International / Intercantonal tax allocation Tax technical course 2017 Module 1 June 6, 2017

Transcription

1 International / Intercantonal tax allocation Tax technical course 2017 Module 1 June 6, 2017

2 Speakers Gil Walser Director, International tax structuring, Swiss certified tax expert Avenue C.-F. -Ramuz 45, CH-1001 Lausanne Direct: Mobile: Morad Laqtaïbi Senior Manager, International tax structuring and M&A, Swiss certified tax expert Avenue Giuseppe-Motta 50, CH-1211 Geneva 2 Direct Phone : Mobile : laqtaibi.morad@ch.pwc.com 2

3 Part 1 International / Intercantonal income tax allocation 3

4 Part 1 International income tax allocation Agenda Tax residency Permanent establishment Profit allocation methodology Taxable basis and inter-company transactions Taxation of inbound flows (dividend, interest, royalty) Anti-Abuse rules Elimination of the double taxation 4

5 Part 1 International income tax allocation Tax residency 5

6 Tax residency Swiss Domestic Law Principles Resident art. 50 DTL Corporations are considered resident and subject to unlimited taxation if : They are incorporated in Switzerland, or If their place of effective management is located in Switzerland Non resident art. 51 DTL Corporations are subject to a limited tax liability in Switzerland on the income attributable to enterprises, permanent establishments or immovable property situated in Switzerland (art. 51 DTL) provided that their legal seat is not registered in Switzerland or that their effective place of management is not in Switzerland. Specific comment The transfer outside Switzerland of the legal seat / effective place of management is assimilated to a liquidation from a tax perspective and hence income tax is due on the latent reserve ( effective realisation ) art. 58 al.1 lit.c 6

7 Tax residency Swiss Domestic Law Principles In Switzerland, residency is determined by its formal place of incorporation, which is determined by the place at which the head office of a company is registered in the Commercial Register. A company incorporated outside Switzerland, may be considered as a Swiss resident if it is effectively managed from Switzerland (see next slide). 7

8 Tax residency Swiss Domestic Law EPM Effective place of management (EPM) is not defined by Swiss law. The interpretation of effective management in Switzerland is not only unclear, but changes with time. The Swiss Federal Tax Administration (SFTA) has not issued any guidelines or safe harbour rules to assist in this task. It is mainly based on case law. This case law generally considers that the decision as to whether a company is effectively managed in Switzerland is based on circumstantial evidence. For this reason, when auditing a foreign/offshore company from a Swiss effective place of management perspective, the Swiss Federal Tax Administration generally ask a series of questions ( Check-List ) in order to determine whether there is a significant Swiss nexus. 8

9 Tax residency Swiss Domestic Law EPM (cont d) Jurisprudence of the Swiss Supreme Court of December 4, 2003 places a high importance on the day-to-day business rather than on the effective management and control. The day-to-day business is subject to interpretation and tax practice may vary from one Swiss canton to an other Swiss canton. However, in the same case law, the following references can serve as guidance: Effective and economic centre of the companies existence; Place of real management; Place of day-to-day management; Place where all the administrative decisions are taken which should normally be at the head office; Place where the actions which lead to realisation of the statutory aim of the company are taken; Place where the essential decisions of the company are taken; Place of CEO function. 9

10 Tax residency OECD Model Tax Convention In case of conflict between two States on the residency of a company, the OECD model provides with the following principles: Tax residency art. 4 Resident any person who is liable to tax by reason of place of management or any other criteria of similar nature For companies place of effective management Importance of the substance for the recognition of such place of effective management 10

11 Part 1 International income tax allocation Permanent Establishment 11

12 Permanent establishment Swiss Domestic Law Principles Based on art. 52 DTL, Swiss entities subject to an unlimited taxation are subject to income tax on their worldwide income. However, income that may be allocated to a permanent establishment (PE) outside Switzerland is only taxable abroad. Switzerland, in general, applies the exemption method, whether or not income taxes are actually paid in the PE jurisdiction (warning: antiabuse rules developed by the Federal tax administration court). The notion of PE derives from article 51 al.2 DTL. 12

13 Permanent establishment Swiss Domestic Law Principles Definition of PE At the federal level (art. 51 par. 2 DTL) Fixed place of business which is wholly or partially engaged in the business activities of an enterprise or an independent profession. In particular, branches, manufacturing plants, workshops, sales offices, permanent agencies, mines and other plants for the extraction of mineral resource and building or installation projects with a duration of at least 12 months. This definition does not necessarily exclude activities that are preparatory or auxiliary. 13

14 Permanent establishment Swiss Domestic Law Principles Allocation to a PE Regarding the substance of a Swiss company in the Cayman Islands, the Swiss Federal Court considered that the activity in the Cayman Islands had a lack of substance and thus the company structure did not fullfil the condition of existence of a PE abroad to which a part of income should be allocated (RDAF 2013 II p. 445, dated October 5, 2012). Therefore there is no sufficient proof of the existence of a permanent establishment in the Cayman Islands according to art. 51 par. 2 DTL. From a Swiss tax administration point of view, the definition of PE is applied in a strict way for Swiss entities claiming the existence of PE abroad (PE not recognized if there is not enough substance abroad); however a Swiss PE of a foreign entity will be easily recognized (larger PE definition). The substance is assessed based on a evidence of proof relying mainly on people, function and risks. 14

15 Permanent establishment Swiss Domestic Law Principles PE Swiss perspective The definition of a PE according to the Swiss tax law is similar to the one provided by the OECD Model Tax Convention. However, it does not include a list of activities excluded from the definition of PE, respectively qualitative and quantitative notion. For this reason, the Swiss concept of PE is wider than the OECD one. 15

16 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (currently under revision BEPS action 7) PE fixed place of business through which the business of an enterprise is wholly or partly carried on «Place of business» premises, facilities or installations used for carrying on the business of an enterprise May exist where no premises are available but there is certain amount of space at disposal (e.g. a pitch in a market place) May be situated in business facilities of another enterprise (painter spending three days a week in the office building of the client for two years) Home office of a salesman in another jurisdiction Offices used by the local affiliate of a Swiss company 16

17 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) «Fixed» place of business link between place of business and geographical point If by nature of business activities are moved between neighboring locations, commercial and geographical coherency should be taken into account (e.g. mine, «office hotel», a pedestrian street in different parts of which a trader regularly sets up his stand) Degree of permanency not of purely temporary nature Over six months Short period of time with usage taking place regularly over long period of time Can become PE retrospectively 17

18 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) «Carrying on of the business» of the enterprise through this fixed place of business Leasing of facilities, industrial, commercial or scientific equipment to third parties through a fixed place of business Leasing of containers specific topic, covered by report entitled «The taxation of income derived from the leasing of containers» «Roaming agreements» between telecommunications operators no PE Presence of employees of the enterprise regardless of lack of authority to sign the contracts 18

19 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) Paragraph 2. The term «permanent establishment» includes especially: a place of management a branch an office a factory a workshop a mine, an oil and gas well, a quarry or any other place of extraction of natural resources The list is not exhaustive PE is created only if the conditions of Paragraph 1 are met Exploration activities are not included into the list, it is up to Contracting States to agree upon insertion of a specific provisions 19

20 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) Paragraph 3. A building site or installation project constitutes a PE only if it lasts for more than 12 months Construction of buildings, roads, bridges or canals, the renovation of all those mentioned, the laying of pipe-lines and excavating and dredging On-site planning and supervision of the erection of a building are also included «Installation project» - not only installation related to construction project, but also installation of new equipment Twelve-month period test applies to each individual site or project A site exists from the date on which the contractor begins his work, including any preparatory work. Seasonal or other temporary interruptions should be included in determining the life on the site Where parts of a substantial structure such as an offshore platform are assembled at various locations within a country and moved to another location within a country for final assembly; this is part of a single project 20

21 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) Paragraph 4. Activities excluded from definition of PE: a) use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise b) the maintenance of a stock of goods and merchandise solely for the purpose of storage, display or delivery c) the latter activity for the purpose of processing by another enterprise d) maintenance of a fixed place of business solely for purchasing goods or collecting information, for the enterprise e) maintenance of a fixed place of business solely for the purpose of carrying on activity of preparatory and auxiliary nature, etc. f) maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e) provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. 21

22 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole A fixed place of business whose general purpose is one which is identical to the general purpose of the whole enterprise constitutes a PE An enterprise cannot fragment a cohesive operating business into several small operations in order to argue that each is merely engaged in a preparatory and auxiliary activity A fixed place of business used for both PE and non-pe activities would be regarded as a single PE and taxable accordingly 22

23 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) Paragraph 5 dependent agent. A person acting on behalf of the enterprise who habitually exercises in a Contracting State (hereafter referred to as CS ) an authority to conclude contracts in the name of the enterprise Involving the enterprise to a particular extent in business activities in the State concerned Making use of this authority repeatedly and not merely in isolated cases Contracts binding on the enterprise even if those contracts are not actually in the name of the enterprise Authority has to be habitually exercised in the State of potential PE Negotiation of all elements and details of the contract in a way binding on the enterprise in that State even if signed by another person in another State 23

24 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment art. 5 (cont d) Paragraph 7. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State shall not of itself constitute either company a PE of the other Electronic commerce Could a mere use of in electronic commerce operations of computer equipment in a country constitute a PE? Distinction between a web site and the server on which it is stored Evidence of PE: enterprise having a server at its disposal, which is located at a certain place for a sufficient period of time, and the business of an enterprise is wholly or partly carried on at such location 24

25 Permanent establishment OECD Model Tax Convention - Principles Permanent establishment / The taxation of services The profits from services performed in the territory of a Contracting State (CS) by an enterprise of the other CS are not taxable in the first-mentioned one if they are not attributable to a PE situated therein Reluctance of some states to adopt this principle for services performed in their territory. For such states there is possibility to apply taxation, provided the following conditions are met: Taxation should not extend to services performed outside the territory of the State Should apply only to profits from these services rather than to the payment for them There should be a minimum level of presence in a State 25

26 Permanent establishment OECD Model Tax Convention - Examples 1. Opening of a Swiss desk by a foreign industrial company to conduct marketing activities M-OECD: the desk qualifies as fixed place of business but only conduct auxiliary activities. Hence, it does not qualify as a PE. DTL: the Swiss tax law does not necessary exclude auxiliary activities and hence such a desk could qualify as a PE and be taxable in Switzerland (in case of double tax treaty is signed with the state of residence of the foreign company). The profit allocation shall be based on the direct objective method. 2. Maintenance work performed by a foreign company in Switzerland (customer services) M-OECD: the customer services is considered as essential part of the activity of a company and hence could not qualify as auxiliary (Commentary of M-OECD). In case the maintenance work is performed by a local employee in Switzerland of the foreign company, it could qualify as a PE. DTL: such activity would qualify as PE from a Swiss tax perspective and hence part of the profit generated by the foreign company would be taxable in Switzerland based on the direct objective method. 26

27 Permanent establishment BEPS considerations 2015 Final Report Overview Action 7 shall revise the definition of PE in Article 5 of the OECD MTC (and its commentary) in the following areas: A. Commissionaire arrangements and similar strategies (Art. 5 Para 5 & 6); B. Specific activity exemptions and fragmentation of activities (Art. 5 Para 4); C. Splitting-up of contracts (Art. 5 Para 3). 27

28 Permanent establishment BEPS considerations 2015 Final Report Executive summary of key aspects BEPS Action 7 and the changes to the PE rules on A. Commissionaire arrangements and similar strategies Expand the scope of the dependent agent test Narrow the independent agent test Taken together, the proposed rules will clearly lower the threshold compared to existing PE rules B. Specific activity exemptions and fragmentation of activities Restrict specific activity exemptions to preparatory or auxiliary nature Cover fragmentation of activities situations with a rule intended to prevent abuse of the PE rules by segregating activities across associated entities C. Splitting-up of contracts Constructions sites or installations projects of less than 12 months still not PE but: Activities of group companies shall be consolidated or Introduction of a wider treaty principal purposes test (PPT) 28

29 Permanent establishment BEPS considerations 2015 Final Report Summary Rule Current threshold New threshold Impact Dependent Agent Agent acting for overseas enterprise and habitually concluding contracts in name of overseas enterprise Habitually plays the principal role leading in the conclusion of contracts that are routinely concluded without material modification by the enterprise Commissionaire Sales and client relationship leads Travelling employees in sales/deal making capacity Independent Agent (i) Economic and (ii) operational independence and (iii) acting in ordinary course of own business Not available where agent acting exclusively or almost exclusively for closely related enterprises FS Any agent relying on exemption and working related parties Specific Activity Exemptions (i) Specific fact pattern exemptions ; or (ii) preparatory or auxiliary 2 options: retain current guidelines or move to single preparatory or auxiliary rule Group relying on specific fact exemptions Anti-fragmentation rule New rule Complementary functions and cohesive business operations in a territory must be considered together in determining where Art. 5(4) exemptions available Any large groups with multiple presence in a jurisdiction Splitting up of contracts New rule Proposal remains for the addition of an example in the Commentary on the PPT rule and changes to the Commentary on Art. 5(3) Construction or Services PEs, i.e. relating to same or a connected project 29

30 Permanent establishment BEPS considerations 2015 Final Report A. Commissionaire arrangements Arrangement: an entity sells products in a given state in its own name but on behalf of another foreign entity that owns the relevant products Allow the foreign enterprise to sell products in a state without creating a PE because the entity concluding the sale does not qualify as dependent agent PE for the purposes of Article 5(5). The entity concluding the sales cannot be taxed in that state on the profits derived from those sales. It is only taxed on the remuneration received from its services performed (usually a commission). To avoid that sales contracts be substantially negotiated in a state but ultimately finalized and concluded offshore and avoid the application of Article 5(5), or to avoid that a person in state exercises an authority to conclude contracts on behalf of another but nonetheless qualify as an independent agent under Article 5(6) despite being closely affiliated to the foreign entity on behalf of which it is acting, the OECD proposes to: Expand the scope of the dependent agent PE: An agent acting on behalf of an enterprise where it habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the [principal]. Limit the scope of the independent agent exclusion: Where an agent acts exclusively or almost exclusively for one (or more) related enterprises, the agent shall not be considered to be an independent agent for the purposes of the exemption. 30

31 Permanent establishment BEPS considerations 2015 Final Report B. Specific activity exemptions An exemption from PE status is provided where specific activities are conducted through a fixed place of business in a state, but relate to the maintenance of facilities for the display, storage, or delivery of goods, etc. Action 7 report proposes that each of those activities also be of preparatory or auxiliary character and qualify for an exemption from PE status. Additional Commentary: Commentary to clarify the meaning of preparatory and auxiliary phrase is now also proposed: Preparatory - generally carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole, and is therefore carried on during a relatively short period; Auxiliary - generally corresponds to an activity that is carried on to support, without being part of, the essential and significant part of the activity of the enterprise as a whole. Anti-fragmentation rule: the anti-fragmentation rule aggregates the business activities of an enterprise in that state, together with those activities of closely related entities in that same state, to assess whether the totality of activities in combination will qualify for the preparatory or auxiliary exemption. 31

32 Permanent establishment BEPS considerations 2015 Final Report C. Splitting-up of contracts Previously: a construction site or installation project only constitutes a PE if it lasts more than 12 months. Rise to abuses: according to the OECD, this exception has given rise to abuses through the practice of splitting-up contracts between closely related enterprises. Options proposed: the artificial splitting-up of contracts to circumvent this 12 month rule is to be addressed either through: PPT rule advocated in Action 6: include of a wider treaty principal purposes test proposed under Action 6 or; Specific and targeted solutions: include an automatic rule that would take account of any activities performed by associated enterprises. Observation: it remains unclear which solution states will ultimately favour. Individually preferences likely will be affected by the scope and application of any GAAR provisions or domestic judicial doctrines that already may provide an adequate means to address such behaviors without the need for added legislative complexity. 32

33 Permanent establishment BEPS considerations 2015 Final Report Overall key points Significant lowering of PE threshold by BEPS Action 7 Increased subjectivity in proposals Potentially broad impact, including expected collateral impact on arrangement/structures not specifically targeted PE proposals likely to further encourage general interest in PE rules (including in relation to fixed place of business test) Increased focus from tax authorities on whether companies are creating PEs Open questions on profit attribution to new PEs Need to reassess approach to PE issues 33

34 Permanent establishment BEPS Status of implementation around the Globe Country ACTION 7: Prevent the artificial avoidance of PE status Italy Europe Rebuttable presumption of PE in Italy for online game providers 2016 Italian Budget Law introduced a rebuttable presumption of Italian Permanent Establishment for non resident entities carrying out activities in Italy in the online betting/gambling industry. The new provision addresses different BEPS actions concerning both the avoidance of PE and the digital economy taxation. Furthermore, the provision at hand could conflict with the PE features as provided by DTTs signed by Italy. Germany Prevent treaty abuse and artificial avoidance of PE status Germany has started including provisions in its recent double tax treaties following BEPS recommendations with respect to Action 7. Art. 5 of the new signed Australia-Germany Treaty contains the BEPS Action 7 recommended language which broadens the definition of a PE in the treaty context. The expanded scope covers commissionaire arrangements, dependent agents performing a material role leading to the conclusion of contracts and fragmented activities between closely related entities. It can be expected that Germany will continue concluding new treaties in which provisions with respect to Action 7 will be included. UK Diverted Profit Tax (similar in Australia) The UK government enacted a new tax - the Diverted Profits Tax ( DPT ) which applies from April 1, 2015 at a rate of 25% to profits seen as diverted from the UK as defined. The policy objective of the DPT is to counteract arrangements which result in the erosion of the UK tax base and applies in 2 scenarios. Scenario A: Entities or transactions lacking economic substance. Applies where sales are booked in the UK but groups create a tax benefit by operating models where deductible payments are subject to low tax for the recipient or where income should otherwise be taxable in the UK due to the lack of substance in the arrangements. Scenario B: Avoidance of a UK taxable presence. This scenario applies where foreign companies are supplying goods or services directly, and where there is UK activity in connection with those supplies. This is aimed at perceived exploitation of permanent establishment rules. This is a unilateral measure and does not directly fall within the BEPS process although the UK government considers that it is consistent with the themes and drivers behind the BEPS process. There are elements of different BEPS actions within this new tax e.g. avoidance of PE, and recharacterization. 34

35 Permanent establishment BEPS Status of implementation around the Globe Country ACTION 7: Prevent the artificial avoidance of PE status Mexico New Maquila Rules North America Amongst other reforms for maquiladora entities, the following change is relevant as it will have an impact in determination of the income subject to tax in Mexico: The only transfer pricing options for maquiladoras are safe harbor and APA since other maquiladora options were eliminated beginning in The safe harbor option will probably result in higher taxable income since this procedure includes a return on foreign owned fixed assets and foreign owned inventories; thus, APA and other operating options might beadvisable. This measure would fall within action 7 of the BEPS Action Plan, as the new Maquila rules are addressed to limit the cases in which non-residents would create a PE for Mexican domestic purposes. For Mexico the benefit derives in a higher taxable income subject to tax at the level of the Mexican entity. South America Colombia New PE provision based on OECD definition Introduction of effective place of management rules; PE refers to a fixed place of business in Colombia through which a non-resident entity or individual wholly or partially conducts its business. A fixed place of business may be a branch, an office or agent, a factory, a workshop, a mine, an oil or gas well, a quarry, or any other place of natural resource extraction ; PE may also be created where a person other than an independent agent acts on behalf of the non-resident and has the authority within Colombia to conclude binding contracts for the non-resident. Auxiliary or preparatory activities generally do not create a PE. Decree 3026 of 2013, provides the following: No PE will exist in Colombia when a foreign enterprise maintains a fixed place of business with the sole purpose of conducting preparatory or auxiliary activities (include the use of premises only to store, display, or deliver goods, to collect information, or a combination of the above). Similarly, the use of a fixed place of business to conduct advertising and marketing activities, even when conducted by a representative office, will also be considered preparatory or auxiliary as long as the representatives are not allowed to bind the foreign enterprise as principal. Activities that are essential, significant, or primary to the foreign enterprise's business will not be considered preparatory or auxiliary. 35

36 Permanent establishment BEPS Status of implementation around the Globe Country ACTION 7: Prevent the artificial avoidance of PE status China PE Asia China s domestic treaty interpretation rules in Circular Guoshuifa [2010] No. 75 has addressed a lot of issues mentioned in Action 7 report. For example, Circular 75 requires the preparatory and auxiliary test to apply to all activities included in Article 5(4) of the standard double tax treaties. It also provides that dependent agent provision may also apply to the situation where contracts are not concluded in the name of the foreign enterprise. The State administration of Taxation ( SAT ) may consider inclusion of the recommendations in Action 7 report during negotiation of double tax treaties in the future. The SAT s work plan in relation to PE will focus on improving PE administrative rules and strengthening the administrative practice. To achieve this, the SAT will also establish a PE information sharing system between local-level state tax bureaus and local tax bureaus and enhance information sharing with exit and entrance (immigration) administrations. Africa Kenya Preventing the artificial avoidance of PE status The definition of PE in the Kenyan Income Tax Act focused mostly on the existence of a fixed base in Kenya for 6 months or more. In practice however, the tax authorities sometimes placed reliance on OECD interpretations to extend tax to service PEs. The definition of a permanent establishment in the Finance Act 2014 has now been amended to include a dependent agent that habitually concludes contracts for others. The amendment brings the definition of PEs in the Kenya Income Tax Act closer to the definitions contained OECD Model Convention on Double Tax Treaties. 36

37 Part 1 International income tax allocation Profit allocation 37

38 Permanent establishment Profit allocation Swiss internal law Swiss outbound PE Principle Profits of a foreign PE of a Swiss tax resident are excluded from the Swiss taxable basis (objective exemption based on the separate pro forma accounts of the PE Arm s length principle) Losses of the foreign PE Losses of the foreign PE can be deducted from the Swiss taxable basis (subject to recapture in Switzerland if future foreign profits of the PE offset prior losses in the PE jurisdiction within the following 7 years) Swiss inbound PE Principle Profits of a Swiss PE of a foreign tax resident are subject to tax in Switzerland (objective taxation based on the separate pro forma accounts of the Swiss PE Arm s length principle). Losses may be carried forward (7y). Losses of the foreign head office Losses of the foreign head office cannot be deducted from the Swiss PE taxable basis. At least the income deriving from the Swiss PE operations must be subject to tax in Switzerland. 38

39 Permanent establishment Profit allocation OECD Model Tax Convention Business profits taxation art. 7 MOECD Principle profits of an enterprise of a Contracting State (CS) shall be taxed only in that State Exception profits generated through a PE in another CS, are attributable to the other CS Profit determination Should be based on the arm s length principles 39

40 Permanent establishment Profit allocation - Examples With respect to international allocation, Switzerland applies the direct objective method. An example is provided hereafter. Facts : X SA in Switzerland holds permanent establishments in CS1 and CS2. Exclusive attribution of elements of income and capital to the tax domiciles Objective allocation Based on art. 52 para. 3, the Swiss headquarter may compensate the foreign PE loss FY N CH headquarter CS1 CS2 Total Income based on commercial and tax law (20) 80 Partial result under allocation method (20) 80 Taxable income in CH If during the following 7 years period the PE in CS2 generates incomes, the loss of 20 incurred by the PE in CS2 will be added back to the Swiss taxable income of the headquarter (tax adjustment) FY N + 1 CH headquarter CS1 CS2 Total Income based on commercial and tax law Partial result under allocation method Taxable income in CH

41 Permanent establishment Profit allocation - Examples Facts: X SA incorporated outside Switzerland, has a Swiss PE as well as PE in CS2 and CS3 Foreign headquarter CH PE CS2 CS3 Total Results 50 (10) Taxable income in CH - (10) (1) - - (10) Foreign headquarter CH PE CS2 CS3 Total Results (10) (10) 80 Taxable income in CH Objective allocation based on the Swiss PE results (according to a separate accounting) (1) can be offset within a 7 years limit 41

42 Part 1 International income tax allocation Taxable basis and intercompany transactions 42

43 Taxable basis and intercompany transactions Swiss internal law Determination of the taxable income The Swiss corporate income tax is levied on the net profit (art. 57 DTL). To define the taxable profit, Swiss tax law is based on the balance of the income statement. The taxable profit is determined by the statutory P&L, which is established according to the commercial law rules. Financial statements which are compliant with the commercial law are binding for the tax authorities (principle of determinance) unless the tax law indicates specific corrective rules of the taxable income (art. 58 DTL). Thus, the taxable income includes the balance of the P&L statement and i) The expenses which are not commercially justified (art. 58 al.1 lit. b DTL) ii) iii) Incomes which have not been booked in the P&L statement (art. 58 al.1 lit. c DTL) Latent reserve in case of transfer outside Switzerland of the legal seat / effective place of management (assimilated to a liquidation from a tax perspective) ( effective realisation - art. 58 al.1 lit.c) 43

44 Taxable basis and intercompany transactions OECD Model Tax Convention Associated enterprises art. 9 In case entities are part of an international group which are located in different CS and have commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which is not booked due to such conditions would be added to the taxable income of the entity and taxed accordingly primary adjustment. Then the other State shall make an appropriate adjustments to the amount of the tax charged therein on those profits correlative adjustment. Intra-group transaction should be based on the arm s length principle and supported by appropriate Transfer Pricing study. Swiss approach for the correlative adjustment: opening of a mutual agreement procedure 44

45 Taxable basis and intercompany transactions Mutual agreement procedure (OECD Model) Swiss tax consequences triggered by an inter-company transfer pricing adjustment made in connection with a successfully completed mutual agreement procedure. Adjustment Description Taxes Qualification Comment Primary adjustment Matching adjustment Missing income / excess of expense in CH Excess income / missing expense in CH CH CIT Adjustment of the taxable basis Taxable subject to tax status or ruling CH WHT Deemed dividend No CH tax consequences as long as the matching adjustment is recorded CH CIT Reduction of the taxable basis CH WHT n/a n/a Deductibility of the tax adjustment Secondary adjustment Excess earnings in the CH entity is refunded by mean of a credit note/additional invoice CH CIT CH WHT Adjustment of financial statements Adjustment of financial statements n/a, already taken into account in the matching adjustment n/a, deductible expense 45

46 Taxable basis and intercompany transactions Mutual agreement procedure Swiss conditions Swiss tax authorities may support a Swiss taxpayer willing to enter into a mutual agreement procedure only if the following conditions are met: The tax payer is subject to two different CS tax decisions, both entered into force; There is a DTT between the two CS; The double taxation is covered by the DTT in place; The Mutual Agreement Procedure (MAP) should be requested within 3 years from the date of the first tax notification, if the tax decision implies a taxation not compliant with the DTT; In Switzerland, the MAP requests should be addressed to the State Secretariat for International Financial Matters (SIF), which is the competent authority with respect to MAP; The MAP will not be available for tax payers which did not act according to the good faith principle. BEPS Action 14 purpose is to find a way to make MAP mechanism more effective. 46

47 Taxable basis and intercompany transactions Practical case The Group is active in various jurisdictions and is manufacturing and distributing sports equipment. Relevant for the present case are the following group companies: Comany A, Switzerland: Procurement of raw material and further delivery to Company B. Company B, Czech Republic is the manufacturing company of the Group and especially delivers its products to Company C, Germany and Company D, Switzerland. Company C, Germany and Company D, Switzerland are distributing companies. Company C further holds the IP of the group and charges license fees to Company B Purchasing company A B Manufacturing company Distributing company C D IP Distributing company 47

48 Taxable basis and intercompany transactions Practical case Outcome of the German tax audit In 2013 Company C faced a tax audit in Germany covering the years 2006 to As a result of the tax audit, the German tax authorities concluded, that the group internal transactions do not meet the arm s length principle. Company C holds the IP, which is the main driver for the success of the whole group and therefore, qualifies a central element with strategic influence. Therefore, the profit of the group shall after deduction of adequate profit shares of the other group companies be allocated to Company C (residual approach). In order to increase Company C s profit, the license fee has been increased from 3% to 7.5% of the net revenue. Purchasing company A B Manufacturing company Tax audit Distributing company C D IP Distributing company 48

49 Taxable basis and intercompany transactions Practical case Primary Adjustment at the level of Company C Considering the effective profit split within the Group it has been concluded that Company B s profit is adequate. The margins of Company D for the years 2006 to 2012 however, have been qualified as too high. Therefore, the additional license fees have been charged to Company D directly. The primary adjustment at the level of Company C was based on German local law and has been accepted by the Group as it could be comprehended from a transfer pricing perspective. Purchasing company A B Manufacturing company Tax audit Distributing company C D IP Distributing company Additional license fees invoiced 49

50 Taxable basis and intercompany transactions Practical case Corresponding adjustment at the level of Company D Discussion/agreement with the cantonal tax authority Company D discussed the impact of additional royalty payments with the cantonal tax authorities covering corporate income and capital tax. The cantonal tax authority reviewed the adequacy of the additional payments for all the years in question (2006 to 2012) and principally considered them as reasonable. The simplified approach (direct charge to Company D) was considered correct as well. The cantonal tax authority took the position that the profit for the years 2006 to 2009 could not be adjusted without a MAP as these periods have already been finally assessed and referred to statute of limitation (?) The adjustments concerning the years 2010 to 2012 have been accepted as tax deductible expense in the tax year

51 Taxable basis and intercompany transactions Practical case Secondary adjustment at the level of Company D Principles Primary as well as corresponding adjustments are adjustments in the tax balance resulting in a difference between the tax balance on the one hand side and the commercial balance on the other hand side. The secondary adjustment in the commercial balance reflects the adjustments made in the tax balance. The question if such a secondary adjustment is necessary has to be answered based on local commercial law. Concrete case In the concrete case, the entire primary adjustment covering the years 2006 to 2012 has been booked in the business year 2013 (whole amount invoiced and paid). The adjustment in the tax balance has therefore, also been reflected in the commercial balance. 51

52 Taxable basis and intercompany transactions Practical case Withholding tax consequences - Tax audit carried out by SFTA Background During the tax audit carried out by the SFTA it has been noted, that the secondary adjustment has to be reviewed in detail regarding potential withholding tax consequences. Considerations Similar to the qualification of the cantonal tax authority it would be adequate, if the SFTA comes to the same conclusion, i.e. that the adjustment is commercially justified. Therefore, the secondary adjustment should not result in a hidden dividend distribution with withholding tax consequences. However, based on the current practice of the SFTA withholding tax is levied on the whole amount of the secondary adjustment. Considerations (cond.) Based on current practice of the SFTA the payment of additional royalties is not possible without withholding tax consequences, as the payment does not base on a completed MAP. If a MAP could be initiated is questionable as the solution in place has been agreed with the cantonal tax authorities. Conclusion Hidden dividend distribution due to the fact that the SFTA has not been involved from the very beginning (i.e. when discussions with the cantonal tax authorities took place). Solution found based on discussions: Additional payment only partially qualified as hidden dividend distribution. Withholding tax of 35% with partial refund of 20% (pending). 52

53 Part 1 International income tax allocation Taxation of inbound flows (dividend, interest, royalty) 53

54 Taxation of inbound flows (D/I/R) Dividends Swiss internal law Inbound dividends With respect to Swiss income tax on dividends, a tax reduction is applicable on dividends provided that some conditions are fulfilled (art. 69 and 70 DTL): Participation of at least 10% of the share capital of the subsidiary, right on 10% of the profit and reserves of the subsidiary, or market value of the participation in the subsidiary of CHF 1 million Dividend income not meeting these conditions is taxed at the ordinary rate. Such dividend may also be subject to foreign WHT based on the local tax law; this WHT may be fully orpartially refunded based on DTT or the EU Savings Agreement The participation exemption closes any opportunity to claim a tax credit in Switzerland (reduction based on DTT possible). DTT reduction or tax credit are subject to conditions provided by the Federal Council Decree of 1962 and in the Federal Ordinance on the lump sum tax credit of

55 Taxation of inbound flows (D/I/R) Dividend - OECD Model Tax Convention Dividends art. 10 A Contracting State (CS) has the right to apply withholding tax on outbound dividend WHT rates may not exceed: 5% when the beneficial owner is a company which holds directly at least 25% of the capital of paying company WHT: (a) 5% (b) 15% 25% B Switzerland CS 15% in all other cases, including payments to shareholders - individuals The term «beneficial owner» is not used in a narrow technical sense, it should be understood in light of the object and purpose of the Convention, including prevention of tax avoidance WHT: 15% B Switzerland CS Is there a double taxation in these situations? 55

56 Taxation of inbound flows (D/I/R) Interests/Royalties - OECD Model Tax Convention Interest/Royalties art. 11/12 Based on art. 11 of the OECD Model, interests may be taxed in the CS (CS of residency of the beneficiary of the interest source State). «Interest» - income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in profits. Based on art. 12 of the OECD Model, royalties are only taxable in the CS (source State). «Royalties» refers to the payment of any kind received as a consideration for the use / right to use any copyright of literary, artistic, or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. Interests and royalties are subject to tax in Switzerland. Hence, if the CS (source State) applies its right to tax interests/royalties and if this right is not waived by the terms of the DTT with Switzerland, interests/royalties would then be taxed in both States, which may generate a double taxation that is to be cured. 56

57 Taxation of inbound flows (D/I/R) Interests/Royalties - OECD Model Tax Convention Interests/royalties art. 11/12 Contracting State (CS) has the right to apply withholding tax Switzerland includes the interest income in the taxable basis, hence creating a potential double taxation This double taxation should be eliminated according to the DTT signed between Switzerland and the CS WHT: 10% A B Switzerland CS 57

58 Part 1 International income tax allocation Anti-abuse rules 58

59 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions The Swiss domestic anti-abuse rules which apply when a Swiss resident claims relief (reduced DTT rate and lump sump tax credit) from foreign withholding tax on the basis of a tax treaty 1962 Abuse Decree condemns the application of tax relief in the following situations: 1) If the conditions specified in the tax treaty (domicile, registered office, beneficial owner, etc.) are not fulfilled and 2) If it is abusive Tax relief is claimed abusively by an individual, a legal entity or partnership resident in Switzerland if, through such a claim, a substantial part of the tax relief would benefit, directly or indirectly, to persons not entitled to benefit from a tax treaty (Art. 2(1) 1962 Abuse Decree) 59

60 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions Under 1962 Abuse Decree, tax relief is considered to be abusive in four alternative situations: 1) Abusive transfer of income to non-qualifying persons (50% base erosion) 2) Inappropriate profit distributions (25% on received income ) 3) Fiduciary relationships, and 4) Foreign-controlled family foundations and partnerships Strict rules of 1962 Abuse Decree are alleviated in the case of companies which fulfil the «active business test», «stock exchange test» or the «holding test» under the 1999 Abuse circular («Qualifying companies») 60

61 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions 1962 Abuse Circular letter 1) Transfer to non-qualifying persons 1999 Abuse Circular Letter 1) Transfer to non-qualifying persons Base erosion: max of 50% of income for which tax relief is requested on the basis of tax treaty may be used to satisfy contractual rights or claims of persons not entitled to benefit from the treaty Expenses: only the administrative costs and taxes relating to the treaty protected income remaining after satisfying the claims of persons not entitled to treaty relief may be deducted Base erosion: deductible payments made by Swiss resident companies may exceed 50% of their treatyfavoured income as long as the payments are commercially justifiable and can withstand scrutiny (only for qualifying companies) Expenses: has not been modified 61

62 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions 1962 Abuse Circular letter 2) Inappropriate profit distributions Dividend distribution: foreigncontrolled companies are required to distribute a minimum of 25% of gross treaty protected income every business year Financial and interest rate: thincapitalization rules 1999 Abuse Circular Letter 2) Inappropriate profit distributions Dividend distribution: dividend distribution should exceed 6% of total net equity in case: More than 80% of the capital of the Swiss company is foreign controlled The majority of assets are located abroad or majority of claims relate to non-swiss creditors (relate to all companies) Financial and interest rate: same thin-capitalization rules apply to all companies 62

63 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions The 1999 Abuse Circular Letter defines a SFTA practice based on four tests 1. Active Swiss entity The entity runs effectively a commercial activity in Switzerland Swiss entities performing financing and licensing activities are also considered as active entities (narrow interpretation which does not include IP/Licencing activity) 2. Listed company The shares of the entity are listed in a recognized stock exchange market in Switzerland or abroad (or direct subsidiary of a listed company) 3. Holding company The entity should be a pure holding company, meaning that more than 90% of the gross asset be qualified participation and the non-participation incomes should not exceed 5% of the total income 4. Financing test Thin capitalization rules should be observed These tests being satisfied, the entity is entitled to pay more than 50% of the privileged incomes. 63

64 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions Consequences of non-compliance Refuse to grant the official confirmation solicited on the form which is to be sent to the foreign authority in order to obtain a refund of tax Refuse to transmit, or forbid the transmission of, the claim form Revoke a certificate already given Recover the withholding tax of the CS, on behalf of the tax authority of this state, to the extent that the tax relief has been claimed improperly, and Inform the tax authority of the CS that tax relief has been claimed improperly if it is not possible by any other means either to remedy this deficiency or to effectively prevent such an improper claim for tax relief in the future Refuse to grant Swiss lump sum tax credit Tax evasion (penalty and interest; criminal case not excluded) 64

65 Anti-abuse rules Swiss domestic law Anti-Abuse Provisions - relaxed interpretation of 2010 The Decree before only applies when the DTT between Switzerland and the other CS does not include a special anti-abuse provision. For the following CS, specific anti-abuse rules applies (as of January 1 st, 2017) as such, the Decree procedure does not apply to relief claimed on the basis of the following DTTs: Albania, Australia, Belgium, Bulgaria, Chili, China, Cyprus, Colombia, Arab emirates, Spain, Estonia, USA, France, Hong Kong, Hungry, India, Iceland, Italy, Japan, Malta, Morocco, Mexico, Netherlands, Oman, Peru, Portugal, Qatar, Czech Republic, UK, Russia, Slovenia, Taiwan. The relaxed interpretation of 2010 conducted also to extend the definition of active Swiss entity to IP/Licencing company provided the activities go beyond mere administrative work. 65