Taxation of Corporations in Switzerland1
1. The Swiss government is proposing a major tax reform, primarily of the corporate income tax (CIT). On March 21, 2018, the Swiss Federal Council made a proposal to reform the CIT (known as ‘Tax Proposal 17’), after the rejection of a previous reform plan (‘Corporate Tax Reform III’) in a popular vote in February 2017. It is foreseen that Parliament will decide on the reform this year. According to the current schedule, the major part of the reform could enter into force in 2020 at the earliest.2
2. The substance and timing of the proposed reform were triggered by international developments in corporate taxation. In particular, Switzerland is committed to meet international minimum standards of the CIT set out in the G-20 OECD Base Erosion and Profit Shifting (BEPS) project, including Action item 5 on “countering harmful tax practices more effectively, taking into account transparency and substance” (Box1). Existing preferential tax regimes in Switzerland no longer conform to these international standards. Further, the Council of the EU, in its December 2017 conclusions, included Switzerland in the group of cooperative countries, subject to the successful delivery of its commitments (‘grey list’).3
3. The CIT reform involves trade-offs between objectives and constraints. The reform objectives are to abolish preferential tax regimes to meet international commitments; to maintain tax competitiveness in the absence of these regimes; and to ensure CIT revenues within budgetary parameters. The reform also takes into account the Swiss-specific relationship between cantons and the Confederation. Furthermore, the Swiss authorities are seeking to avoid a prolonged period of uncertainty. Legal stability is an important consideration, and reform plans have been under discussion for several years.
4. This paper analyzes key features of corporate taxation in Switzerland and ‘Tax Proposal 17’. The reform proposal is an opportunity to revisit tax competitiveness in a changing international CIT environment and be mindful of potential spillover effects from and onto the Swiss economy. Section B describes the current Swiss CIT system. Section C puts the proposed reform into perspective by laying out the main measures, and Section D discusses the potential impacts of the proposed reform. Section E concludes.
Box 1.Switzerland’s International Commitments Regarding the CIT
Switzerland has committed to the four Minimum Standards of the G-20 OECD BEPS action plan, where implementation is subject to peer review. These standards are:
|Countering harmful tax practices: This includes:|
|Transparency framework regarding tax rulings||Following a peer review, no recommendations have been made. On 1 January 2017, the domestic and legal framework for spontaneous exchange of information entered into force, allowing for spontaneous exchange of information as of 1 January 2018 (revisions to the Tax Administrative Assistance Act and the Tax Administrative Assistance Ordinance, Convention on Mutual Administrative Assistance in Tax Matters).|
|Reviewing existing preferential regimes||In the October 2017 Progress Report of the Forum on Harmful Tax Practices, the holding company regime, the auxiliary company regime, the mixed company regime, and the commissionaire ruling practice were classified as ‘in the process of being eliminated’ reflecting the Swiss commitment to abolish these regimes. The tax proposal 17 aims at abolishing the holding company, the auxiliary company, the mixed company and the commissionaire ruling regimes.|
|Preventing tax treaty abuse:||On June 7, 2017, Switzerland signed the Multilateral Convention to Implement Tax Treaty Related Measures (MLI). Alternatively, Switzerland also stands ready to implement this minimum standard through a bilateral revision of its Double tax agreement (DTAs) (e.g., Switzerland included this minimum standard in its DTA with Latvia).|
|Transfer pricing documentation and country-by-country reporting (CbCR):||Following a peer review no recommendations have been made. On December 1, 2017, the Federal CbCR Law and Ordinance entered into force, which implement country-by-country reporting in line with the transfer pricing documentation requirements.|
|Dispute resolutions||Recommendations following a peer review have been made. Switzerland is implementing this minimum standard through the MLI or through bilateral revisions of its DTAs.|
B. The Current System of Taxing Corporates in Switzerland
5. The Swiss CIT system is notable for the large role played by sub-national level (cantonal and municipal) corporate taxes. Taxation of corporations is levied at three levels: federal, cantonal (26 cantons), and municipal (2,222 municipalities as of January 2018). Under the Swiss Federal Constitution (the “Constitution”), the cantons are sovereign, including in matters of taxation, except to the extent limited by the Constitution.4 Within a canton, municipalities exercise taxing authority under cantonal law.
6. While cantons have extensive autonomy in taxation, the Federal government has authority under the Constitution to harmonize cantonal direct taxation. The Federal Tax Harmonization (FTH) law assures common treatment of many elements of the tax law, including the provision of special tax status to companies under prescribed conditions (i.e., preferential tax regimes discussed below).5 Further, the FTH authorizes cantons to set their own direct tax rates. The withholding tax on payments by a Swiss resident company to nonresidents is a Federal level tax and administered by the Federal government.
7. The CIT base in Switzerland has relatively few “tax expenditure” provisions, other than preferential tax regimes. Consistent with common international practices, deductions are allowed for expenses necessary to earn income, such as inventory costs, expenses for repair of equipment, general and administration costs, and commercially justified depreciation allowances and reserves and provisions. Certain special deductions and credits are allowed for policy purposes. For example, water pollution abatement machinery is eligible for accelerated depreciation. Losses may be carried forward seven years but may not be carried back.
8. Statutory combined (federal, canton, and municipality) CIT rates in the Swiss cantonal capitals range from 14 percent to 31.9 percent. The federal statutory CIT rate is 8.5 percent. Because the CIT itself is deductible, the ‘effective’ federal CIT rate is 7.83 percent.6 The tax rates of a canton and a municipality in that canton are imposed in addition to the federal tax, and these taxes themselves are also deductible (see Appendix 1). Taking into account that the tax amount itself is deductible in Switzerland (and disregarding preferential tax regimes discussed below), the 2017 ‘effective’ combined CIT rates in cantonal capital cities ranged from a high of 24.16 percent in Geneva to a low of 12.32 percent in Luzern (Figure 1). The unweighted and weighted average effective combined CIT rates in Switzerland are 17.7 and 19.6 percent, respectively.
Figure 1.Effective Combined (Federal, Canton, and Municipal) CIT Rates in Canton Capitals
Source: Federal Department of Finance.
Note: The weighted average is based on federal CIT revenues’ weights (weights averaged for 2012–2014).
9. Cantons are obliged to impose a tax on corporate capital (‘net worth’). No net worth tax is levied at the federal level. The taxable base for the net worth canton tax is the equity of the company, defined as paid-in capital plus reserves. In some cantons, the corporate income tax can be credited against the net worth tax. Cantonal net worth taxes on legal entities range from 0.001 percent to 0.525 percent.
Preferential Tax Regimes
10. Cantons provide tax relief from the cantonal and municipal CIT to auxiliary, mixed and holding companies (so-called “status companies”), but the federal tax does not provide tax relief for status companies. At the cantonal-level, the CIT system differentiates between the relatively “immobile CIT base” — broadly defined as Swiss-sourced income subject to the ordinary CIT— and the “mobile CIT base” — broadly defined as foreign-sourced income subject to lower taxation through cantonal preferential tax regimes. As the preferential tax regimes are governed by the federal harmonization law, these preferential tax regimes are almost identical across cantons, and provide a preferential tax treatment on the cantonal and municipal levels for qualified income, but the federal tax must be paid by all companies—including those that benefit from preferential tax regimes. In contrast to the preferential regimes, generally, the Swiss federal tax law imposes a worldwide income taxation without distinguishing between Swiss and foreign-sourced income (including a deduction based on dividends from a substantial participation in a resident or nonresident company).
11. There are three cantonal preferential tax regimes allowed by the current FTH law:
Holding company regime. Holding companies are, in principle, exempt from any cantonal and municipal tax on income and pay only a reduced cantonal tax on net worth. Holding companies generally qualify for the income tax exemption if their participations (or income from participations) represents at least two thirds of total assets (or total income), but “participation” is not specifically defined in the tax statutes. A holding company may not be actively engaged in a commercial activity in Switzerland. While most European countries adopt a participation exemption regime7—whereby qualified “participation income” of holding companies is exempt from taxation—the Swiss holding company regime applies to all income (in addition to dividends and capital gains), including income not derived from qualifying participation such as interest income.8 This feature makes the regime inconsistent with current international standards.
Auxiliary company regime. An auxiliary company may obtain tax benefits under cantonal tax law if it only carries on administrative activities such as managing its own assets. Auxiliary companies have their legal seat in the canton, but do not have commercial activities in the canton or in Switzerland and derive income from abroad. Foreign-sourced income, including royalties and management fees, as well as income from substantial participations, are exempt (albeit not fully) from cantonal and municipal CITs, whereas Swiss-sourced income and real estate income are taxed at ordinary rates.9 This differential treatment of foreign and Swiss-sourced income offers tax benefits in the absence of substantial domestic activities and thus has been found to be inconsistent with current international standards.
Mixed company regime. This taxation regime for mixed companies is almost identical to the regime of auxiliary companies. A management company that earns some business income in Switzerland, referred to as a “mixed company,” may qualify for a treatment as a management company provided that the underlying business activity is performed predominantly outside of Switzerland. This condition is considered satisfied if at least 80 percent of sales and purchases take place outside of Switzerland and there is no production or manufacturing in Switzerland.
The taxation of cantonal status companies may be the subject of a tax ruling.
12. In addition to the above three preferential tax regimes, the Swiss “commissionaire ruling” practice that enables federal tax relief (also known as a “principal” company regime) has also been considered inconsistent with international CIT standards. A so-called principal company is a trading company that controls the manufacturing of products sold internationally. Under such a structure, a foreign controlled manufacturer produces products on behalf of the Swiss principal company and receives a compensation on a cost-plus basis. The Swiss principal sells the goods internationally through commissionaires (i.e., local agents) that receive a commission as compensation (typically 3 percent of sales or costs). The Swiss system deems the foreign commissionaire affiliate company as a permanent establishment (PE) of the Swiss principal company (the principal company itself can ultimately be owned by a non-Swiss resident). Further, 70 percent of the net profit of the principal is considered trading profit and only 30 percent as manufacturing profit. The commissionaire ruling practice attributes up to 50 percent of the trading profit to the foreign deemed PE (which may not correspond to the allocation in the country of the PE), and hence exempts this income from federal, cantonal and municipal taxes. In practice, such a ruling is combined with a mixed company regime such that the taxable income will benefit from exemption from cantonal and municipal taxes. The effective tax rate of this arrangement may be as low as nearly 5 percent.
Further International Aspects of the CIT
13. The Federal withholding tax on dividends is 35 percent except as reduced by a double tax treaty (DTA) or other international agreement. Under the 2004 agreement with the European Union, Switzerland exempts dividend payments to companies residing in EU Member States. Switzerland has also signed over 90 bilateral double tax treaties. These treaties generally reduce the withholding tax rate on dividends to qualifying shareholders (depending on the applicable DTA) to a rate generally between zero and 15 percent depending on the treaty. Switzerland has domestic anti-abuse rules applicable to withholding tax. Switzerland does not impose withholding taxes on royalties or technical or managerial fees. There is no withholding tax on interest on company loans. However, Switzerland levies a federal withholding tax of 35 percent on certain types of investment income from Swiss sources (e.g., interest on Swiss bank deposits, income from bonds of Swiss issuers, Swiss shares and other participation certificates) and on lottery gains.10 For Swiss resident beneficiaries, the withholding tax is not a final tax. For non-resident beneficiaries, the Swiss withholding tax may represent a final tax on Swiss-source investment income.
14. In January 2017, the Swiss domestic legislation adopted international spontaneous exchange of information in tax matters.11 This allows the spontaneous exchange of tax rulings regarding (i) corporate and individual income, (ii) corporate and individual net worth, and (iii) withholding taxes. Additionally, as of the end of January 2018, 51 tax treaties in force included an exchange of information provision conforming to international standards. Switzerland also has signed 10 tax information exchange agreements, 9 of which are in force. As of January 1, 2018, Switzerland has automatic exchange of information on financial accounts with over 75 states and territories.
15. The Swiss tax law contains selected anti-avoidance rules. Switzerland generally follows the arm’s length principle for transfer pricing, but it does not specify rules (i.e., there is no transfer pricing legislation) and cantonal authorities retain some degree of discretion to agree on transfer pricing methods. The thin-capitalization legislation denies deduction of interest expense of “hidden equity” (defined as debt which would not have been granted by third persons under the same conditions), and a Federal Circular (from 1997) lays out safe-harbor rules for assessing total debt of a company in relation to assets (e.g., a debt-to-equity ratio of 6:1 for financial companies). In Switzerland, there is no controlled foreign corporation (CFC) legislation.
Revenues From the CIT
16. Revenues from the CIT comprise an above-average 11 percent of total tax revenues in Switzerland (Figure 2). The CIT-GDP ratio is 3 percent, above the OECD average (2.8 percent). A detailed fiscal equalization system is in place to mitigate the differences between the cantons in terms of their financial capacity.12
Figure 2.CIT Revenues in OECD Countries
Source: OECD Revenue Statistics.
C. Tax Proposal 17
17. Tax Proposal 17 abolishes cantonal preferential regimes, and provides cantons with a modified financial and legal basis to reduce the tax burden in the absence of these regimes. There are two key elements in the proposed reform for maintaining reduced effective tax rates in the absence of preferential regimes:
1. Legal element: While the Swiss CIT system currently does not contain innovation-related tax incentives,13 under Tax Proposal 17, cantons:
Must introduce a patent box regime (a ‘mandatory’ measure) according to the G-20 OECD BEPS standards, and are free to set tax relief of up to 90 percent of qualified income from patents;
May introduce super R&D tax deductions of up to 50 percent (optional measure), i.e., qualified R&D expenses can be deducted at a rate of up to 150 percent.
However, there is a general limitation, whereby the overall cantonal tax relief (all measures including R&D deductions and the patent box by a canton) may not exceed 70 percent of pretax profits, i.e., at least 30 percent of income must be subjected to taxation.
2. Financial element: While changes in cantonal CIT rates are not an explicit element of the official reform package, the Proposal would nonetheless incentivize cantons to reduce their statutory CIT rates by raising the share of federal direct tax revenue—from 17 to 21.2 percent— that cantons would receive.
The federal statutory CIT rate remains 8.5 percent, while the new innovation tax incentives apply only to the cantonal tax.
18. Further, Tax Proposal 17 increases cantonal taxes on dividends for individuals (i.e., for those not subject to participation exemption applicable between related companies) by subjecting at least 70 percent of these dividends to taxation. Cantons would be able to tax a higher fraction than 70 percent. Currently, in most cantons, 40–50 percent of dividends are exempt. Further, under the proposal, the minimum amount employers must pay for child and education allowance would be increased by CHF 30 per month. Additionally, Tax Proposal 17 contains transitional measures.14
19. Aligning the CIT system with international standards is advised not only to avoid possible reputational damage and counter measures, such as EU black’ listing, but also to minimize potential outward spillover effects from the Swiss system. While progress has been made regarding the ‘transparency framework’ of international exchange of information, and three of the four minimum standards in the BEPS project (Box 1), abolishing existing preferential tax regimes remains vital to respect Swiss commitments to the minimum standards. The existing commissionaire ruling practice is difficult to reconcile with the internationally agreed arm’s length standard and can have particularly negative spillovers for developing countries.
20. In the new equilibrium, if the reform is implemented, CIT rates would be less dispersed across firms and cantons. The federal CIT rate is imposed on all firms (8.5 percent). However, cantons are expected to lower their statutory CIT rates, bringing the combined effective unweighted average rate from 17.7 percent to 13.9 percent (Figure 3), close to that of Ireland but somewhat higher than the lowest rate in the EU (9 percent in Hungary; Figure 4). Moreover, the coefficient of variation for cantonal tax rates— a measure of their dispersion— would be expected to decrease from 19.7 to 13.1 percent.
Figure 3.Expected Effective Tax Rates in Cantons
Source: IMF staff estimates based on data of the Federal Department of Finance.
Note: Excepted effective combined rates are computed assuming that cantonal and municipal taxes are imposed on only 30 percent of pre-tax profit, the federal tax is imposed on the entire pre-tax profit, and the tax amount itself is deductible (see also Annex 1).
Figure 4.CIT Rates, Selected Countries
Source: IMF FAD Tax Rates Database.
Note: The rates for Switzerland are unweighted averages of cantons’ rates (those imposed in 2012 and expected rates under Tax Proposal 17).
Status Companies Would Face a Higher CIT Rate…
21. Assuming that cantons grant the maximum allowable tax relief (70 percent), effective CIT rates in Switzerland would range from 10.2 to 12.75 percent for the companies that fully use the newly introduced tax benefits. The effective unweighted average rate would be 10.9 percent (Figure 3), and the coefficient of variation would be close to 7 percent. These effective CIT rates serve as a reference, and many companies would face rates higher than these minimum effective rates, depending on their use of innovation incentives. Even these minimum effective rates would imply an increase in the tax burden for status companies (because these currently face approximately the federal rate, and some an even-lower rate). The exact tax increase at the firm level would depend on the company and the regime that the canton and municipality have chosen. For instance, international commodity traders would likely face a higher tax burden than firms with high R&D intensity.
… And Switzerland Would Become More Attractive as a Location for Real Investment
22. This overall CIT rate cut in Switzerland is part of an international trend (Figure 4). A number of OECD countries, including Belgium, France, and the US, have recently lowered their CIT rate. As a small open economy, CIT changes in other countries can be important for Switzerland. For example, the US is the major FDI partner country for Switzerland (Box 2). Taken together, however, repealing preferential CIT regimes combined with an overall lower effective CIT rate would maintain Switzerland’s position as a relatively low taxation location, albeit at some cost to revenue. A low CIT rate is generally not advised if it triggers a minimum tax in the home country of the foreign parent company — e.g., foreign CFC rules and similar provisions such as the new U.S. minimum tax (with no deferral) on ‘Global Intangible Low-Taxed Income’. In that case, the low CIT rate is both ineffective and costly.
23. While preferential treatment would be eliminated, the wider Swiss tax system would become more competitive. By offering cantonal preferential tax regimes, cantons compete for the most mobile capital without lowering the tax on the immobile capital. Removing this targeted tax treatment intensifies tax competition over all (mobile and immobile) capital resulting in a lower the CIT rate (Keen, 2001). Theoretically, it is not entirely clear that the rate cut would be welfare enhancing. In fact, theory predicts that in the new equilibrium, total CIT revenue would be lower because of lower taxation of immobile capital (Keen, 2001). This theoretical framework is relevant for international as well as cantonal contexts.
There Are Important Differences Between Cantons
24. There is a competitiveness-efficiency trade-off associated with the expected reduction of cantons’ CIT rates. Companies that currently do not benefit from a preferential tax regime would gain from the planned CIT rate cut. Such companies, however, tend to be relatively immobile, including in response to changes in the CIT rate. Therefore, lower CIT revenues from these companies imply an efficiency cost. At the same time, the lower CIT rate would potentially have a favorable dynamic investment effect by reducing the cost of capital for these less mobile firms. The medium-term net effect will therefore depend on relative elasticities.
25. Consistent with theory, cantons with larger economies tend to impose higher CIT rates. As discussed in Keen and Konrad (2013), theory predicts that smaller jurisdictions tend to undercut large jurisdictions, exacerbating potential pressures on revenues in large jurisdictions. Four cantons — Bern, Geneva, Vaud, and Zurich — together constitute about 50 percent of Swiss GDP and 52 percent of total CIT revenues in Switzerland (Figure 5). However, despite these cantons significantly contributing to the aggregate CIT revenues, they have relatively low shares of CIT revenues from status companies (Figure 5). Lowering the CIT rate in these cantons would result in higher revenue forgone from non-status companies. As shown in Figure 3, Geneva signaled a significant CIT rate cut from 24.16 to 13.49 percent. Vaud announced it will cut the rate in 2019 from 21.37 to 14 percent. In contrast, the rate cut would be less costly in cantons such as Zug and Basel City, which contribute significantly less to country-wide CIT revenues and collect about 50 percent of their cantonal CIT revenues from status companies.
Figure 5.Larger Cantons Have Higher CIT Rates and Lower Revenues from Status Companies
Sources: Federal Department of Finance; and IMF staff estimates.
Note: The line in right panel corresponds to the green dots.
Increased Mobility Intensifies Taking Advantages of Cantonal CIT Differences
26. The cantonal CIT rate and base would play a significantly more prominent role in location and investment decisions between cantons following the abolishment of preferential tax regimes. Under the current system, for a company that qualifies for a preferential tax regime, the cantonal CIT rate is (almost) irrelevant because income is (almost) exempt from the cantonal tax. However, after the reform, the cantonal CIT rate and base matter for these companies, making differences between cantons more important for location and investment decisions by mobile firms.
27. In contrast to the existing system, the reform opens a wider door for CIT base differences between cantons. For example, differences in the R&D tax treatment make it attractive for a company to allocate R&D expenses to cantons with generous R&D deductions but maintain the legal ownership of resulting patents in other cantons with generous patent box regimes. In an international setup, such a structure is somewhat mitigated by the modified nexus approach whereby income from a patent can qualify for the regime if the patent is developed in the same country.
28. The precise rules regarding inter-cantonal profit splits in Switzerland are based on case law. CIT differences between cantons can be used to lower effective taxation. Currently, the profit of an inter-cantonal company in Switzerland is split either based on separate accounting or by an assigned quota (typically between 10 to 20 percent of profits goes to the headquarters’ canton). Other federations (such as Canada, Germany, and the US), adopt a formulary apportionment in the law to allocate profits between cantons. In the short-term, strengthening domestic transfer pricing rules and their application would safeguard revenues. In the medium term, tax law-based formulary options to apportion profits between cantons could be considered.
29. The fiscal equalization system provides an implicit limit to cantonal tax competition. The financial capacity of a canton — based on taxable income and wealth — determines the position of a canton in the fiscal equalization system. Attracting more direct income implies that a canton receives less from (or contributes more to) the fiscal equalization scheme, which in this case can alleviate tax competition between cantons. However, the general limitation rule that restricts the tax relief to a maximum of 70 percent of taxable income can intensify CIT rate competition. If a canton seeks to lower the tax burden but the general limitation rule is binding, then cutting the CIT rate becomes the option to achieve this policy goal.
Encouraging Innovation Through Taxation
30. R&D deductions are generally more effective and efficient than IP box regimes (IMF, 2016b). The policy question is: what is the best option for spending CHF1 on a tax relief for innovation? Existing evidence suggests that a CHF1 R&D deduction would result in significantly higher R&D activities than CHF1 spent on a patent box.15 While a patent box regime in Switzerland can be motivated by the large existing stock of “know-how” assets in Switzerland that receive royalties, for a given cost, maximizing the use of R&D deductions in combination with a less generous patent box relief would yield the highest R&D activities. The patent box effective rate would generally be at the higher end of international comparators (Table 1) because of the federal CIT rate and the limitation on the maximum allowed cantonal tax relief of 70 percent. However, as discussed above, the overall CIT rate in Switzerland would remain competitive.
|Year of Introduction||Effective Rate (%)|
|Switzerland (expected)‡||2019 or 2020||10.9|
31. Currently, distributed corporate profits tend to be undertaxed compared to noncorporate business income.16 A study by the Federal Finance Administration (see Bundesrat, 2018) shows that at present incorporating a business with an annual income of at least CHF300,000 has a tax advantage relative to taxing it at the individual level in all cantons. Lowering cantonal CIT rates would further lower the marginal and average tax burden for distributed corporate profits, exacerbating non-neutrality between different legal forms. Therefore, increasing dividend taxation becomes important to preserve the backstop function of the CIT (i.e., protecting the personal income tax base). In fact, taxing 70 percent of dividends under prevailing CIT rates would still imply a tax benefit from incorporation in 17 Cantons (Bundesrat, 2018). Thus, if CIT rates were to be cut, increasing the fraction of taxed dividends, as proposed under Tax Proposal 17, would alleviate distortions in organizational forms, but would not achieve full tax neutrality.
32. An allowance for corporate equity (which is not part of Tax Proposal 17) would align the tax treatment of equity and debt financed investments. The ACE system has well-known favorable neutrality properties, importantly neutralizing debt bias (IMF, 2016; De Mooij, Hebous, and Hrdinkova, 2018).17 As a neutral system, the ACE encourages investment, including of SMEs, by taxing only abnormal returns (i.e., economic rent). However, the design of the ACE matters for its effectiveness, including the definition of the base of the ACE and the allowance rate. Further, the design of the ACE should not be thought of as a system for encouraging conduit financing companies, and the design must adopt appropriate anti-avoidance rules (IMF, 2016; Hebous and Ruf, 2017). Political economy considerations in Switzerland — particularly the notion that the inclusion of a proposed ACE was identified as the major reason for the rejection of a previously-proposed CIT reform in 2017—may motivate an appropriately designed ACE as an option only for the future.
33. The proposed reform is expected to have a static cost.18 The static cost includes, inter alia, the revenue forgone due to lowering the cantonal CIT rates as well as the increase in dividends taxation, but does not consider possible dynamic effects on firms’ investment. The overall budgetary impacts are to some extent uncertain depending on behavior by individual firms, cantons’ final implemented tax packages (CIT rates and innovation tax incentives), the exact federal package that will be implemented, and CIT developments in other countries. Regarding firms’ responses, one key parameter for estimating the revenue impacts of the reform is the elasticity of taxable income. Recent meta-analysis in Beer et al. (forthcoming) suggests that the semi-elasticity of profit with respect to the CIT rate is −1.2 and tends to be larger for US companies. Importantly, Dowd et al. (2017) find using U.S. firm-level data that the profit semi-elasticity is nonlinear in the CIT rate, ranging from −0.7 (for an increase in the CIT rate from 29 to 30 percent) to −4.7 (for a CIT rate increase from 4 to 5 percent).
34. The Swiss corporate tax system includes many aspects of a territorial regime; is highly attractive for MNCs; and collects non-negligible revenues, but the status quo is not sustainable. The proposed reform would eliminate differences in the tax treatment of foreign and Swiss sourced income. Further, cantons are expected to lower their CIT rates, bringing the combined (municipal, cantonal, and federal) tax rate (averaged across cantons) to about 13.9 percent. Costs of lowering the CIT rates would be unequally distributed across cantons, and would be costlier for cantons with a large immobile CIT base. As the tendency towards CIT rate and base competition between cantons—including for less- mobile capital—intensifies, strengthening measures to tackle possible income shifting between cantons would safeguard revenues. From an international perspective, there is a limit to the benefits from a low CIT rate as it can prompt the payment of tax in the country of the foreign investor, and hence become ineffective in attracting FDI. Additionally, it is important to consider the neutrality of the tax system with respect to the legal form that may put the personal income tax base at risk. Regarding encouraging innovation, at a given cost, the innovation package should maximize the use of R&D tax deductions in relation to the patent box to encourage real domestic investment and job creation.
Box 2.Potential Spillover Effects of International Tax Reforms on Switzerland
FDI is important for Switzerland. The stock of inward FDI equaled 128 percent of Swiss GDP in 2016. The US is an important source of FDI for Switzerland. The share of U.S. FDI in Switzerland, after correcting for the country of the ultimate-beneficial owner, has increased from about 30 percent in 2006 to about 44 percent in 2016. In contrast, FDI from the EU has declined from 43 to 37 percent during this period. According to the US BEA, about 5 percent of total U.S. corporate net income abroad reported in Switzerland, but which is likely an under estimate as it does not consider U.S. FDI in Switzerland through a third country. In contrast, 1 percent of employment by US companies abroad is in Switzerland, corresponding to 118,000 employees.
Figure 1.Swiss Inbound FDI Capital Stock
Sources: SNB; and IMF staff calculations.
Switzerland remains an attractive host to investment, despite recently-intensified tax competition. There is a global trend toward lowering the CIT rate and strengthening rules against outbound profit shifting. For example, both France and Belgium have recently announced they will lower their CIT rates to 25 percent, and the 2016 EU’s Anti-Tax Avoidance Directive obliges Member States to adopt several rules again tax avoidance. The 2018-cut in the US federal statutory CIT rate to 21 percent (25.75 percent combined rate), follows this international trend, and could make the US more attractive for investment (IMF, 2018), but this rate remains higher than the expected Swiss post-reform average of about 13 percent. The ‘territorial’ aspect of the new US CIT system intensifies international competition over U.S. investment (IMF, 2018), but Switzerland would remain relatively competitive compared to other countries. One measure of the effective CIT rate on US investment in Switzerland was 7.7 percent in 2014, close to the Swiss federal rate, possibly reflecting the use of cantonal preferential regimes. This rate is higher than in Luxembourg and Ireland, but lower than in Germany and France. The Swiss effective CIT rate is expected to increase (to about 10.9 percent after abolishing the preferential regimes), but other countries’ effective CIT rates will increase as well, as e.g., in the EU (ATAD and recent European Court of Justice decisions regarding state aid).
Swiss FDI in the US benefits from the US reform, whereas some Swiss companies may be negatively impacted by the strengthening of the US anti-abuse rules. Ultimately, the effect of the US tax reform is company-specific. Swiss companies in the US—particularly highly-profitable companies, such as pharmaceuticals—benefit from the US CIT rate cut in the form of windfall gains and a lower cost of capital. However, Swiss banks and Swiss insurance companies, may be negatively impacted because of the strengthening of the US anti-abuse rules, such as the introduction of the ‘Base Erosion Anti-Abuse Tax’ (BEAT) and of the anti-hybrid rule. The BEAT applies to gross payments to foreign related-parties. The anti-hybrid rule addresses situations, e.g. where Swiss banks finance their branches in the US using instruments captured as equity for capital requirement purposes, but treated as debt in the US for tax purposes.
Incentives to repatriate profits held by U.S. subsidiaries abroad can have a short-term impact on withholding tax revenues in Switzerland. The withholding tax rate on dividends for corporations in the bilateral tax treaty between the US and Switzerland is 5 percent (a final tax as US tax credits are no longer possible). Routing dividends through a third country with a zero withholding tax, such as the Netherlands or the UK, though possible, may be impeded by Swiss treaty rules against treaty shopping and may trigger, under certain circumstances, a Swiss tax.
Thus, overall, the spillover effects from the recent U.S. tax reform on Switzerland appear to be moderate. There is no evidence, thus far, of major shifts of US-Swiss FDI patterns. However, this is a preliminary view since it is still rather early to fully assess the spillover effects of the U.S. reform.
Figure 2.U.S. Affiliates Abroad
Sources: US BEA and IMF staff estimates.
Note: Numbers are for 2014. The right panel presents a measure of the effective tax rate of U.S. affiliates abroad computed as the ratio of income taxes paid by foreign subsidiaries of US companies with positive current earnings and profits (E&P) to current E&P before income taxes.
In addition to the federal tax rate, many cantons levy a flat CIT rate on total taxable income. In some cantons the rate is multiplied by a canton ‘multiplier’. For example, in the canton of Zurich the canton rate is 8 percent and the multiplier is 1 (i.e., the rate is multiplied by one). The municipality tax is computed as a multiplier of the canton tax. In the city of Zurich, the multiplier is 1.2901 of the rate in the canton of Zurich. Table A1 presents an example of computing the effective CIT rate in Zurich.
|Federal l rate||8.5%|
|Canton of Zurich (8% * 1)||8%|
|City of Zurich (8% * 1.2901||10.3208%|
|Total (statutory) rate||Sum the above 3 rows: 26.8208%|
|Effective combined rate† (because the tax itself is deductible) = statutory rate/(1+statutory rate)||21.15%|
BeerS.De MooijR. and LiL. forthcoming International Corporate Tax Avoidance: A Review of the Channels, Effect Sizes and Blind SpotsIMF Working Paper.
Bundesrat2018Botschaft zum Bundesgesetz über die Steuervorlage 17 (SV17). Bern March 2018.
ChatagnyF.KoethenbuergerM.StimmelmayrM.2017Introducing an IP License Box in Switzerland: Quantifying the EffectsInternational Tax and Public Finance 24927–961.
De MooijR.HebousSHrdinkovaM.2018Growth-Enhancing Corporate Tax Reform in BelgiumNordic Tax Journal Forthcoming.
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Prepared by Shafik Hebous (FAD) and Stephen Shay (external expert). This paper has benefited from discussions with the Swiss authorities.
The timetable would be delayed if a referendum were called, which would occur in 2019 with the major part of the reform legislation (abolition of cantonal tax regimes), if approved, becoming effective in 2021.
The Council of the EU did not define any measures against these jurisdictions, but implementation of the commitments by these jurisdictions will be monitored. On October 14, 2014, Switzerland and EU Member States signed an understanding on business taxation. In this statement, the Federal Council affirmed its intention to take measures to remove certain tax regimes. No specific deadline for abolishing the regimes was specified in the joint statement. Switzerland remains committed to the 2014 Joint Statement and is planning to abolish the specified tax regimes through Tax Proposal 17.
The Federal government is granted exclusive authorization to impose certain taxes, but nonexclusive taxes, including direct taxes, may be imposed by the cantons as well as the Federal government. Municipalities play an important governmental role and may impose taxes as authorized under cantonal constitutions.
These include: standardized assessment for legal entities; taxation of foreign directors’ remuneration; deduction of direct taxes; tax rollover relief for reorganizations; definition of holding companies and management companies; and tax incentives for newly incorporated companies.
8.5%/(1 + 8.5%) = 7.83 percent. In this paper, ‘effective’ refers to this formula. See Annex 1.
For instance, in some cantons, long-term loans to subsidiaries are considered in the notion of “participation” for the purpose of the holding company regime.
As noted, the federal tax allows a “participation deduction”, which is similar in effect to a participation exemption system.
Foreign-sourced income is taxed at the cantonal and the municipal level to the extent of management activities in Switzerland (See Art. 28 para. 3 of the Federal Act on the Harmonization of Direct Taxation at Cantonal and Communal Levels).
Reduced withholding tax rates are applied on annuities and pensions (15 percent) and on other insurance benefits (8 percent).
The Federal Act on International Administrative Assistance in Tax Matters, January 2017.
Except for the canton of Nidwalden that adopts a patent box regime with an effective rate of 8.8 percent.
For details, see Bundesrat (2018).
See IMF (2016b). For example, in the Netherlands, €1 spent on a patent box generates 56 cents of additional R&D, whereas granting €1 in an R&D tax incentive for inputs results in €1.77expansion in R&D.
Analyzing tax neutrality between legal forms (corporate vs. individual) in Switzerland involves detailed analysis since it depends on each canton’s personal income tax schedule, CIT, net worth taxes, and social security contributions, inter alia. Therefore, a detailed coverage of this issue is beyond the scope of this paper.
Switzerland levies a one-time federal stamp duty (of 1 percent) on the issuance of corporate equity.
The expected budgetary cost of Tax Proposal 17 is lower than the reform proposal rejected in 2017 (Chatagny et al., 2017), which foresaw, inter alia an ACE.