For the first time in its history, Switzerland will review its corporate taxation not for internal reasons but in response to international pressure.
Switzerland has agreed to comply with international company tax standards by the end of 2018. The rules developed by the Organization for Economic Co-operation and Development (OECD) require, among other things, the abolition of special tax status for foreign companies.
Last December, the European Union (EU) placed Switzerland on the “Grey List” of countries that have not yet taken the necessary measures to comply with the new standards. If Switzerland does not quickly adapt its legislation, the country could end up on next year’s black list of jurisdictions considered uncooperative by the EU.
Unlike the previous reform in 2008, when the main objective was to lower the taxation of small and medium-sized enterprises in the country, this revision is primarily needed to comply with international standards.
Some Swiss cantons had set up tax packages for foreign companies to attract employment and capital. These packages were sometimes extremely advantageous, a privilege reserved only for these foreign companies and not Swiss companies.
This had led a number of companies to set up in Switzerland to avoid tax costs. Under increasing international pressure, Switzerland was called upon to reform its tax system so that all companies would be treated equally.
Switzerland could simply abolish these tax lump sums, but this would lead to the departure of many international companies and a significant tax and job loss. It was therefore decided to reform corporate taxation to reduce the tax burden and introduce a single system for all.
However, Switzerland is a federation and it has been decided to maintain tax competition between the cantons. Although distorted by fiscal equalization, a system for distributing wealth between rich and poor cantons, tax competition makes it possible to have very different taxation from one canton to another and has given a very good incentives for self-discipline in the keeping of state accounts.
In order to maintain this competition, it was decided to establish a “tax toolbox.” This describes “instruments” that cantons can use to reduce the usual corporate taxation. We will look at some of these tools to increase Switzerland’s tax attractiveness.
For example, there is the “patent box,” which allows significant tax deductions for all research and development expenses. The aim of this box is to encourage innovative companies that create future jobs.
Another instrument that is the subject of debate is “notional interests.” These are fictitious interests that a company can deduct under certain conditions. The idea is to reward highly capitalized companies on the same basis as those that get into debt and can deduct interest from the debt.
In the toolbox, there is also the “step-up,” which allows special-status companies to cushion the impact of ordinary taxation over five years. This complex mechanism consists of a tax reassessment of the company’s goodwill followed by a tax amortization of this goodwill over a period of 10 years. This amortization would ideally reduce the tax burden to the same level as an auxiliary company.
A first refusal by the Swiss population
For those who know Switzerland, such a revision takes an extremely long time. In fact, this third review of corporate taxation (RIE3) began in 2014.
The legislative proposals and drafts have been renegotiated several times to reach a consensus between the different parties. In 2017, the revision was proposed to the population but, to everyone’s surprise, a referendum conducted by the extreme left and right had succeeded.
The reasons for the opposition ranged from refusing to comply with international pressure and the affront to the autonomy of the cantons (right) to refusing to offer so many tax rebates to companies (left). Despite the consensus reached in Bern by the major Swiss parties, the population refused this compromise. By a narrow majority, the Swiss population has unusually stood up against political establishment.
The previous reform, the Federal Council predicted hundreds of millions of tax losses and it was billions. The left said that the right tends to obtain tax rebates and lie about the consequences.
The right does not deny a deficient estimate of RIE II’s losses, but it counterattacks by pointing to the gains. The 2nd reform was, on balance, a success, as net revenues increased significantly.
In any case, the reform was rejected in 2017 and the challenge now is to find a consensus with the left to put it ahead of international sanctions as soon as possible.
The merger of pension with taxation revision
It is therefore in 2019 that the second proposal for the revision of company taxation will take place. This revision remains very close to that of 2017 but includes a revision for the collective pension system known as “old age and survivors’ insurance.”
This merger of two very different problems, corporate taxation and the pension system, comes from the fact that the two reforms were rejected by the people for different and sometimes opposing reasons.
The politicians therefore decided to group the two solutions together to cancel the objections. Since everyone is partially satisfied, no party really dares to oppose the tax and pension project fused together.
It will therefore be the “last chance review” for the political world. At least that is what they called their proposal, which combines several different changes.
The two Chambers have decided to introduce social compensation into the initial tax plan: 2 billion Swiss francs ($2 billion) will have to be paid into the solidarity pension system. This means that insured persons’ contributions will increase by 0.15 percent, as will employers’ contributions. The Confederation’s contribution to the pension system will also increase gradually, depending on the effects of the tax reform on public authorities.
In summary, since the corporate tax review is likely to reduce tax revenues by $2 billion and was rejected by the people in 2017, it was decided to compensate for this loss by increasing taxes for the pension system.
Where does the legislative process stand today?
This new bill, which merges the review of corporate taxation and the pension system, was accepted by both chambers at the end of September 2018.
As provided by law, the population has the possibility to hold a referendum to oppose a law passed by parliament. A subject as essential as this revision is very likely to provoke a referendum again.
The Greens and far-left circles have already stated that they are ready to collect signatures to oppose it. Consequently, the validation of this project will not take place until June 2019 and the debates are likely to be very intense again.
The problem that this revision will encounter for the population’s vote is that it does not respect the “unity of matter.” In other words it forces a vote on several unrelated matters and is therefore in violation of the basic principles of the rule of law.
“The unity of matter” is precisely present to avoid such a montage on the part of politicians. The complex combination of two subjects as different as pensions and corporate taxation will have to be explained to the people and politicians will have the difficult task of justifying their actions.
Another problem is that the Swiss are very conservative and view the reforms with great skepticism. Many political actors, generally regional or municipal, see this revision as a major upheaval that could lead to significant tax losses but above all to uncertainty.
A new refusal would necessarily trigger a reaction from the OECD as well as possible international sanctions against Switzerland, mainly from the European Union.
This revision should therefore also be understood in the context of a conflictual relationship between Switzerland and the European Union. The Confederation is in the process of renegotiating bilateral agreements, following the population’s decision to limit immigration and therefore to oppose the agreements on the free movement of persons that have been signed with the European Union.
Swiss politicians are therefore forced to introduce legal changes to avoid further difficulties and maintain their overall trade relations with foreign countries while maintaining a competitive tax system.
The fact that the tax proposal is called the “faint hope package” is an indication of the pressure behind such a review.