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 duty 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.
According to the latest report of the SFTA, tax controversies related to corporate income and individual income tax matters raised, in 2019, CHF220 million of additional revenues (including back taxes and fines) at federal level. The amount of such revenue is subject to major variations as it always depends on the tax matters at hand (eg, less than CHF50 million was raised in 2018).
On the other hand, VAT audits conducted by the SFTA increased VAT revenues by CHF142 million and withholding tax audits conducted the SFTA raised less than CHF20 million of additional revenues (including back taxes and fines). Such revenues, depending on the tax matters at hand, are also subject to major variations from one year to another.
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 subsequent disputes.
The latest report from the SFTA indicates that, in 2019, more than 6,000 tax rulings were handled showing the relevance of such advance discussions in Switzerland. Tax rulings filed by taxpayers each year to the various cantonal tax authorities are also of major importance and are frequently used to mitigate disputes on taxes levied at cantonal level.
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 and transfer pricing matters being more strictly reviewed.
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. If a taxpayer considers that an amount of tax is not due, the main recommendation is rather to avoid paying the challenged amount. In the field of spontaneous taxation, in particular VAT matters, any payment of tax is a recognition of taxes owed.
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.
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 once 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 for 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.
The exchange of information, mutual assistance between tax authorities as well as the constant development of international tax rules have certainly led to an increase in 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 subsequently issue a new decision.
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.
The filing of such an administrative complaint is a requisite step before initiating a judicial phase. Under certain circumstances and only if approved by the taxpayer, a sufficiently motivated administrative complaint filed to the tax authorities may be directly transferred to the judicial authorities.
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 a 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 a 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 in writing 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 sufficient 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.
Under criminal tax procedure, the tax authority may use coercive measures (eg, warrants and sequestrations) to gather sufficient evidence against the taxpayer.
Legal analysis and reassessment of the tax administration's position is the most important aspect of tax litigation. While producing new documents, evidence or even expert reports is still possible under judicial proceedings (except in front of the Federal Supreme Court), it is usually more efficient to produce evidence during the proceedings' early stages.
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 the 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. With regard to cross-border and local tax issues, the ECHR's case law is also taken into account, in particular within criminal tax procedures. International guidelines also provide elements of interpretation on which the courts occasionally rely. Tax doctrine (academic articles) is a source of interpretation used by courts, but they are not bound by it.
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 (if provided by cantonal rules) 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 may be appealed to its second-instance court within 30 days following the first-instance court's decision under certain circumstances. The appeal can also be lodged by the tax authority or the taxpayer, or both. Judgments concerning tax matters processed by the Federal Administrative Court may be appealed directly 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 4.1 Initiation of Judicial Tax Litigation and 4.2 Procedure of Judicial Tax Litigation regarding the first-instance cantonal court, as well as 5.1 System for Appealing Judicial Tax Litigation regarding the second-instance cantonal court, the Federal Administrative Court and the Federal Supreme Court. Under these various stages, 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 cantonal court, a judge usually renders his or her decision with the help of two associate judges specialised in tax law. The second-instance cantonal court is usually composed of three professional judges. The composition of cantonal courts may vary depending on the case at hand and local rules.
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 courts do not share the criteria on which they appoint judges to render their decisions.
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 preserve their rights according to Swiss tax law, taxpayers should file a complaint against the relevant tax authority, which will be suspended during the MAP.
Following the initiation of a MAP, certain double tax treaties provide arbitration procedures in tax disputes. After a certain period (from two to three years), taxpayers may request that unresolved questions under the MAP be settled by an arbitration procedure. Such procedure may be denied if a domestic court has already rendered a decision (unlike the initiation of MAPs).
In international tax matters, a MAP may be carried out if the procedure initiated before 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.
The international arbitration process (as part of an initiated MAP) starts with the taxpayer's request. Double tax treaties define the applicable terms of the arbitration process, if available. Requests for tax arbitrations are quite rare in practice.
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 or arbitration procedure (if available), 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 to the 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. Under these same rules, the taxpayer may only request an arbitration afterwards if the competent authorities under the MAP have not reached an agreement within two years after the initiation of a MAP.
Under BEPS rules, an average of 24 months has been set to finalise MAPs. Switzerland committed to this objective in relation to the improvement of dispute settlement as from 2016. According to the latest report of the SIF, the average time taken in Switzerland to finalise an open case in 2019 was 21 months.
There is no appeal possible against the outcome of a MAP or arbitration procedure.
ADR is mostly used in transfer pricing cases. With regard to MAPs, and according to the 2019 statistical report of the competent authority, out of 313 cases filed, 95 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 direct income and equity taxes, the penalty is limited to CHF10,000. For other types of tax, the limit varies as developed below.
Tax evasion related to direct taxes is where the taxpayer, with intent or through negligence, omits certain items in their tax return, or causes a final assessment to be incomplete. If a tax evasion is ruled, 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, where a taxpayer tries to elude taxes, the fine amounts to two thirds of the amount determined for complete evasion. The statute of limitations is six years.
Regarding indirect taxes, where the principle of spontaneous taxation applies, the SFTA can issue additional tax assessments in the event of tax evasion, tax jeopardy or non-compliance with legal requirements (eg, failure to report within the deadline provided by law).
For withholding tax purposes, fines vary from CHF5,000 to a maximum of CHF30,000. The same applies to stamp duties, except that the maximum amount, if it results in a higher fine, can be extended to up to three times the amount of evaded tax.
Under VAT provisions, tax evasion can lead to a maximum penalty of CHF800,000, which is extendable to up to twice the amount of evaded tax. In the event of aggravating circumstances, the maximum penalty is doubled and can lead to imprisonment for up to two years.
Tax Evasion Procedure
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. Under certain circumstances, a criminal process is avoidable if the taxpayer spontaneously announces amounts not dutifully declared to the tax authorities.
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 within the tax authorities' competence.
Tax authorities initiate such proceedings when they suspect that a tax return or final assessment is incomplete, or that self-reporting requirements are missing (under the spontaneous declaration procedure). 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, late interest and the 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 tax misdemeanours, appeal possibilities are the same as explained in 7.4 Stages of Administrative Processes and Criminal Cases, 7.5 Possibility of Fine Reductions and 7.6 Possibility of Agreements to Prevent Trial, if specific deadlines are observed.
For tax offences, an appeal to the second-instance court 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 before the competent authorities.
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.
For Switzerland, the OECD's Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) entered into force on 1 December 2019. As Switzerland follows the amending view, the implementation of new standards on dispute resolution to avoid double taxation (MAPs and arbitration) require, following internal procedures, a modification of double tax treaties. As only a few Swiss double tax treaties have been amended bilaterally, no impact has yet been observed regarding the use of international remedies by taxpayers. In recent years, MAPs on transfer pricing issues have continued to increase.
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.
Under the principal purpose test (PPT) introduced by the MLI, the scope of anti-avoidance rules is broader than the previous applicable rules developed by the Swiss Federal Supreme Court. It is thus expected that additional controversial issues will be raised between tax authorities and taxpayers. As the interpretation of the PPT is broadly discussed among scholars, Swiss tax courts will probably have to clarify the application of the PPT.
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, will, in practice, apply 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. Consequently, taxpayers in practice increasingly request MAPs.
Advance pricing agreements may be used in the context of rulings (see 6.4 Avoiding Disputes by Means of Binding Information and Ruling Requests) to avoid or mitigate transfer pricing matters.
With regard to APAs, and according to the 2019 statistical report of the competent authority, out of the 272 cases opened, 105 were filed during 2019. Their number increased compared to the 2018 statistical report.
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 this respect, transfer pricing policies as well as transfer of assets and functions within multinational groups are under increasing scrutiny from the Swiss tax authorities.
In general, a ruling is the most effective way to prevent litigation under Swiss tax law and to prevent the risk proactively.
Under the Swiss double tax treaties, arbitration clauses are currently not always provided for and, if available, rarely used.
As part of the MLI, Switzerland has accepted to apply part VI to its amended double tax treaties (see 8.1 Mechanisms to Deal with Double Taxation).
When an arbitration clause is available, double tax treaties concluded by Switzerland do not limit access to specific matters but may require the fulfilment of certain conditions (eg, no binding decision rendered by a domestic court of one of the states involved in the cross-border dispute).
Under the MLI, Switzerland has reserved its right to replace the two-year period provided with a three-year period before authorising the initiation of arbitration.
Switzerland prefers the baseball arbitration procedure, a method also known as "final offer arbitration", under which a proposal is submitted by each competent authority of the relevant state to the arbitration panel. The arbitration panel is then bound and has to decide between the two proposals.
This methodology is preferred by Swiss authorities as it stimulates reasonable proposals from the various competent authorities involved and eases dispute settlements. It is currently available under the double tax treaty with the USA, and the double tax treaty with Germany.
Switzerland is not an EU member state but is actively involved in the recent developments made by the OECD.
As mentioned above, Switzerland implemented the MLI as part of the BEPS recommendation of the OECD and accepted the inclusion of binding arbitration clauses under its amended double tax treaties (see 8.1 Mechanisms to Deal with Double Taxation).
Apart from a constant growth in the use of MAPs, the initiation of an arbitration process within a cross-border tax disputes is still rarely seen in practice. According to the 2019 statistical report of the competent authority, out of the 313 cases opened under MAPs, 226 were closed. It is expected that the implementation of binding arbitration clauses under double tax treaties may ease the settlement of disputes under MAPs, as competent authorities may prefer to avoid binding decisions from an arbitration court.
The Swiss competent authorities do not publish decisions related to international settlement of disputes, which are confidential to ensure a framework of compromises between the competent authorities of various states.
Switzerland benefits from a wide tax treaty network, currently being renewed following the recent entry into force of the MLI. Such network is thus the main source of legal instruments used by the competent Swiss authorities to settle international tax disputes (see also 8.1 Mechanisms to Deal with Double Taxation).
Taxpayers are not part of the international tax arbitration process they initiate (see 6.2 Settlement of Tax Disputes by Means of ADR) and thus, are not able to hire any independent professionals to engage in arbitration discussions. They are, however, able to hire such professionals to be their representatives as well as initiate the procedure on their behalf and at their own costs.
Competent authorities, as part of the arbitration procedure, are usually able to designate at least one representative to the arbitration board. According to the set of rules provided by the relevant double tax treaty, independent professionals may be designated due to the competent authorities' inability to appoint their own employees.
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 at an early stage 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, including the arbitration procedure, 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 indicates that this Court processed, during 2020, 348 cases in tax matters. Additional statistics on the values dealt with are not available.
The latest report available from the Federal Administrative Court indicates that this Court processed, during 2020, 106 cases in tax matters. Additional statistics on the values dealt with are not available.
In 2020, the Federal Supreme Court processed 252 cases for direct taxes, none for stamp duties, 30 for indirect taxes, nine for withholding tax, none for military tax, six for double taxation, 49 for other taxes and two for tax exemption. Additional statistics on the values dealt with are not available.
In 2020, the Federal Administrative Court processed 30 cases for customs, one case for direct taxes, 59 for VAT taxes, two for various indirect taxes, 12 for withholding tax, none for double taxation and one for miscellaneous finance. Additional statistics on the values dealt with 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.
As a location of numerous multinational companies and a leading financial centre, Switzerland is particularly affected by international developments at the level of the OECD and the Inclusive Framework on BEPS.
On the one hand, the Swiss companies of multinational enterprises (MNEs) are exposed comparatively often to foreign unilateral, bilateral or multilateral tax audits. In order to strengthen legal certainty, Swiss taxpayers therefore have a particular interest in concluding advance pricing agreements (APAs) or conducting mutual agreement procedures (MAPs). The Tax Treaty Implementation Bill, which is currently being discussed in the Federal Parliament and is expected to be passed this year, contains important new procedural provisions for the initiation, implementation and enforcement of MAPs, which are likely to be applied analogously to APAs. The following article therefore takes a look at these new procedural provisions, which are expected to enter into force on 1 January 2022.
On the other hand, the Swiss tax authorities are also under pressure to take measures to protect the Swiss tax base. In this context, the focus is particularly on combating treaty abuse and profit shifting with the use of low -tax companies. Important developments have also occurred in this regard, which are explained below.
Bill on the Implementation of International Tax Agreements
Given the importance of APAs and MAPs for MNEs conducting business activities in Switzerland, it is surprising that important domestic procedural issues are still not statutorily regulated in Switzerland. The Bill on the Implementation of International Tax Agreements aims to remedy this situation and thus also increase legal certainty. It will regulate the application and the conduct of MAPs as well as the implementation of mutual agreements into domestic law. The law is also to apply, mutatis mutandis, to APAs.
The MAP is, essentially, a procedure between the competent authorities of two or more states. Formally speaking, the taxpayers affected by the MAP are not parties to the proceedings. Accordingly, they have no procedural rights, which is criticised in the international discussion around them. This also applies to MAPs in which Switzerland is involved due to the framework of the treaty law. As a consequence, the taxpayers have no right to inspect the files of the proceedings. According to the current state of discussions, however, the taxpayers concerned should be granted the right to be heard as far as possible. In concrete terms, this means that the State Secretariat for International Financial Matters (SIF), ie, the Swiss authority responsible for conducting the mutual agreement procedure, must provide the taxpayer applying for a MAP with information on the status of the procedure. However, the right to be heard also gives the applicant the opportunity to comment on the position papers of the states involved in the procedure. In this way, the applicant can indirectly influence the technical argumentation of the SIF. In principle, Switzerland does not participate in joint audits. In the context of a MAP or an APA, SIF is, however, authorised, with the consent of the person making the request, to conduct an inspection together with the competent authority of the other state if this serves to establish the facts.
The implementation of mutual agreements sometimes leads to difficulties in practice. Various states require the payment of compensation in the framework of a secondary adjustment when a profit adjustment is made (primary adjustment). According to the practice of the Federal Supreme Court, such a payment is generally regarded as a constructive dividend on which a withholding tax of 35% must be paid according to the domestic withholding tax law if it is made to a foreign parent or sister company. However, the practice has now been relaxed for those cases in which the refund was made on the basis of a mutual agreement. However, there are situations, in practice, where no mutual agreement is reached and, as a consequence, the 35% withholding tax becomes due if a compensatory payment needs to be paid. This is the case when the competent authorities cannot agree on a mutual agreement. There are also situations in which a foreign tax audit is concluded by a unilateral mutual agreement, in which the taxpayer undertakes to forego a subsequent mutual agreement procedure.
The planned Tax Convention Implementation Act now brings some relief: already, under current practice, double taxation that has arisen due to a primary adjustment made abroad can be eliminated by a unilateral agreement concluded between SIF and the canton responsible for the assessment. The planned law now explicitly states that a compensation payment made on the basis of such a unilateral agreement is also exempt from withholding tax. However, a corresponding adjustment granted autonomously by the cantonal tax authority without involving the SIF will not protect the taxpayer from withholding tax in the future if the foreign state demands a compensation payment. The same applies with regard to subsequent taxes owed by a foreign company if these are charged to a Swiss subsidiary or sister company.
BEPS Action 14 (Minimum Standard) requires that MAPs be implemented independent of domestic limits. However, Switzerland has made a reservation in this regard. The Bill on the Implementation of International Tax Agreements will oblige the competent cantonal authority to implement a mutual agreement, provided that the request for implementation of the mutual agreement procedure is submitted within ten years of the issuance of the ruling or decision that relates to the matter of the implementation ruling. The legislature rejects the restrictive view of some cantonal tax authorities that the obligation to implement a mutual agreement expires ten years after the ruling or decision that caused the double taxation was issued.
Abusive Tax Treaty or Tax Rule Shopping
Swiss withholding tax also poses a risk in the case of a cross-border sale of shares in a company domiciled in Switzerland. Due to the different bilateral provisions in the double taxation treaties, the withholding tax burden might be lower in the buyer's country of residence than in the seller's country of residence. Under certain circumstances, it may therefore be possible to reduce the withholding tax burden by means of a cross-border sale of participations. The FTA has therefore developed various practices to prevent sales and restructurings motivated by the reduction of the residual withholding tax burden. As a consequence, the FTA regularly checks whether a transfer of shares could result in the loss of Swiss withholding tax base. Due to this tax audit focus of the FTA, the sale of a Swiss company by means of a share deal must always be examined with regard to its retained earnings which are subject to deferred withholding taxes. This examination is an important component of every tax due diligence.
Probably the most prominent doctrine in this regard is the so-called "old reserves practice" applied by the FTA. This aims to deny the application of the lower withholding tax rate of the country where the buyer is resident on a dividend distribution subsequent to the acquisition of a company. The sale of an equity interest can take place either between related group companies or independent third parties. It is irrelevant whether the target company is sold to a Swiss or a foreign company. The only decisive criterion according to the FTA is the improvement of the buyer's refund position under the applicable tax treaty or the domestic withholding tax code as a result of the sale.
International transposition and proxy liquidation
Doctrines related to the old reserves practice are, amongst others, the so-called “international transposition” and the “proxy liquidation”, as they also counter the abusive refund of withholding tax in international corporate acquisitions.
International transposition involves an intra-group sale (excluding sales to independent third parties) to a Swiss buyer, whereby the purchase price is left standing by means of a loan to the previous participation holder and is amortised over time, free of withholding tax, through loan interest payments. The interest on the loan is financed from the dividend distributions of the target company.
In the case of a proxy liquidation, the refund of withholding tax is denied if the economic objective of the transaction was not a share deal but an asset deal. The decisive factor here is that the intention of the seller – to bring the company or its assets into a liquid form after the sale or to absorb the company in its entirety – was already clear at the time of the sale. The existence of a proxy liquidation can only be established by means of indications such as a prompt liquidation after the transaction and the absence of economic reasons for the share deal.
In practice, the withholding tax issues concerning the retained earnings of a Swiss target company quite often lead to controversies with the FTA and must be clarified in a ruling before the transaction is carried out for reasons of legal and planning certainty. As a result, cases are very rarely the subject of court proceedings. An important point of discussion with the FTA is often whether the intended share deal leads to an abuse of treaty or tax avoidance. In this regard, there were two cases concerning the old reserve practice before Swiss court authorities last year.
Recent old reserve practice cases
The Federal Supreme Court decision of 20 April 2020, 2C_354/2018, deals with the Irish A Co, which is a group company of the world's largest manufacturer of coffee machines. In 2005, it acquired shares in the Swiss F Co from its Dutch sister company E Co. F Co distributed various dividends in the years 1999 to 2003, for which E Co requested a full refund of the withholding tax based on the Swiss-Dutch Double Tax Treaty. However, the FTA refused to refund 15% of the withholding tax. It took the view that the Swiss participation was acquired without any economically motivated reason from a company resident in the Netherlands Antilles that was not entitled to any treaty relief.
Two years after F Co was sold to A Co, the former distributed a dividend to A Co in the amount of CHF14 million. Based on Article 15 paragraph 1 of the Savings Tax Agreement (now Article 9 paragraph 1 of the Agreement on the Automatic Exchange of Information with the EU), A Co applied for a full refund of the withholding tax. This was refused by the FTA.
The Federal Supreme Court supported the FTA. In its analysis, it referred, on the one hand, to the Denmark cases decided by the ECJ (C-116/16 and C-117/16) and, on the other hand, to the current OECD commentary on the principal purpose test (PPT). According to this, there is abuse if obtaining a more favourable tax position was one of the main purposes of the transaction or arrangement concerned and granting the treaty benefit would run counter to the object and purpose of the relevant treaty provisions. The Supreme Court explained that it has already previously followed the treaty abuse standard as expressed in the PPT in its case law on the unwritten prohibition of abuse. Taking the Federal Supreme Court at its word, the PPT brings nothing new to Swiss practice. In particular, it applies regardless of whether it is contained in a double tax treaty. Thus, Switzerland has already de facto implemented the minimum standard according to BEPS Action 6 on treaty abuse, even though not all DTTs have been revised in this regard yet. The question now is which criteria are to be applied for the existence of treaty abuse to be manifest, and what legal consequences result from this.
The Federal Supreme Court ruled that the transfer of the shareholding in the Swiss company was not motivated by economic reasons. It found evidence of this in the fact that A Co employed neither staff nor had business facilities in Ireland. In addition, A Co had to borrow heavily from its parent company in order to acquire B Co, especially as it did not have any liquid assets. According to the Federal Supreme Court, it would have been simpler and would have led to the same economic result if B Co had distributed its retained earnings to its then parent company in the Netherlands before the transfer and A Co's sister company had thus received the retained earnings through dividends instead of through a purchase price payment.
Based on this consideration, the company was completely denied the refund of the withholding tax. According to previous practice, which is also covered by the case law of the Federal Supreme Court (ruling of 16 August 1996, 2A.11/1994), the old reserves practice is actually only aimed at denying the taxpayers the effective tax savings that they tried to obtain through the transaction. Based on the Federal Supreme Court ruling, this practice should still apply despite the latest court ruling. However, as a consequence of the new court ruling, the recipient of a dividend charged with withholding tax should base the refund claim on the relevant bilateral DTT rather than on the agreement on the automatic exchange of information between Switzerland and the EU.
The second case, A1795/2017 of 1 December 2020, is currently pending before the Federal Supreme Court and was first heard by the Federal Administrative Court, the second-last instance in Switzerland. The case concerned a Swiss operating company active in the fiduciary sector, which was sold by its parent company resident in a non-Swiss DTT state to a Swiss company. The sale took place between independent third parties on 31 December 2004. At the time of the sale, B Co had distributable retained earnings of CHF636,174.
When, five years later, B Co distributed a dividend of CHF820,300 to its parent company A Co in 2010, the FTA refused to refund the withholding tax to the extent of the old reserves (thus to the extent of CHF636,174) on the grounds that there was tax avoidance and that the distributable, nonoperating substance should have been distributed before the sale (thus an application of the old reserves practice).
The Federal Administrative Court did not back the FTA's argumentation and the appeal of A Co was upheld. The Federal Administrative Court could certainly recognise an economic interest in the purchase of B Co. Particularly as A Co had already acquired and developed operationally active companies in the fiduciary sector in the past, it did not seem outlandish that the liquidity and retained earnings of B Co were of additional interest. Moreover, when acquiring B Co, A Co had undertaken to continue its business at least until the end of the year of acquisition and, due to profitable business activities, had even continued its operations until 2008. In addition, the time span of more than five years between purchase and distribution argued against the abusive nature of the transaction. Also, no unusual financing of the purchase price had taken place by the seller company.
The fact that tax avoidance was denied in this case shows that case law requires a differentiated practice regarding old reserves. Contrary to the opinion of the FTA, it is not sufficient for the existence of tax avoidance that the transferred company has distributable retained earnings. The ruling was appealed by the FTA at the Federal Supreme Court and the highest court ruling is still pending. The signal effect of a Federal Supreme Court ruling confirming the lower court's considerations would be very significant for taxpayers, especially since the tax authorities would therefore be instructed to examine the economic motives in M&A transactions more closely before concluding that there has been an abuse of rights.
Controlled Transactions with Low-Tax Companies
The Swiss tax authorities and courts have always critically examined transactions with low-tax companies. Whereas, in the past, the tax authorities examined offshore companies primarily from the perspective of the place of effective management or general anti-avoidance rules, today the focus is more on transfer prices. Various important findings have emerged from the Federal Court rulings handed down in the last two years.
According to the Federal Supreme Court in 2C_343/2019, the OECD Transfer Pricing Guidelines are also applicable to transactions with offshore companies that are not resident in a DTT country. The version applicable should be the one that was current at the time of the taxation periods in question. The Federal Supreme Court reiterated that the tax authority has to prove that the remuneration paid by the taxpayer was not proportionate to the services provided by the related group company. In addition, the Federal Supreme Court, emphasised the importance of the comparability analysis – in which, according to the OECD, five comparability factors have to be taken into account – to demonstrate that the transactions used for the benchmark analysis were, in fact, uncontrolled transactions to which the intra-group transactions were comparable. However, in its ruling of 20 December 2019 (2C_1073/2018, 2C_189/2018), the Federal Supreme Court did not conclude that the tax administration acted unlawfully solely due to the fact that it took comparables from 2013 and 2014 although the tax audit concerned the financial years 2003–2010. According to the justices, the taxpayer should have specifically explained why the figures from 2013 and 2014 led to a disproportionate level of compensation. However, it failed to do so. Recent cases also remind taxpayers that the violation of the arm's-length principle may constitute a tax evasion if it also entails a breach of the accounting principles.
The practice of recent years shows that the Swiss tax authorities have obviously targeted controlled transactions between Swiss companies and foreign low-tax companies. There are still other cases in the pipeline which may be brought before the courts. When analysing the recent case law, it becomes apparent that the Swiss tax authorities and courts are continuously expanding their knowledge in the area of transfer pricing. The tax authorities are also not reluctant to conduct criminal tax investigations. In the case of transactions between Swiss companies and those domiciled in low-tax countries, it is therefore important to clearly regulate the transfer prices in contracts and to back them up with OECD-conforming transfer pricing analyses. Due to recent rulings by the Swiss Federal Supreme Court, the Swiss tax authorities are particularly careful to check whether the contractually agreed rights and obligations are actually exercised. If not, there is a risk that the tax authorities will ignore the contracts and challenge the applied transfer pricing approach.
Switzerland has made a major effort in recent years to bring its tax legislation in line with the minimum standards set by the OECD and the Inclusive Framework on BEPS. The regimes for holding companies, mixed companies and domiciliary companies as well as the special profit allocation rules for principal companies developed in practice were abolished as of 31 December 2019. Instead, the legal framework for a patent box and a super-deduction for research and development were introduced. With the tax reform, the statutory average profit tax rates have fallen from around 19.6% to around 14.5%. If a company makes full use of the new tax incentives for research and development, it can even reduce the effective tax burden to below 10%. In an international comparison, Switzerland thus remains an attractive location for multinational companies in terms of taxation. However, a fundamental paradigm shift has taken place. Whereas prior to the corporate tax reform, income from foreign business activities of companies that had little substance in Switzerland was taxed at a privileged rate, today, it is those companies that carry out research and development activities with high added value in Switzerland with their own staff that benefit from preferential tax regimes.
Those who believed that the implementation of the internationally recognised minimum standards would bring legal and planning certainty to Switzerland are now seeing themselves deceived. Until the launch of the two-pillar project, the mantra was that profits should be taxed where the value creation actually takes place. The OECD and the Inclusive Framework on BEPS now intend to fundamentally soften this principle for large multinational corporations in two respects:
In addition, the mobility of international employees, which has been increased by the possibility of "remote working", is likely to arouse new desires and lead to new focal points in tax audits. If one considers the international developments outlined above and takes into account the huge government deficits caused by the COVID-19 pandemic, it can be stated without further ado that the international battle for tax base is about to enter the next round. Needless to say, these developments will also result in an increase in cross-border tax disputes.