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07 September 2007
As the ordinary rates of corporate income tax in Switzerland are low compared to those of some other European countries, Switzerland has become an attractive location for multinational companies. Several such companies have transferred substantial commercial activity to Switzerland in recent years, which has prompted EU member states and members of the European Parliament to complain to the European Commission. The commission has reacted to these complaints and has formally challenged the cantonal corporate tax regimes.
Corporate profits are ordinarily subject to a federal income tax at 7.83% and to cantonal and municipal taxes which range between 6% and 14%. Under some conditions, the following special tax regimes are available at the cantonal but not the federal level. A company can request to be taxed as a holding company if (i) up to two-thirds of its assets consist of participations in affiliated companies or (ii) up to two-thirds of its income stems from such participations. In these cases dividends and capital gains are exempt from tax, as are interest, royalty fees and income from commercial activities. Holding companies pay only the federal tax at the rate of 7.83%, which can be reduced by application of the participation reduction.
Companies that conduct only a minor portion of their commercial activities in Switzerland can request to be taxed as mixed companies. At the cantonal level, these companies are taxed according to the proportion of their business activity performed in Switzerland. Their effective tax burden, federal and cantonal combined, is between 9% and 13%.
'Management companies' are companies that conduct management activities only in Switzerland, and do not carry on any trade or business in the country. They are subject to an effective tax of between 8% and 11%.
The impact of these tax regimes is substantial: approximately 2,000 companies with some 150,000 employees benefit from these regimes. They represent 8% of all corporate taxpayers in Switzerland and include many subsidiaries of Fortune 100 groups with important operations in Switzerland. They account for some 39% of the total proceeds of the federal corporate income tax.
On February 13 2007 the commission rendered a decision that the cantonal tax regimes are in violation of Article 23 of the 1972 Free Trade Agreement (FTA) between the European Economic Community (EEC) and Switzerland.(1) On May 14 2007 the commission obtained a mandate from the European Council to conduct negotiations with Switzerland with a view to abolishing the cantonal tax regimes.
Article 23 of the 1972 EEC-Switzerland FTA reads as follows:
"The following [is] incompatible with the proper functioning of the agreement insofar as [it] may affect trade between the community and Switzerland: any public aid which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods."
While Article 23 of the FTA and Article 87 of the EC Treaty have practically the same wording, they further different purposes: the goal of the FTA is to promote free trade in goods, while the EC Treaty regulates the interior market.
The commission holds that the cantonal tax regimes constitute state aid in violation of Article 23 because they provide for a tax reduction on non-Swiss income. The commission reserves the right to take safeguarding measures provided for by the FTA if the regimes are not terminated within a reasonable time.
The Swiss government's response is that the cantonal tax regimes pre-dated the 1972 FTA and were not challenged during its negotiations. The practice of the commission and the case law of the European Court of Justice on state aid were developed later. As the FTA and the EC Treaty serve different purposes, the case law under the treaty is not applicable to the FTA. The cantonal tax regimes are held not to be discriminatory as they are available to Swiss and non-Swiss taxpayers alike. The regimes do not affect trade in goods between the European Union and Switzerland; unlike state aid, which impedes competition between enterprises, the cantonal tax regimes affect only tax competition between countries. The federal government has stated that taxation is a matter of cantonal sovereignty and that the cantonal corporate tax regimes are not negotiable.(2)
Several outcomes of the dispute are conceivable.
The Swiss government could yield to the pressure of the commission and abolish the tax regimes. This option is unlikely to be realized as it could cause intermediary holding companies, headquarters and IP development companies to leave Switzerland. In addition, substantial research and development functions could also withdraw, resulting in a substantial loss of tax revenue and jobs.
The Swiss government could resist the pressure and maintain the tax regimes already in effect. This option does not seem feasible as the commission is unlikely to relent. If the government acted in this way, it must be expected that the commission would block negotiation of pending bilateral matters important to Switzerland.
The third option is a fundamental revision of the corporate income tax system, consisting of a general reduction of tax rates or the taxation of parts of corporate income. Theoretically, the federal corporate income tax could be abolished in favour of an increase in value added tax (VAT). This could be done by raising the VAT rate from 7.6% to 9%. This would still be substantially below the threshold of 15% within the European Union. Another alternative would be a system where dividends, interest, royalties and commission fees are each taxed at a lower rate. Also, the introduction of a notional interest tax deduction could be considered.
The relationship between Switzerland and the European Union is a hotly disputed matter in Swiss political circles and in the population at large. As there will be parliamentary elections in Switzerland in mid-October, it is unlikely that substantial developments in this matter will occur before that time, at least from the side of the European Union.
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