Update

Tax Proposal 17*: Council of States gets things on track


* meanwhile the National Council has followed - with minor exceptions - the proposal by the Council of States and the reform package has been approved with clear majority by both Parliamentary Chambers on 28 September 2018.

On 7 June 2018, the Swiss Council of States made substantial changes to the Federal Council’s Tax Proposal 17 (TP17; see Disclose issue 27 for more details) to assure this important reform of political support from both left and right. Now it is the National Council’s turn. The second chamber of parliament is unlikely to make any great changes when it debates the proposal in its autumn session. Since there is pressure from the EU and things now have to move fast, the process of reconciling the differences between the two chambers of parliament and approving the package have also been scheduled for the autumn session. At the same time, various cantons have issued their plans for consultation so that they will be ready for a successful implementation at the beginning of 2020. In this article, we describe the major changes made by the Council of States and give an overview of the current status of implementation plans in the cantons.



Armin Marti

Armin Marti

Partner, Leader Corporate Tax Services, PwC Switzerland

The major parties are agreed that changes to the corporate tax system are crucial for the sake of Swiss competitiveness. Switzerland must act quickly, not least because of pressure from abroad. To avoid being blacklisted and EU countermeasures, it has to abolish tax regimes deemed by the international community to be harmful. New, internationally recognised mechanisms are needed to keep this country attractive as a place to do business. Otherwise, general corporate income tax rates would have to be reduced to considerably less than the cantons had previously anticipated, which would make the reform massively more expensive.

It is clear that good tax reform needs to be accompanied by compensatory measures to ease the social impact. After all, the previous proposal, Corporate Tax Reform III (CTR III), was rejected by voters in February 2017 after resistance from the left. Figure 1 shows the amendments to TP17 in comparison with CTR III proposed by the Federal Council, plus the changes brought forward by the Council of States.

Figure 1: An overview of the key measures under Tax Proposal 17
TP17 Measures Corporate tax reform III Dispatch on draft law bill by Federal Council State council
Date of communication 17.06.2016 (rejected in public vote 12.02.2017) 21.03.2018 07.06.2018
Patent box
(cantonal level, mandatory)
R&D incentive (super-deduction)
(cantonal level, optional)
Taxation of hidden reserves
(two rate approach)
Maximum relief for all measures 80% 70% 70%
NID
(federal and cantonal level, mandatory)

NEW: optional on cantonal level for cantons with high tax rates (currently, only the Canton of Zurich would fulfill the criteria to introduce this measure)
Capital tax
(possibility to reduce the capital tax base with equity related to investments, patents and loans to group companies)

(possibility to reduce the capital tax base with equity related to investments and patents)

NEW: in addition to investments and patents, possibility to reduce the capital tax base with equity related to loans to group companies
Partial taxation of private dividend income 70%
NEW: 70% on federal, min. 50% on cantonal level
Increase of child allowances
(by CHF 30)
Increase of social security contributions
NEW: increase of social security contributions by 0.3% (split equally between employer and employee)
Increase of cantonal share in direct federal tax revenues
(from 17% to 21.2%)

(from 17% to 21.2%)

(from 17% to 21.2%)
Amendment regarding capital contribution reserves
NEW: 50% proportionality rule for tax exempt repayment of capital contribution reserves for companies quoted at Swiss stock exchange with exemptions for relocations and distributions within multinational groups (to safeguard attractiveness of Switzerland for foreign investments)
View figure

The following core elements of the reform remain unchanged:

  • Abolition of cantonal tax regimes (special arrangements for holding, domiciliary and mixed companies) and abolition of the rules applying to federal tax for principal companies and companies known as Swiss finance branches

  • Mandatory introduction of a patent box by the cantons in line with the OECD standard

  • Optional introduction of a special cantonal deduction for research and development

  • Transitional rules for hidden reserves (with the cantons now permitted to bring them into force earlier)

  • Introduction of a limit on the maximum tax relief enabled by the new mechanisms mentioned above (known as maximum overall tax relief, but reduced to a maximum of 70% of net profit taxable at the cantonal level)

  • Increase in the cantons’ share of revenues from direct federal tax.

These measures were discussed in detail in Disclose 27 in the article Tax Proposal 17: The second attempt has to work!

The main changes introduced by the Council of States are as follows:

Contribution to funding the AHV/AVS system

The Council of States held that the Federal Council’s proposal to raise the minimum child and education allowances by CHF 50 was insufficient. The SP (Social Democratic Party), the winner of the CTR III vote, called for more. To meet this demand the suggestion was made that each franc in tax revenues lost as a result of the reform should be offset by a franc of additional funding for the old age and survivors insurance scheme (AHV/AVS). To compensate for an estimated CHF 2 billion in lost tax revenues, the rates for AHV/AVS contributions on pay are to be increased by 0.3% overall, and a portion 1% out of VAT proceeds are to be redirected to the old age insurance fund. This would direct another CHF 2 billion or so into the AHV/AVS.

The measure has come in for criticism because it lacks an intrinsic connection with the issue of corporate taxation. For this reason, the National Council will look into the question of whether the two different topics can be combined in one bill. The AHV/AVS reform failed at the first vote because of resistance from the political right. Regardless of how the combination of AHV/AVS and corporate tax reform is viewed, the current situation sends out a positive signal, demonstrating the willingness of all parties to reach a political agreement to avoid delaying urgently needed tax reform any longer.

Amendments to the capital contribution principle

The capital contribution principle entered into force at the end of 2010 after Swiss voters had accepted CTR II by a very narrow majority in February 2008. The capital contribution principle not only allows the withholding and income tax-free repayment of contributions paid into the nominal capital by the owners of an entity, but also, on a systematic and appropriate basis, of contributions paid by shareholders into the reserves (capital contribution reserves). The entity is also free to decide whether it pays dividends to shareholders from taxable retained earnings or tax-free capital contribution reserves. With the abolition of what was, by international standards, a very heavy tax (35% withholding tax) on capital contribution reserves, the introduction of the capital contribution principle not only remedied a systemic shortcoming in Swiss corporate tax law, but also eliminated one of Switzerland’s major disadvantages for foreign investors. Numerous listed companies moved to Switzerland as a consequence.

After the narrow result in the vote, the political left repeatedly criticised the Federal Council for, in its belief, failing to make transparent allegedly massive losses in tax revenues resulting from the introduction of the capital contribution principle. For this reason, the left has long repeated its call for limits on the principle – even though a look at the development of withholding tax revenues in the years since its introduction fails to reveal any visible losses.

The Council of States has made a further concession to the left in the form of a modification to the capital contribution principle: the introduction of a so-called proportionality rule when reserves and earnings are repaid to their owners. Under this rule, companies listed on the Swiss exchange will, in future, have to pay half of their dividends out of retained earnings, and half out of capital contribution reserves. This means that whatever happens, 50% of a distribution will now become subject to withholding tax and recognised for income tax purposes.

To avoid damaging Switzerland’s attractiveness for foreign investors, by way of exception the proportionality rule does not apply to capital contribution reserves originating from abroad or which already existed before an entity relocated to Switzerland. This exception is to apply to capital contribution reserves created since the entry into force of CTR II on 1 January 2011. The idea is to ensure that legitimate expectations are met and that Switzerland remains a reliable destination for foreign investment.

However, there is a technical error in the way the exception to the proportionality rule has been designed, an error which the National Council will have to remedy. Because so many companies relocated between 2008 and 2010, shortly after the Yes vote to CTR II, on the strength of the introduction of the capital contribution principle in its present form and as accepted by Swiss voters, the exception must be extended to cover the period from the date of the CTR II referendum. It would not be logical to subject the first wave of companies that relocated after the capital contribution principle was accepted in 2008 to worse tax treatment than those that came to Switzerland after 2011.

Changes to partial taxation of private capital gains

As a compensatory measure, the Federal Council wanted to raise the previously lower partial taxation of private dividend income to 70%. This would mean that in the future, 70% of private dividend income would have to be subject to taxation at federal, cantonal and municipal level. Up till now, only 50% of a dividend has been taxable at federal level and in certain cantons the percentage is even lower. There had been considerable resistance to this rule among shareholders in SMEs and family businesses.

Against this backdrop, the Council of States decided that at least 50% of private dividends must be subject to tax at the cantonal and municipal level in the future. The Council of States has endorsed the Federal Council’s proposed increase to 70% for federal tax. On a nationwide basis this takes us closer to the principle of legal-entity-neutral taxation, which requires that the choice of legal entity for business activity (partnership or incorporated company) not be distorted by considerations of tax burden. The arrangement the Council of States has opted for still leaves the cantons a fair amount of freedom to incorporate this principle in their implementation of the rule.

Relief on cantonal capital tax

The Council of States has reversed the Federal Council’s proposal to limit (in comparison with CTR III) the admissibility of relief on cantonal capital taxes to participations and patents, and is again allowing this relief to be extended to inter-company loans – at the express wish of the cantons. This way the cantons can largely avoid having to increase the tax on capital burden on companies that previously benefited from tax regimes.

Notional interest deduction

The Council of States also took account of the canton of Zurich’s concerns and reincorporated the notional interest deduction (NID), completely abandoned by the Federal Council, in the proposal – but only as a ‘Lex Zurich’, in other words a special arrangement for high-tax cantons and limited to cantonal taxes.

The notional interest deduction is designed to enable the Canton of Zurich to prevent a great deal of financing activity from leaving the canton (and Switzerland). As the largest contributor to the national fiscal equalisation scheme, the Canton of Zurich had been vigorous in its demands for an NID, as Zurich is unable to fund more than a modest reduction in its corporate income tax rate. Not only that, but a closer analysis of the NID in the Canton of Zurich revealed that this mechanism would probably not just help prevent the departure of a comparatively large number of finance companies from the Canton of Zurich, but would also result in considerable increases in tax revenues.

It is to be hoped that the notional interest deduction is not just reserved for the Canton of Zurich, and that the National Council sets the yardstick for what constitutes a ‘high-tax’ canton somewhat lower. This way, at least a handful of cantons would qualify for this optional mechanism at cantonal level.

Cantons prepare for implementation

On the basis of the Federal Council’s dispatch, various cantons have already begun preparing to implement the new arrangements in their tax legislation. Some of them have released their implementation plans for consultation. The main concern is about deciding on optional relief measures and the scale of such relief. Another aspect of the cantons’ implementation of the proposal will be any reduction in cantonal corporate income tax rates and adjustments to the tax on capital. Figure 2 gives an overview of the planned parameters for implementation in the cantons.

Figure 2: Planned implementation of Tax Proposal 17 in the cantons (as of 5 June 2018)
Canton Patent box R&D super-deduction Special rate on realised hidden reserves Step-up practice Maximum relief for all measures Effective corporate income tax rate after TP17 (Capital of Canton) Effective corporate income tax rate before TP17 Dividend taxation of individuals
AG 90% 50% Yes 70% 18.17% 18.61% 70%
AR 30% – 50% 50% Yes 50% 13.04% 13.04% 70%
AI 30% No 2.00% No 50% 12.66% (for non-distributed profits) 14.16% 70%
BL 90% 20% from 2020: 2.2% from 2023: 2.56% (max.) Yes 50% 13.45% (planned:18%: 2020–2022; 15.9% 2023–2024, 13.45% as from 2025) 20.70% 70%
BS 90% No 3% Yes 40% 13.04% 22.17% 80%
BE open Yes Yes open 16.37% 21.64% 70%
FR 90% 50% No 20% 13.91% 19.86% 70%
GE 10% 50% 6.5% No 9% 13.79%/13.49% 24.16% 70%
GL open No Yes No indication 12.43% 15.70% 70%
GR 70% No Yes 70% 14.02% 16.12% 70%
JU 90% 50% No 60% 17.48% / 15.40% 20.66% 70%
LU 10% No 1.48% Yes 20% (excl. Step-up) 70% (incl. Step-up) 12.32% 12.32% 70%
NE 10% – 20% 50% No 10-20% 12.5% – 13.5% 15.61% 70%
NW 80% open Yes 70% 12.05% – 12.66% 12.66% 70%
OW 80% 50% Yes 70% 12.74% 12.74% 70%
SG 50% 50% 1.68% No (Merk-postenlösung) 50% 15.20% 17.40% 70%
SH 90% No (for first 5 years) 1.00% Yes 60% / 70% 12.09% 15.97% 70%
SZ 90% 50% 1% or 1.67% Yes 70% 14.43% (scenario reduction) or 12.51% (scenario unitary rate) 15.19% 70%
SO 90% 50% 2.20% Yes 50% 13.00% 21.38% 75%
TG 40% No 1.40% Yes 50% 13.40% 16.43% 70%
TI 90% 50% (likely) 3%/4% (likely) Yes 30% (likely) 16.72% 20.55% 70%
UR 30% No 1% Yes 50% 12.51% 14.92% 70%
VS 90% 50% No 34% 12.66% / 15.61% 21.56% 70%
VD favourable favourable No favourable 14.00% 21.37% 70%
ZG 90% 50% 1.18% – 2.36% Yes 70% 12.03% 14.51% 70%
ZH 90% 50% 1.15% Yes 70% 19.7% /18.19% 21.15% 70%
View figure

Figure 3 shows the planned reductions in effective corporate income tax rate (ETR) and the range of lowest ETRs possible with relief under the reform. The differences stem from the fact that each canton opts for a different maximum relief threshold, and not all exploit the maximum room for manoeuvre. Companies engaged in research and development and selling products protected by patent stand to derive particular benefit from the lower tax rates, as do companies that have benefitted from special tax regimes until now. However, the latter will only benefit during a transitional phase (generally from five to a maximum of ten years) unless they also have R&D activities in Switzerland or generate revenues with patented products.

Figure 3: Planned reduction in effective income tax rate (ETR) and ETR possible with maximum relief in the various cantons (correct at 17 May 2018)
Cantons 0% 5% 10% 15% 20% 25% Zurich Argau Ticino Bern Solothurn Valais Jura St. Gallen Schwyz Grisons Vaud Basel-Land Fribourg Neuchâtel Geneva Thurgau Appenzell Ausserrhoden Basel-Stadt Nidwalden Obwalden Appenzell Innerrhoden Uri Glarus Lucerne Schaffhausen Zug ETR with maximum relief with TP 17 measures Ordinary tax rate (effective) announced according to Tax Proposal 17 (as per Federal Council Dispatch of 21 March 2018) Ordinary tax rate (effective) in 2018 Note: Certain cantons have announced a range of possible rates. The graph shows the least favourable rates. It may be necessary to take account of additional specific cantonal arrangements regarding relief and other measures.
View figure

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Armin Marti

Armin Marti

Partner, Leader Corporate Tax Services, PwC Switzerland

+41 58 792 43 43

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