The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
June 23 — Switzerland, a sophisticated, mountainous nation of 8 million already attractive to U.S. tax directors seeking a European jurisdiction for their group intellectual property, is likely to maintain its competitive position in the post-BEPS world.
Switzerland reacted to the final guidance under the Organization for Economic Cooperation and Development's project to combat base erosion and profit shifting by passing comprehensive corporate tax legislation. The two houses of the Swiss Parliament—the National Council and the Council of States—passed the Corporate Tax Reform Act III on June 17.
Likely to take effect in 2019 or 2020, the legislation would permit cantons to significantly reduce their corporate tax rates and adopt both a patent box and a “super deduction” for research and development. The outcome for multinational companies is likely to be an effective Swiss tax rate of about 10 percent.
If the Swiss Social Democratic Party collects 50,000 signatures, an up or down referendum vote will be held—likely in the spring of 2017 (see related story).
Switzerland has many advantages beyond tax. It has a highly educated workforce, an excellent transportation infrastructure, a practical regulatory environment, good transportation infrastructure and a high standard of living.
The World Economic Forum's global competitiveness report for 2015-16 ranked Switzerland third on IP protection and the world’s most competitive country for the seventh year in a row.
However, no picture is perfect. Switzerland is the most expensive European country in which to do business, so U.S. companies with Swiss European headquarters are under pressure to move their decision makers to lower-cost European countries, such as Ireland, Poland and the U.K.
In recent interviews with Bloomberg BNA, practitioners from the Big Four accounting firms discussed what benefits Switzerland's finely calibrated corporate tax overhaul would offer U.S. groups, and the benefits of the country's current tax regime. They also addressed non-tax factors.
With the demise of Bermuda and other zero-tax jurisdictions as viable locations for group IP—one result of the OECD's sweeping project to combat tax base erosion and profit shifting—U.S. groups are looking to locate their IP in jurisdictions that are less likely to trigger an audit of the transaction by the home country.
Not surprisingly, the BEPS mantra of “substance, substance, substance” is the key factor for U.S. companies locating group IP in Switzerland, meaning they will need to carry out enough activities in the country to be able to defend their structures.
“Having adequate economic substance in relation to intangible assets is key in a post-BEPS environment—irrespective of the jurisdiction,” Thomas Semadeni, an international tax partner in Ernst & Young LLP’s New York office, told Bloomberg BNA. “Thus, this is not only important for Switzerland but for any other country that adheres to existing or new OECD standards.”
Switzerland, he added, generally follows the revised OECD transfer pricing guidelines.
Benjamin Koch, partner for transfer pricing and value chain transformation at PricewaterhouseCoopers in Zurich, said more U.S. executives are moving to Switzerland in an environment where companies are sure to be asked, “Where are your value-adding significant people functions for logistics, manufacturing, R&D, production, sales and marketing?”
Al Sonander, a tax partner at KPMG LLP in New York, said in light of recent trends in tax legislation, structures without business substance are likely to fail to deliver intended tax benefits.
Semadeni said the new legislation will align the Swiss corporate tax system “with new international standards in order to strengthen the attractiveness of Switzerland as a business location in a post-BEPS world.” Scheduled to take effect as early as 2019, proposed features include:
Sonander said the tax advantages of choosing Switzerland “include a low tax rate and a respectful tax audit environment.”
Geneva's 24 percent tax rate includes both the cantonal and federal tax rate, Koch noted. Geneva plans to reduce its tax rate to 13 percent, he said.
Given the reductions that have been announced in other cantons, “we are now talking about total tax rates—federal and cantonal—in the range of 12 to 16 percent, without even taking into account a special tax regime,” the PwC practitioner said.
While special regimes could further reduce these rates by a substantial amount, “an effective tax rate below 10 percent may become difficult to achieve,” he added.
Koch said he expects a referendum vote on the Corporate Tax Reform Act III in the spring of 2017 and that the legislation likely will be effective in 2019 or 2020.
The June 17 tax overhaul legislation includes an OECD-compliant patent box and a super deduction for R&D, both to be implemented at the cantonal level.
Under the R&D super deduction, Koch said, “if you invest one Swiss franc in innovation, you can deduct one Swiss franc and 50 cents.”
Once the IP generates a return, the patent box would apply to net profits, which would be taxed at a reduced rate. Practitioners estimated the final effective tax rate under the patent box would be between 8 percent and 13 percent.
Koch said that, depending on the canton, companies can expect an effective tax rate of 10 percent to 13 percent.
Diego Weder, Swiss tax desk leader at Deloitte Tax LLP in New York, said the proposed patent box could produce effective taxes rates of 8 percent to 10 percent. Further, he said, “amortization and leveraging can further reduce the ETR of the patent box to as low as 1 to 3 percent, similar to the current ‘mixed company' regime.”
The mixed-company regime gives preferential tax treatment to international companies that are predominantly engaged in business abroad.
Koch said 10 percent seems to be the “lowest effective tax rate generally accepted internationally.” In Austria, he noted, royalties or interest paid to any company with an effective tax rate below 10 percent aren't deductible under a rule implemented in 2014, and he said it will be interesting to see whether other countries or multilateral organizations such as the European Union adopt similar ideas.
If 10 percent is the generally accepted minimum, Koch said, it “remains to be seen whether a 6.25 percent Irish patent box regime, which may in the end lead to an ETR of below 10 percent, will remain sustainable from an international perspective.”
Others pointed to benefits in Switzerland's existing tax regime. Of those, certainty was seen as one of the most important.
Both Semadeni and Rene Zulauf, an international tax partner at Deloitte in Zurich, noted that Switzerland is a rulings-based jurisdiction, able to give companies legal certainty in advance about new structures, one-off transactions and reorganizations.
Switzerland has 115 tax treaties, including the EU-Swiss tax agreement, which aren't subject to the EU rules on “state aid” that preclude favorable tax treatment for individual companies, Semadeni said. Swiss companies also wouldn't be subject to the proposed EU Anti-Tax Avoidance Directive or anticipated EU rules to require public country-by-country reporting of tax and profits.
According to Semadeni, additional advantages of the current Swiss tax regime are:
Koch said companies currently may set up principal, mixed-company and holding company structures in Switzerland. Once the new legislation enters into force, these structures will be abolished, “but until then, these tax regimes are still valid and widely used,” he said.
Semadeni said only one Swiss canton currently has an IP box regime. A Swiss IP holding company is typically taxed under the mixed-company regime given that its business activity is primarily related to business abroad. A similar tax treatment applies to Swiss principal companies and most other international companies domiciled in Switzerland. The tax rate depends on the company’s location and facts, but generally ranges from 8 percent to 11.5 percent on net income before tax. The effective tax rate can be significantly lower when taking into account potential IP amortization.
Regarding structures that a multinational group may consider using in placing its IP in a Swiss entity, Semadeni said that in Switzerland, IP ownership is often combined with “the centralization of entrepreneurial functions, activities and risks in a Swiss principal, or regional headquarters company.”
As a result, numerous large U.S. multinationals have their European headquarters in Switzerland, with hundreds or thousands of employees who oversee and control the business activities within the supply chain.
Semadeni said typical offshore IP structures, such as double Irish or “CV-BV structures,” are hardly seen in Switzerland given that the tax rates for Swiss principal companies are already competitive.
“In a post-BEPS world, in which the tax structure must be fully aligned with the business operations, the further consolidation of value-creating functions in a tax-favorable jurisdiction such as Switzerland should be considered,” Semadeni said.
If a company owns the IP and funds the further development of the IP, it is critical that the entity also performs or controls the important value-creating functions of developing, enhancing, maintaining, protecting and exploiting the IP—the so-called DEMPE functions.
Sonander said outright ownership of IP works best for a multinational group considering placing its IP in a Swiss entity.
Weder said Switzerland’s mixed-company regime currently allows for “an IP company in Switzerland, with amortization and leveraging effect, to achieve an effective tax rate of as low as 1 to 3 percent.” The mixed-company regime will remain in effect until it is abolished as part of the Corporate Tax Reform Act III, probably in 2019 or 2020.
Koch said choosing the canton for the multinational group's activities typically depends on three elements: the tax rate, the availability of employees and “where the CEO wants to go.”
Many companies choose a particular cluster where prospective employees have the requisite skills for their industry, Koch said. “Commodity traders gravitate to Geneva and Zug. In the wider Lucerne and Zug area, there is a cluster of medical technology and pharmaceutical companies; the canton of Basel has a cluster of pharmaceutical companies too, including Novartis and Roche,” he said. “The fashion industry is located in the canton of Ticino.”
Zulauf said that because of the corporate tax regime overhaul, many cantons in 2019 or 2020 are likely to significantly reduce their effective tax rate—including federal, cantonal and communal taxes—to between 12 percent and 14 percent. Zug will reduce its effective tax rate to about 12 percent, Schaffhausen to 12.5 percent, Geneva to 13 percent, Fribourg to 13.72 percent, Vaud to 13.8 percent and St. Gallen to between 12 percent and 14.5 percent.
Cantons such as Appenzell IR, Appenzell AR, Lucerne, Nidwalden, Obwalden and Schwyz “already today have very low effective tax rates for companies of between 12 percent to 14 percent,” Zulauf said.
The requirements and preferences of each multinational company for choosing a canton are different, Zulauf said. Some companies prefer the main economic centers of Zurich and Geneva. Others prefer cantons with the lowest tax rates, such as Zug, Lucerne or Schwyz, or cantons that are known to offer tax holidays, such as Schaffhausen, St. Gallen, Neuchatel or Vaud.
Sonander said Zug's attractive features include proximity to Zurich.
Of course, multinational groups consider factors other than tax when deciding where to locate a foreign entity.
Zulauf said Switzerland is an important center for commodity trading activities as well as for innovation in the life science, information and communications, technology, mechanical and electrical engineering, and “clean technology” industries.
Switzerland is an “internationally renowned location for headquarters of multinational enterprises,” Zulauf said. The country has a strong infrastructure and a high standard of living, with three cities in the top 15 under human resources consulting firm Mercer LLC's 2016 quality of living worldwide city rankings. Zurich is ranked second, Geneva is eighth and Berne is ranked No. 14.
Semadeni listed other features likely to attract multinational groups to Switzerland:
Koch said Switzerland’s biggest European competitors for U.S. group IP include Ireland, which has the advantage of being an English-speaking country with strong familial ties to the U.S. The country also has a headline corporate tax rate of 12.5 percent, a generous research and development credit, a new knowledge development box and robust protection of IP rights (24 Transfer Pricing Report 1759, 4/28/16).
The U.K. is another attractive location for placing a central European hub, Koch said. From a U.S. perspective, a 17 percent headline tax rate is appealing, and the U.K., like Ireland, is an English-speaking country. However, the U.K.’s diverted profits tax will give companies pause.
As for other locations, Koch said the Benelux countries—Belgium, the Netherlands and Luxembourg—“at least in the past” were attractive.
Semadeni listed Switzerland’s main competitors for inbound investment in Europe as “typically the Netherlands, Luxembourg, Ireland and the U.K.” He predicted Switzerland would gain ground against those countries as headline tax rates become more of a determining factor.
“We are in a transition phase in which internationally accepted preferential tax practices will decline, and low statutory tax rates will gain more importance,” Semadeni said.
Switzerland's European competitors have one advantage in that they are cheaper places in which to conduct business. Switzerland is the most expensive European country in which to operate, with higher costs for staff than Ireland, Poland or the U.K.
As for executives, Koch said, “there is almost no difference in cost” of hiring them in Switzerland versus in the U.S.
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