Swiss residents are generally taxed on their worldwide income. In order to prevent or reduce a potential double tax burden that would otherwise arise when passive income such as dividends, interest or royalties is taxed by both the resident and the source state from which the income is derived, Switzerland's double tax treaties generally allow non-recoverable foreign withholding taxes to be credited against the Swiss income tax imposed on the respective income. The details concerning the tax credit provided for in the applicable double tax treaties were set out in an ordinance which has been significantly amended with effect from 1 January 2020.
Traditionally, Switzerland followed the credit method for mitigating double taxation in case of dividends, interest or royalty payments. The respective domestic ordinance implementing the credit system stemmed from the 1960s and was outdated for various reasons, including as follows:
- Since the 1960s the double tax treaties have contained further provisions in which a residual source tax is foreseen. For instance, a few Swiss tax treaties contain a residual source tax in case of pension payments and some treaties contain a provision on technical services following Article 12A of the United Nations Model Tax Convention which also provide for a non-exclusive source taxing right.
- The old ordinance contained specific rules concerning tax regimes such as the holding regime or the mixed company regime which had expired by the end of 2019.
- Some Swiss cantons introduced new tax measures such as research and development super deductions, patent boxes and notional interest deductions which also required amendments to the credit system.
- Political initiatives required an expansion of the tax credit for permanent establishments of foreign companies in Switzerland in order to be competitive.
Therefore, the drafting and publication of the new ordinance (SR 672.201) allowed for the consideration of various developments and the modernisation of the Swiss tax credit system.
Key features of new credit regime
Who has access to a tax credit?
As has always been the case, both individuals and corporate taxpayers have access to a tax credit if they are resident in Switzerland. However, since 1 January 2020, permanent establishments of foreign companies have also been granted a tax credit concerning source taxes withheld abroad. According to Article 2a(1) of the ordinance, a permanent establishment of a foreign company may request a tax credit if there is a double tax treaty between:
- Switzerland and the resident state of the company;
- Switzerland and the source state of the income; and
- the resident state of the company and the third state (ie, the source state of the income).
Which income is in scope of the new tax credit?
A tax credit is possible on:
- dividends;
- interest;
- royalties;
- income from technical services; and
- pension income.
However, no tax credit is granted if the income is exempt in Switzerland – for instance, for dividends from qualifying participations (ie, above 10% of the share capital or a fair market value of more than one million of the participation). Such dividends are de facto tax exempt in Switzerland and, therefore, the taxpayer has no access to a tax credit as no double taxation need be mitigated. Needless to say, the taxpayer must fulfil the requirements for the application of the double tax treaty.
How high is the tax credit?
The starting point for the calculation of the tax credit is the source tax withheld in the other state in line with the double tax treaty. However, the tax credit is limited to the amount of tax due on the income subject to source taxation in the other state (the 'maximum amount').
One of the most important changes in the new ordinance relates to the calculation of this maximum amount. The ordinance foresees a 'per basket limitation'. This means that for each of the income categories (ie, dividends, interest, royalties, income from technical services and pensions), the maximum amount must be calculated separately. Moreover, there is a separate calculation for the maximum amount for royalties benefiting from the patent box.
Until 31 December 2019, Swiss tax practice followed an overall limitation (ie, the domestic tax due on all income subject to source taxation). Therefore, there were no baskets for the different income categories. This new per basket limitation might have negative consequences for taxpayers receiving different income categories subject to source taxation.
Within the baskets, applicants must calculate the actual domestic (corporate) income tax amount due in order to determine the maximum amount. Therefore, applicants must allocate the costs relating to the income received in order to define the net tax base subject to (corporate) income tax in Switzerland. To do so, interest, other costs and tax-effective deductions need be considered. The ordinance foresees some lump-sum deductions (eg, 50% of the gross income in case of royalties not benefiting from the patent box and 5% in the case of interest and dividends). However, both the taxpayer and the authorities have the right to apply the actual costs if they are significantly higher or lower than the lump-sum amounts.
Costs that have an economic link to the income received are also relevant. This means that, for instance, costs to develop a patent need not be considered if the taxpayer does not yet receive income from exploiting such patent. The question of which costs relate to the income subject to source taxation might trigger difficulties in practice, particularly if a certain expense is both necessary to generate income subject to source taxation and income not subject to source taxation.
Once the net tax base is determined, the maximum amount is the applicable (corporate) income tax on such a net tax base.
Tax credit and specific tax deductions
On 1 January 2020, many Swiss cantons introduced a research and development super deduction, a patent box or a notional interest deduction. However, the Federal Tax Harmonisation Act provides for an overall limitation of these benefits of 30% of the corporate income (ie, the tax base must be at least 70%). All three instruments are designed as additional deductions (ie, even a taxpayer applying the patent box receives an additional deduction). Therefore, these deductions also reduce the net income for the calculation of the maximum amount of the tax credit. In practice, it is challenging to allocate these deductions (and the overall limitation) to a specific income category. The new ordinance provides for a formulary allocation of the deductions.
The new ordinance on the tax credit system provides welcome amendments such as an extension of the scope of application to Swiss permanent establishments of foreign companies and other amendments concerning the calculation of the maximum amount. In contrast, other new features introduced in the ordinance, such as the per basket limitation, may have a negative effect on taxpayers.(1)
Endnotes
(1) Further information on the new regulation (in German) is available here.
