Overview of the 50/50 Practice in Switzerland

Transcription

1 Stephan Baumann Overview of the 50/50 Practice in Switzerland Instrument to determine a corporate taxpayers tax basis Switzerland offers a wide range of privileged taxation schemes on cantonal/communal income tax level. The 50/50 practice, which works both for federal income and cantonal/communal tax as well as for withholding tax, is not a «tax incentive» but an administrative instrument to determine a corporate taxpayer s tax basis. A newly issued circular of the Federal Tax Administration (FTA) confirms the application of the 50/50 practice for federal income and withholding tax. 1. Introduction to the 50/50 Practice Switzerland offers a wide range of privileged taxation schemes on cantonal/communal income tax level. No taxation privilege is applicable for federal income tax or its statutory rate of 8.5% on income after tax (resulting effective income tax rate on income before tax: 7.8%). Over years the Federal Tax Administration has accepted a lump sum expense on certain kinds of business activities, which reduce tax basis subject to the standard federal income tax rate. In the end such lump sum expense may result in a substantially lower effective income tax. Considering a domiciliary company privilege for cantonal/communal tax and application of the deemed expense for federal tax, an overall income tax rate of approximately 3.9% is achievable; a mixed company status on cantonal/communal level lifts the effective income tax rate to approximately 5.1%. Lump sum expenses became known under the term «50/50 practice». It is a tool regularly used in qualifying transactions. The 50/50 practice, which works both for federal income and cantonal/communal tax as well as for withholding tax, is not a «tax incentive» but an administrative instrument to determine a corporate taxpayer s tax basis. The application of the 50/50 practice is highly controversial as some terms are not defined but may only be cleared through advanced rulings with the competent tax administration. A newly Stephan Baumann, Dr. oec. publ., dipl. Steuerexperte, Partner, Deloitte & Touche, Zürich issued circular [1] of the Federal Tax Administration (FTA) confirms the application of the 50/50 practice for federal income and withholding tax /50 Practice How and When it Works 2.1 General Concept and Requirements The 50/50 practice was first developed for foreign owned corporations active in international trade. Such Swiss corporations typically had no or very limited infrastructure, no employees or any other substance or nexus to Switzerland. The corporation typically acted as reinvoicing company on behalf of a foreign parent company, which took advantage of Switzerland s treaty network and its favorable taxation schemes. Based on their foreign activities the companies were granted tax privileges on cantonal/communal level and were typically taxed as domiciliary companies [2] or as mixed companies [3]. The place of actual business activities of a Swiss reinvoicing company is outside the territory of Switzerland. From its trading activities the Swiss reinvoicing company renders significant gross profit, whereas based on the limited local infrastructure only marginal domestic costs are incurred. Following Swiss tax and law practice companies have to substantiate that expenses are business related for them to be tax deductible. Reinvoicing companies are often unable to prove or substantiate that the total amount of expenses, such as «management fees», «provisions» or «support services», is business related because no proper do- Der Schweizer Treuhänder 10/02 941

2 cumentation of foreign incurred costs or transfer prices is available. According to domestic tax law the authorities may estimate the correct income basis in cases where no proper documentation is available. Under the 50/50 practice, the FTA estimates the expenses of reinvoicing companies to 50% of gross profit. Resulting net income is only to be reduced by marginal administrative costs [4] and direct taxes. In effect, Swiss authorities accept that 50% of gross profit qualify as commercially justified expense and may be paid to related or unrelated parties or offshore accounts with no further explanation. This guarantees fair and equal treatment of qualifying corporate taxpayers. Lump sum expenses under the 50/50 practice are both accepted for federal income and withholding tax. Two grounds support the rationale behind an estimated 50% expense assessment: The first argumentation path is based on domestic tax law, which exempts foreign branch income from Swiss taxation. As all added value of a Swiss reinvoicing company is incurred outside the territory of Switzerland, one could argue that this is to be treated as a deemed foreign branch or permanent establishment. Consequently, the allocable foreign income is to be exempt. A second argumentation path follows the idea that effective place of management of Swiss Co. is abroad. This leads to a situation where Switzerland only has the right to impose withholding tax due to legal base, but no income tax. Determination of taxable income is based on the materially correct income statement of the statutory accounts. All expenses need to be accounted for in the appropriate financial statement in order to be accepted. Some cantons, as assessing authority for both federal as well as cantonal/communal income tax, relaxed from this requirement in 50/50 practice situations. Thus, it is not always required to account for the deemed 50 % expense in the statutory books of a Swiss base company but separate tax books guarantee a lump sum deduction. Although a break with Swiss tax law, this is accepted in some cantons. Deferred Swiss withholding tax, which is based on statutory accounts, is not 942 Figure 1 Typical calculation of a reinvoicing company exploiting the 50/50 practice Foreign Co. Trading turnover Cost of goods sold ( ) Gross profit Lump sum/non-specified deduction according 50/50 practice* ( ) Actual administrative expenses ( 60000) Swiss taxes payable** (~11%) ( ) Profit after tax; tax basis Effective tax rate on all income tax levels = / = 5.1% reduced through separate tax books accounting. Mixed companies [5] carrying out limited business activities in Switzerland are subject to ordinary income tax on the domestically incurred income (determined either in an objective or proportionate calculation). Domestically earned financial income or income from trading activities in Switzerland, therefore, do not benefit from a 50 % deemed deduction. Foreign X X X X Switzerland Swiss Co. X X X X Foreign purchases sales * Accepted as business related expenses ** Tax rate based on ordinary federal income tax rate (7.8% effective) and privileged cantonal/communal taxation under mixed company regime A distinction needs to be made between the 50/50 practice and fiduciary activities. In a 50/50 practice transaction, gross profit generated on trading activities legally and economically belongs to the Swiss company. The relevant issues are determination of the correct income tax basis for such trading activities and how to define taxdeductible expenses. On the other hand, in fiduciary transactions, legal and economic owner of profits routed through a Swiss company is a third party typically a foreign person [6]. Consequently, in a fiduciary structure, the trust company is to receive a commission usually defined as a percentage of the values held or managed by the trust company [7]. The distinction between the 50/50 and the fiduciary concept is decisive in important court decisions [8] where Swiss corporate taxpayers claimed a fiduciary relationship with a foreign third party, leaving only a marginal taxable income in Switzerland; the FTA instead only allowed a 50 % deduction of gross profit. Most cases were decided in favor of the FTA, primarily because the taxpayers were unable to demonstrate the existence of Der Schweizer Treuhänder 10/02

3 a fiduciary relationship. Payments made in excess of the 50 % deemed deduction are considered constructive dividends to related parties and as such are subject to a 35 % withholding tax [9], which needs to be borne by the foreign recipient [10]. Circular No. 9 of December 19, 2001 provides some decisive information on how to handle the 50/50 practice and gives guidelines on its applicability through various examples. The new circular has identified the following characteristics of the 50/50 practice: Uncertainties consist if expenses are business related; as a compromise the 50 % deduction may be applied. In cases where the Swiss corporate taxpayer does not accept the 50/50 practice, justification for each and every business expense must be proved [12]. «The 50/50 practice is not a tax incentive but an administrative instrument to determine tax basis.» Key figure in calculating the 50 % deemed deduction is gross profit, which is determined as trade turnover (net after rebates, debtor losses etc.) less costs of goods sold. In real life «costs of goods sold» is not one expense item but may consist of various items such as paid prices for the goods, provisions to non-related third parties, contract manufacturing fees, advertisement charges and so on. As there are no clear guidelines on what is to be included in the item «costs of goods sold», the concept at gross profit is inseparable from cost of goods sold. The company may not have substantial infrastructure (i.e. offices, employees etc.) except in cases where it conducts foreign transactions on behalf of non-swiss persons besides its active domestic activities. It is only applicable if the corporation acts on behalf and in the interest of a foreign person who determines all relevant elements of the business such as product, pricing, advertising and distribution channels. The corporation may be held by foreign or Swiss shareholders [11]. Figure 2 Correction mechanism following the 50/50 practice on claimed fiduciary structures Statutory books Margin of trading business/gross profit 2% of turnover Agreed fiduciary fee: 0.2% of turnover Trading turnover: Trading income Expenses to the beneficiary ( ) Actual administrative expenses ( 20000) Swiss taxes payable (~11%) ( 18000) Profit after tax Correction according to 50/50 practice Trading income = gross profit Lump sum deduction according ( ) to 50/50 practice Actual administrative expenses ( 20000) Swiss taxes payable (~11%) ( 98000) Profit after tax; tax basis Hidden dividend distribution % Swiss withholding tax on hidden dividend distribution Although not explicitly requested in the circular, FTA tends to oblige the Swiss corporation to distribute a portion of its yearly earnings in form of a dividend to its shareholders [13]. Consequently, the FTA implies such requirements when signing ruling requests. It is clearly stated that there are no strict rules on how to apply the 50/50 practice but that circular No. 9 is to be used as a guideline for easy to assess situations. Specifically, the circular does not define the term «gross profit». Obtaining advanced tax rulings on critical or aggressive 50/50 concepts is recommended. 2.2 Use of 50/50 Practice for Service and Intellectual Property Activities Service Companies In general the FTA also accepts the 50/50 practice for service companies which do not have an own organization. However, FTA scrutinizes the calculation of «gross profit» even more. The following calculation is used: Service fees received Service fees paid = Net service fees = gross profit Lump sum deduction; 50/50 practice Actual domestic expenses paid Swiss taxes payable = Profit after tax; tax basis Acceptance of paid service fees require that: The beneficiary of paid out service fees must have rendered actual services at arm s length prices. Service fees may be paid only through the official route to the do- Der Schweizer Treuhänder 10/02 943

4 micile of the beneficiary and not to any corporation domiciled or bank accounts in tax haven countries. If service fees are not paid to individual persons but to corporations, the ultimate beneficiary/individual person needs to be identified by disclosing his residence and address. The amount of service fees received by the Swiss corporation has to be scrutinized as well, in order to avoid unjustified profit transfers from a foreign jurisdiction to Switzerland. In cases where the service company has an own organization, defined as significant infrastructure and a number of employees who have and commonly execute decision authority, the concept of a lump sum deduction according to the 50/50 practice is overruled by regulations covering active service companies, which perform activities on behalf of foreign group companies [14]. According to those regulations the active service company is to account for a minimum taxable income which is based on a cost-plus 5% method. Applying those provisions the following formula is used: A 80 % deemed deduction may conflict with the Swiss measures against treaty abuse [16]. Such measures imply a base erosion, a thin capitalization and a minimum dividend distribution test in cases of non-active IP Co. s which receive treaty benefited income. According to such base erosion test, only 50 % of the treaty benefited income may be expensed to non-qualified persons. A non-qualified person is any ultimate beneficial owner of such charges with non-domestic tax residence. According to the measures against treaty abuse the maximum 50 % pay-out charge also applies to depreciation of intellectual property assets acquired from non-qualifying foreigners. Royalty income received from non-treaty countries may be expensed up to 80% in the form of a lump sum deduction and/or amortization of IP assets. The circular s 1998 amendment introduced besides others an active company test, which overrules the base erosion and the minimum distribution requirements. The new circular defines an active trade of business as a profit oriented operation in the field of production, trading or the providing of services through own employees, conducted in own office premises. The proof of an active business operation needs to be furnished by the claimant. There is some debate as to whether the active company test as stipulated in the measures against treaty abuse [17] conflicts with the definition of a service company with own organization [18]. Tax planning opportunities may arise if for purpose of the measures against treaty abuse, the active company test is fulfilled, whereas for federal income and withholding tax purposes, the IP Co. is not regarded to have an own organization and consequently is not active in that sense. In such a qualification mismatch a deemed deduction of up to 80% may be achieved. To avoid the crucial issue of withholding tax on non-justified expenses/hidden dividend distribution the concept Figure 3 Possible use of a Swiss IP Co. combined with 80/20 practice Service fees paid + Actual domestic expenses paid + Swiss taxes payable = Costs of Swiss Co. + Mark-up of 5 %; tax basis = Minimum service fee Europe Hold Co. X X X X Swiss IP Co. IP Companies and IP Branches FTA accepts both for federal income and withholding tax a lump sum deduction of up to 80 % in intellectual property structures [15]. Crucial item is the definition of gross profit. Questions arise whether the activated IP asset represents a prepaid license right. If this holds true, the IP amortization should be a deductible service fee of Swiss IP Co. As a consequence, gross profit would decrease significantly. There are no guidelines on this issue. 944 Value of IP assets Useful life 5 years Treaty benefited royalties /years Swiss measures against treaty abuse not appliable as «active» in the sense of the measures Calculation Royalty income Necessary depreciation («Prepaid IP expenses») ( ) Gross profit Lump sum deduction according 80/20 practice ( ) Actual administrative costs ( 50000) Swiss taxes payable (~11%) ( ) Profit after tax; tax basis Effective tax rate on all income tax levels = / = 1.9% Der Schweizer Treuhänder 10/02

5 of a Swiss IP Branch offers a possible solution. Swiss branches are not subject to withholding tax; they are not eligible for treaty benefits [19]. Consequently, a Swiss IP Branch neither falls under the scope of Swiss withholding tax nor under the measures against treaty abuse. Therefore a deemed 80 % deduction should be achievable. If the jurisdiction at the location of the foreign corporation/head office[20] exempts allocable income of the Swiss IP branch, a very competitive overall tax rate may result. 2.3 VAT Treatment of the 50/50 Practice A newly issued practice release [21] specifies that expenses accepted for income tax purposes following the 50/50 practice are accepted for VAT purposes as well. Deductions according to the 50/50 practice are considered to be a supply for services from abroad. The Swiss recipient company must pay VAT tax on the receipt of such services if it either has opted for VAT registration or in a course of a calendar year receives services (including payments under the 50/50 practice) for more than from enterprises with their domicile outside Swiss territory. 2.4 Compatibility of the 50/50 Practice with Domestic and International Efforts against Tax Fraud and Criminal Actions Domestic Regulations In 2001 Switzerland adopted the OECD convention on combating bribery of foreign public officials [22]. Expenses for bribery to public officials are tax-wise non-deductible. The 50/50 practice, which is a practical tool to determine tax basis, should not be used to circumvent the anti-bribery provisions. Bribing public officials is a crime and is taken very seriously by the Swiss authorities. The tax authorities have a task force to investigate suspicious cases to ensure that the 50/50 practice is not misused to support criminal behavior. Information Clause in Double Tax Treaties and OECD Model Tax Convention Exchange of information which is necessary for carrying out the provisions of the double tax treaties and, upon request, of the provisions of the foreign domestic law concerning tax fraud in «Enhanced through hybrid structures, the 50/50 practice is an effective tool to minimize and defer income taxes of a multinational corporation.» relation to taxes, which are subject to the treaty, may be exchanged [23]. The term tax fraud is generally defined as a fraudulent conduct, constituting a tax offence, which can be punished with imprisonment in the foreign state as well as in Switzerland. The 50/50 practice does not prevent from prosecution in cases of tax fraud. International Mutual Assistance in Criminal Matters Mutual legal assistance in criminal matters is ensured through international agreements [24]. The basis for mutual legal assistance in criminal tax fraud matters is the proceeding serving to investigate criminal offences. Assistance is provided under the provision of reciprocity and dual criminality. The 50/50 practice does not shelter from international criminal prosecution. 3. Summary Multinational corporations may take advantage of Switzerland's international business and favorable tax treaty network and low rates of taxation, enhanced with the 50/50 practice to reduce the tax base subject to income tax. If properly structured and implemented through an international hybrid structure, the 50/50 practice is an effective instrument to minimize and defer the income tax of a multinational company. This may be specifically beneficial in situations where the Swiss company serves as a front due to treaty restrictions. Obtaining an advance ruling from the tax administration ensures the benefits of a 50/50 practice and results in competitive tax savings. Notes 1 Circular No. 9 issued December 19, 2001: «Fifty-Fifty-Praxis bei der Verrechnungssteuer und der direkten Bundessteuer». 2 Domiciliary company status is granted by all cantons in Switzerland. A domiciliary company is a Swiss corporation managed from abroad that, apart from its registered offices and the Swiss directors who formally represent the company, has no offices, employees or activities of any sort in Switzerland. Generally, a domiciliary company has its registered office with an agent or a lawyer who administers the company. Overall effective income tax of a domiciliary company is 7.8%. 3 A mixed company has a minor activity in Switzerland and is allowed to have an office and employees as opposed to a pure domiciliary company. Most of the cantons limit the volume of domestic transactions and some cantons require that the transactions of the company have only an auxiliary function for a closely connected company abroad. The overall effective income tax rate of a mixed company is approximately 11%. 4 Marginal was defined as per year and was changed in the mid-nineties to a «reasonable» amount for domestically incurred costs for the board of directors fee, accounting and audit. As a reinvoicing company should only have a limited infrastructure in Switzerland, accepted expenses are still limited but are no longer tied to an absolute amount. 5 Based on statements of the Federal Tax Administration, 50/50 situations involving mixed companies in any case are only accepted if advanced rulings are approved. 6 Fiduciary activities need to be marked in the accounts of the fiduciary company or must be shown as off-balance transactions/assets. Based on a leaflet issued by the Swiss Federal Tax Administration in October 1967, fiduciary transactions are only accepted if written fiduciary contracts executed at the time of starting the fiduciary activities were put in place. 7 The federal memorandum of October 1967, which is still in force, stipulates that the minimum remuneration to the trust company should amount to 0.2% on the first 10 Mio. of value, 0.15% on the second 10 Mio. value and 0.1% on the value exceeding 20 Mio. 8 For instance: BGE/Supreme Court Judgment dated , in: ASA 58,516ff; BGE dated , in: ASA 60,492ff; BGE dated , in: ASA 60,558ff; BGE , in: ASA 68,746ff; BGE dated , in: ASA 65,397ff. 9 Withholding tax risks are the main concern when setting up 50/50 structures as withholding tax authorities only sporadically audit Der Schweizer Treuhänder 10/02 945

6 corporate taxpayers. Withholding tax is a selfassessment tax; tax risks may take years until they are questioned by the FTA. On the other hand, income tax is a lesser issue as the corporations in most cases are almost fully tax exempt on cantonal/communal level and direct federal income tax is assessed regularly by the competent authorities. 10 If the foreign recipient is not in a position to or does not pay the Swiss withholding tax of 35% the tax itself will be added back as a constructive dividend, thus leading to an effective Swiss withholding tax of 54% of the hidden dividend distribution. Circular no. 9, through the attached calculation examples, opens interpretations whether the usually followed direct beneficiary approach or the new triangular approach for withholding tax refund is to be applied in 50/50 transactions (see FTA Circular dated February 2001). 11 If Swiss owned, the Swiss resident shareholder needs to proof that he/she does not directly or indirectly benefit from the proceeds paid under the 50/50 practice. 12 This may lead to situations where less than the amount under the 50/50 practice is tax deductible as not all claimed expenses may be substantiated. 13 Such restrictions are based on art. 47 of Swiss withholding tax law. Portion not defined in the law; according to Swiss tax practice 6% of equity according to statutory books. 14 Based on circular no. 14 dated June 29, 1959 «Besteuerung von inländischen Gesellschaften, die ihre Geschäftstätigkeit zur Hauptsache im Ausland ausüben», as well as a memorandum specifying certain aspects of circular no. 14 issued September 17, In general a 80 % lump sum deduction is applicable in sublicense situation where the Swiss corporation is obliged to reimburse the foreign holder of registered trademarks or patents for its use. Usually, it is not applicable if the Swiss corporation itself is the owner of the intellectual property rights. 16 Circular of December 31, 1962 and its amendments stated in a circular issued December 17, 1998 clarifying on Swiss unilateral tax law regarding measures against treaty abuse. 17 The active company test of the measures against treaty abuse requires that the Swiss company has employees. 18 If considered a company with own organization (significant infrastructure and a number of employees etc.) the cost-plus method as minimum taxation concept could apply. 19 It needs to be ensured that the foreign head office company is not deemed to have an effective place of management in Switzerland, as in such situations, following art. 9 of Swiss withholding tax law, the foreign company could become subject to Swiss withholding tax. 20 Exemption method should be achievable for example with Luxemburg or Austria if treaty protection is required or any offshore jurisdiction in cases where treaty protection is not an issue. 21 Praxismitteilung der EStV «Auswirkungen der 50/50-Praxis bei der Mehrwertsteuer» vom 18. April Direct Federal Tax Law/DBG article 59, para See article 26 of OECD Model Tax Convention including Switzerland s reservations. 24 Bundesgesetz über internationale Rechtshilfe in Strafsachen/IRSG of ; Europäisches Übereinkommen über die Rechtshilfe in Strafsachen/EUeR of ; Staatsvertrag zwischen der Eidgenossenschaft und den Vereinigten Staaten von Amerika über gegenseitige Rechtshilfe in Strafsachen/RVUS of ZUSAMMENFASSUNG 50/50 Praxis bei der Verrechnungssteuer und der direkten Bundessteuer Die 50/50 Praxis wurde erstmals bei ausländisch beherrschten Gesellschaften, die ausschliesslich Ausland- Ausland Geschäfte tätigen, angewendet. Sie dient zur ermessensweisen Festsetzung des ausländischen Aufwandes, sofern die betroffene Gesellschaft den vollen Nachweis für die geschäftsmässige Begründetheit nicht erbringen kann oder will. Die 50/50 Praxis ist im Umfeld der steuerlichen Erfassung von Ausland-Ausland Geschäften angesiedelt. Keineswegs kann sie als Instrument zum Abgabebetrug zu Lasten ausländischer Steuerbehörden dienen; diesbezüglich hat die ESTV Sicherungsmechanismen eingebaut. Mit dem Kreisschreiben Nr. 9 vom 19. Dezember 2001 bestätigt die ESTV die Anwendbarkeit der seit Jahren geltenden 50/50 Praxis sowohl für die direkte Bundessteuer als auch für die Verrechnungssteuer. Das Kreisschreiben legt Grundsätze zur Besteuerung nach der 50/50 Praxis fest und erklärt anhand von sechs Fallbeispielen die steuerliche Behandlung bei Standardfällen. Interessant erscheint eine Abgrenzung der 50/50 Praxis gegenüber aktiven Dienstleistungsgesellschaften, welche gemäss ESTV Kreisschreiben Nr. 14 vom 29. Juni 1959 respektive ESTV Kreisschreiben Nr. 14 vom 17. September 1979 auf einer Cost-Plus 5 % Basis zu besteuern sind. Auch von grossem Interesse ist die Frage zur Anwendbarkeit der 50/50 und 80/20 Praxis bei internationalen Immaterialgüterverwertungsgesellschaften respektive -betriebsstätten in der Schweiz. Der Artikel zeigt einige mögliche Planungsvarianten auf und diskutiert sowohl Abgrenzungsprobleme, insbesondere im Bereich der aktiven Dienstleistungsgesellschaften und des Missbrauchsbeschlusses, als auch Qualifikationsinterpretationen betreffend Dienstleistungsaufwendungen bei der Ermittlung des Saldos der Dienstleistungserträge respektive des «Bruttogewinnes» für Zwecke der 50/50 Regelung. Grundsätzlich kann festgestellt werden, dass die 50/50 Praxis gerade für multinationale Unternehmungen, welche hybride internationale Steuerstrukturen verwenden, als effizientes Instrument der Steuerminimierung/ bzw. des -aufschubes dienen kann. Dies insbesondere in Fällen, bei denen die Schweizer Gesellschaft, im Rahmen der Möglichkeiten der schweizerischen Gesetzgebung, beispielsweise betreffend Doppelbesteuerungsabkommensberechtigung, zwischengeschoben wird. Eine Kombination von hybriden Unternehmenssteuerstrukturen mit der 50/50 Praxis kann für eine multinationale Unternehmung in einer Stärkung der Ertragskraft resultieren. SB 946 Der Schweizer Treuhänder 10/02