-way procedure cases of back taxes and tax evasion.
In the vast majority of double taxation cases, domestic legal remedies are used first to correct the tax situation. However, in parallel with domestic remedies, taxpayers increasingly use MAPs available under double tax treaties. As to arbitration, it is quite rare in practice, as arbitration clauses are still relatively new in double tax treaties signed by Switzerland.
As mentioned, in Switzerland, anti-avoidance rules are not contained in a specific act or provision. However, the Swiss Federal Supreme Court has developed a general exception of tax avoidance and abuse of rights, applicable to almost all Swiss taxes.
This general exception also applies to Swiss double tax treaties, if no other anti-avoidance provision is provided under such treaties.
International transfer pricing adjustments are usually challenged first and foremost under domestic tax courts. Although Switzerland does not have any explicit transfer pricing legislation, those courts as well as the tax authorities apply in practice the OECD Transfer Pricing Guidelines.
The majority of tax treaties signed by Switzerland do not contain the corresponding adjustment provisions of Article 9, paragraph 2 of the OECD Model Tax Convention.
Advance pricing agreements may be used in the context of rulings (see 6.4 Avoiding Disputes by Means of Binding Information and Ruling Requests).
Among the various cross-border tax situations, withholding tax is probably the matter that gives rise to the most litigation. This is due to the high withholding tax rate (35%), as well as the fact that Switzerland is a large importer of foreign capital.
In general, a ruling is the most effective way to prevent litigation under Swiss tax law and to prevent the risk proactively.
A formal administrative complaint with the tax authority is free of charge. However, such a procedure may take some time and lead to significant late interest fees on the amount of taxes due if the taxpayer does not settle enough instalments. This item needs to be addressed to mitigate costs related to administrative litigation.
Before cantonal courts, the amount of the fees varies from one canton to another. In Geneva, before the first-instance court, the fees are calculated according to the complexity of the case, but cannot exceed CHF10,000. An indemnity for legal costs may be charged to the unsuccessful party, including the tax authority. The same rules apply before the second-instance court.
Before the Federal Administrative Court and the Federal Supreme Court, fees are calculated based on the challenged amount, the scale and complexity of the case, the parties involved in the procedure and their financial situation. As a rule, legal costs are borne by the unsuccessful party.
Fees are settled once the judgment is rendered, but an advance payment is generally required by the courts. There is no interest payment on it. If the required advance payment is not paid, the courts are unable to move forward with the procedure if the applicable law specifies that this is an admissibility requirement.
There is no possible compensation based on taxation ultimately considered void and null under Swiss tax law. However, any amount already paid by the taxpayer will have to be reimbursed with potential interest in his or her favour.
The MAP is free of charge. However, the taxpayer bears the costs incurred by their request (in particular, the fees of their possible representative).
Statistics of the Geneva authorities are not publicly available.
The latest report available from the Federal Supreme Court in 2019 indicates that this Court processed 422 cases in tax matters. Additional statistics on their value are not available.
In 2019, the Federal Supreme Court processed 308 cases for direct taxes, 3 for stamp duties, 22 for indirect taxes, 23 for withholding tax, none for military tax, 6 for double taxation, 54 for other taxes and 6 for tax exemption. Additional statistics on their value are not available.
According to a private study carried out in 2017, and on the basis of Federal Supreme Court data from the past ten years, an appeal filed by a taxpayer with the Federal Supreme Court in tax matters succeeds only 14% of the time.
The best way to manage a tax dispute is to avoid it by planning, essentially through an early tax analysis of the situation and, if necessary, by an advance tax ruling.
In pending procedures, the legal analysis of the tax administration's position is an essential step. Using a tax specialist is also key when dealing with a tax controversy.
The Base Erosion and Profit Shifting (BEPS) project, which the OECD/G20 Inclusive Framework on BEPS is relentlessly pushing forward, has led to major upheavals in Swiss tax law.
In this context, the exchange of information with foreign tax authorities has been massively expanded in recent years. Switzerland now has a dense network of countries with which bank account information and country-by-country reports are automatically exchanged. In addition, there is the spontaneous exchange of information regarding tax rulings that relate to cross-border situations, as well as administrative assistance on request, which foreign tax authorities make frequent use of, particularly in the context of so-called group and bulk requests. Switzerland has thus implemented all the standards required by the OECD/G20 to increase transparency in tax matters.
In addition, further milestones in international tax policy have been reached in recent months: first of all, The Federal Act on Tax Reform and Pension Fund Financing and the associated enforcement ordinances came into force on 1 January 2020. This marked the successful conclusion of a legislative project that had lasted for more than a decade and Switzerland succeeding in implementing the minimum standard against harmful tax competition set by the OECD/G20 under Action Point 5, into national corporate tax law. As a result, the EU removed Switzerland from the list of non-co-operative states in the area of taxation on 17 October 2019. Secondly, on 1 December 2019, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) entered into force in Switzerland. Last but not least, and following a more than ten year blockade by the US senate, the protocol amending the existing Double Taxation Agreement (DTA) between Switzerland and the USA came into force on 20 September 2019. As a result of these important legislative developments, various trends which multinational enterprises (MNE) and high net worth individuals (HNWI) must keep in mind, and as outlined below, will emerge over the coming years in the area of tax controversy.
Prevention of Treaty Abuse
Over the last few years, Switzerland's Federal Tax Administration (FTA) has won several disputes in connection with the improper use of double taxation agreements. The cases concerned financial derivative transactions for which foreign financial institutions acquired shares in listed Swiss companies in order to minimise or avoid the risks resulting from these agreements, "cum-ex" transactions, the asset management structures of HNWIs, and group structures with intermediate companies that did not have sufficient substance.
The subject of the lawsuits in each case was the refund of the Swiss withholding tax of 35%, which is levied on dividends from Swiss companies. According to the relevant double taxation agreements, the refund requires that the person receiving the dividend is the beneficial owner which means that they are actually entitled to use it. Within the framework of the refund procedure, the person who submits the refund application must provide the FTA with all the information necessary to verify their eligibility for the agreement.
In the respective cases, the complainants were not able to prove that they were the beneficial owners. There are still numerous proceedings concerning the application of the concept of beneficial ownership. These concern, in particular, private equity funds with Luxembourg intermediate companies and other foreign Collective Investment Funds. In view of the case law decided thus far, a successful assertion of the claim for reimbursement, will be contingent upon the complainant's ability to demonstrate, in a precise and comprehensible manner, what risks they have assumed regarding the financial transactions entered into, or what personnel resources they actually had for the management of these risks.
The issue of treaty abuse will become even more important in subsequent years because Switzerland has introduced the principal purpose test (PPT) as part of the conclusion of the MLI and the revision of many double taxation treaties. According to the PPT, a treaty advantage must be denied where obtaining it was one of the main reasons for the chosen arrangement or transaction. In such cases, the DTA can only be invoked if it can be shown that the granting of the contractual advantage is in accordance with the meaning and purpose of the corresponding provision of the double tax agreement.
It is currently difficult to assess, to what extent the PPT will further tighten the already strict practice of the FTA, with regard to the granting of agreement benefits. Indeed, it is true that the FTA has indicated on various occasions that the introduction of the PPT will not bring about any significant changes to current practice. However, it should be noted that the PPT is part of the BEPS minimum standard, the implementation of which will be subject to peer review by the Inclusive Framework. This could increase the pressure on the FTA and other state authorities to apply the PPT more strictly, which could, in turn, trigger new tax proceedings. Hence, legal uncertainty remains with regard to tax treaty entitlement. As a consequence, companies are recommended to provide sufficient substance to their respective intermediate companies in compliance with the transfer pricing guidelines, and to document them accordingly, so that they are prepared for challenges by the tax authorities in the form of tax audits.
Due to the comparatively moderate corporate rates in Switzerland, the transfer prices of multinational companies have not been the focus of Swiss tax authorities in the past. However, there are various indications that the previous reluctance of the Swiss tax authorities to review transfer prices, will change.
In 2019 the FTA established the Transfer Pricing Competence Centre, which is affiliated to the External Tax Audits Department. According to the FTA, the aim of this new organisational unit, comprising a pool of transfer pricing experts, is to optimise the pricing environment of transfer pricing in the FTA and become the number one contact in the field of transfer pricing. In the meantime, the Cantonal Tax Administration of the Canton of Zurich has also significantly strengthened its activities in the area of transfer pricing. Current experience shows that the tax authorities are focusing on intangible properties (IP), asset management services and financial transactions when conducting a transfer pricing audit. In addition, the appropriate compensation of foreign distribution companies, such as limited risk distributors and full risk distributors, is also under scrutiny.
From a technical point of view, the following points are of particular interest. The tax authorities follow the substance-over-form approach in the area of transfer pricing. The splitting of risks and functions, which has been accepted by various tax authorities in the past, is increasingly being questioned by the Swiss tax authorities, and critically so, with regard to the revision of the transfer pricing guidelines. Compensation for the assumption of risks that the compensated group company does not manage with its own personnel, is being challenged.
The concept of development, enhancement, maintenance, protection and exploitation of intangibles (DEMPE) – developed by the OECD in the course of the BEPS project and included in the Transfer Pricing Guidelines 2017 – is also used at times by the Swiss tax authorities for IP transactions that were settled before 2017. It remains to be seen, whether the Swiss courts will support this view. In a recent ruling, the highest court apodictically stated that the version of the OECD Transfer Pricing Guidelines to be applied is the one that existed at the time the transaction under review was settled. In other judgments, however, a dynamic approach has been chosen – notably without in-depth discussion – and the current version of the OECD Guidelines has been applied to transactions that were executed at a time when the current version had not yet been published.
In another important ruling, the Swiss Federal Supreme Court held, in favour of the taxpayers, that the tax authorities must recognise the contractual distribution of functions and risks undertaken by group companies, if these were not merely sham structures.
On 11 February 2020, the OECD published their Transfer Pricing Guidance on Financial Transactions, which will undoubtedly influence the audit practice of the Swiss tax authorities. The new guidance covers the transfer pricing aspects of various intercompany financial transactions such as loans, financial guarantees, cash-pooling, hedging and captive insurance companies. This more detailed guidance will support taxpayers as well as tax authorities in analysing these financial transactions and in determining arm’s length prices.
In Switzerland, the Federal Tax Administration’s Circular Letter No 6 (6 June 1997) regarding hidden equity serves as a safe harbour rule, according to which, hidden equity is assumed if a Swiss entity’s intercompany debt exceeds a certain percentage of the market values of the entity’s balance sheet assets. In addition, the Federal Tax Administration publishes annual circular letters providing inbound and outbound safe harbour interest rates. However, these rates often deviate from realistic interest rates, particularly when the debt instrument is subject to a higher risk. The circular letters specify that the interest rate may deviate from a safe harbour interest rate, but the onus is on the taxpayer to prove that the interest rate applied is at arm’s length. Swiss taxpayers who do not wish to apply the Swiss safe harbour interest rate rules will now be in a better position to support the arm’s length interest rate, by referring to the outcome of an OECD conform transfer pricing analysis (performed contemporaneously).
Prevention of Double Non-taxation
The containment of international double non-taxation is part of the BEPS minimum standard. To this end, and as already mentioned, the MLI which came into force for Switzerland on 1 December 2019, provides for the amendment of the preamble of a double tax agreement. Henceforth, the avoidance of double non-taxation, or reduced taxation through tax evasion, or tax avoidance, will be explicitly included in the preamble of a double tax agreement.
In this context, reference should be made to the ruling of the Federal Supreme Court given on 16 December 2019, in the case of the national airline, Swiss International Airlines Ltd. (Swiss Ltd) In general, Swiss companies are not subject to taxation for their profits generated in foreign permanent establishments. Based on this and applying the formulary apportionment method – as is customary for the purposes of inter-cantonal allocation – Swiss Ltd allocated approximately 30% of its profits to its foreign permanent establishments.
The Federal Supreme Court, despite clear statutory wording, which explicitly refers to the rules of inter-cantonal tax law regarding international allocation of profits, ruled that profits must be allocated internationally using the authorised OECD approach (AOA).
In a first step, the Federal Supreme Court argued that the application of the formulary apportionment method used in inter-cantonal tax law could result in double non-taxation.
In a second step, the court went even further: Swiss Ltd was denied the opportunity to detail the amount of profit it could allocate abroad if the AOA were applied. The Federal Supreme Court argued that, under the income allocation rules of most of the double tax agreements, all profits can be taxed where the airline company is resident.
If Swiss Ltd were allowed to shift part of the profit abroad under domestic law, this would result in double non-taxation. The judgment is not convincing from a purely legal perspective. However, it supports the Swiss tax authorities in their efforts to combat tax planning structures that lead to double non-taxation, by means of a dynamic interpretation of the existing tax laws.
Mutual Agreement Procedure and International Arbitration
The implementation of the BEPS measures is likely to increase disputes between taxpayers and tax authorities and the risk of double taxation. In order to counteract the threat of tax obstacles in cross-border economic transactions and to provide taxpayers with legal certainty, the OECD advocates improving dispute resolution mechanisms.
Within the framework of the MLI, Switzerland has committed to adopting the provisions regarding the mutual agreement procedure (MAP) and incorporating them accordingly into its DTAs. This includes, in particular, the obligation to grant corresponding adjustments if an adjustment is made in a contracting state on the basis of a mutual agreement procedure.
In line with the domestic revision procedure applicable to assessments which had already entered into force, Switzerland considers that the initiation of a MAP requires that the request be submitted within a period of ten years from the date on which the assessment to be revised becomes legally binding. Switzerland therefore made a corresponding reservation to Article 16, paragraph 2 of the MLI. In return, it must now be prepared to accept reciprocal provisions within the framework of DTA negotiations, which restrict the time limit for adjustments in the case of affiliated companies or permanent establishments.
The number of MAPs has increased significantly in recent years and the financial impact of these procedures is considerable. Currently, there are more than 320 procedures pending. In more than 10% of cases, an adjustment of the tax base of more than CHF100 million is in dispute. The Federal Council therefore plans to regulate the procedural rules applicable to MAPs in a new federal law, a preliminary draft of which is currently in consultation. In particular, the new law will also regulate the enforcement of mutual agreements by the cantons. In the past, there have been cases in which cantons refused to make a corresponding adjustment based on a mutual agreement, if it was considered that the company subject to tax had acted against good faith. The planned law is intended to establish a general obligation on the cantons to grant corresponding adjustments if a mutual agreement was reached between Switzerland and the contracting state in the framework of a MAP. This will enhance legal certainty and grant the taxpayer better protection from double taxation.
In its international tax policy, Switzerland advocates the inclusion of arbitration clauses, whereby it prefers the "final offer arbitration" method (also known as last best offer or baseball arbitration). Under this method, the competent authority of each member state must submit a proposal for a decision to the arbitration board. In the course of its decision-making process, the arbitration board has to decide in favour of one of the two submitted proposals. In other words, it cannot make a decision that differs from the proposals submitted.
Switzerland has already gained experience with arbitration proceedings in relation to Germany, and it is expected that the trend towards MAP and arbitration will continue in the coming years. In this context, reference should be made to the Protocol of Amendment to the Double Taxation Agreement with the USA, which entered into force on 19 September 2019 and contains a revised arbitration clause. The relevant procedural provisions for the conduct of arbitration proceedings were laid down in an exchange of letters.
Also, according to the DTA with the USA, the arbitration board will take its decision on the basis of the final offer arbitration method. The inclusion of this kind of arbitration procedure in Switzerland’s DTAs with Germany and the USA can be seen as a significant improvement. The procedure is not only more efficient but advantageous insofar that competent authorities will likely take reasonable positions when establishing their last and final offer, knowing that a less reasonable offer implies a higher risk of being denied during arbitration. This leads to a convergence of positions and provides an ideal incentive to the competent authorities to reach a mutual agreement, even before the arbitration procedure is initiated.
Exchange of Information
In 2019 alone, around 5,000 foreign requests for administrative assistance were addressed to Switzerland, with the number of requests expected to increase in years to come.
The distinguishing feature of Switzerland's international administrative assistance in tax matters is that persons who are affected by foreign administrative assistance proceedings can have a judicial review carried out in Switzerland, to determine whether the conditions for granting administrative assistance under the applicable double taxation agreement are fulfilled. As a result, a comprehensive case law on international administrative assistance has developed in Switzerland. Requests for administrative assistance usually originate by way of a tax audit conducted by a foreign tax authority. In addition to HNWIs, MNEs are particularly affected by information exchanges upon request.
Foreign tax authorities frequently request information on the residency of a HNWI with tax nexuses to several countries. If the person is subject to unlimited tax liability in Switzerland, the foreign tax authorities must state in their request that they have reason to believe that the person is also subject to unlimited tax liability in their own country.
Additionally, tax audits relating to both the place of effective management and transfer prices frequently lead to requests for administrative assistance. In practice, we often find that the requesting tax authorities do not sufficiently explain why the requested information is likely to be relevant to the tax assessment. Many procedures also revolve around the question of the conditions under which information on third parties (such as, employees, external consultants, family members and customers) can be exchanged within the context of administrative assistance. Domestic law offers subtle rules in this respect, which must be observed.
As the Federal Administrative Court decided in a recent ruling, requests made to Switzerland by foreign tax authorities compelling a Swiss group parent company to disclose information on legal transactions within the group, in which only foreign group companies are involved, are illegal.
Proceedings are currently pending before the Federal Administrative Court concerning the application of the Ordre Public, if the information can be used by the other state in criminal tax proceedings, which violate the presumption of innocence, enshrined in the European Convention on Human Rights. Similarly, the Federal Administrative Court is currently examining the question of whether a request for administrative assistance lapses if the person affected by the request for administrative assistance has been able to settle the tax dispute amicably with the assessment authorities of the requesting state. This question is relevant, because in most states the requesting authority is not identical to the assessment authority.
The Protocol of Amendment to the Double Taxation Agreement with the USA, which came into force on 20 September 2019, will bring the exchange of information between Switzerland and the USA in line with the OECD standard. The previous restriction on administrative assistance in cases where "tax fraud or the like" was suspected, will now be abolished for both individual and group requests.
Notably, wide-ranging administrative assistance will apply to cases from 23 September 2009 onwards. Group requests within the framework of the Foreign Account Tax Compliance Act (FATCA) agreement will be admissible for matters from 30 June 2014 onwards. Based on the FATCA agreement, the competent US authority may request all information relating to US accounts that the reporting Swiss financial institution would have had to report under a Foreign Financial Institutions Agreement, if it had received a corresponding declaration of consent to do so from the account holder. It is to be expected that on this new basis, Swiss financial institutions will again have to report a large amount of financial information to the USA in the future.
The considerable legislative changes that Switzerland has had to make in the field of tax law as a result of the BEPS project raise various new legal questions. It is therefore to be expected that tax controversy will become even more important in practice in the coming years. Taxpayers will be challenged: due to their legal obligation to participate in the establishment of the tax-relevant facts and circumstances, they must efficiently process and document the elements of the facts that speak in their favour. In complex cases, it will also be of decisive importance to analyse the legal questions that arise in detail and from different angles, in order to be able to present them in a structured, comprehensible and convincing manner to the competent tax authority or court.