Foreign withholding tax reform: Reduction of the tax burden and the double taxation risk
Interest, dividend or licence fee income is a concrete example of possible international double taxation for Swiss corporate entities. Indeed, this occurs where such revenues, subject to a withholding tax levied in many source states, are likewise taxable in the recipient’s residence state (i.e. Switzerland).
Following the entry into force of the amended rules on foreign withholding tax credit mechanism on the Swiss tax burden, domestic companies and branches of foreign groups now have a better-suited tool at their disposal. Truly, if properly understood, the said credit (the so-called “flat-rate tax credit” up to fiscal year 2019) should enable them to reduce their Swiss tax and facilitate potential double taxation risk mitigation.
Situation prior to the end of 2019
Where a Double Tax Agreement (hereinafter, the “DTA”) concluded with a relative source state allows, Swiss-based interest, dividend or licence fee recipients could request a credit of a non-refundable foreign withholding tax against their respective Swiss tax burden arising from such revenues.
Hence, in principal, the non-reimbursable portion of the foreign withholding tax (hereafter "residual WHT") offsets the Swiss fiscal burden on related proceeds generated within the corresponding year. Nevertheless, in some instances the Swiss tax authorities may refuse the flat-rate tax credit, whether totally or in part.
Switzerland applies the principle of ordinary imputation: the credit is granted to the extent of the source state’s residual WHT as allowed by the relative DTA on one hand, and is capped by the Swiss tax levied on the corresponding income (hereinafter, the “maximum threshold”) on the other.
As such, in certain cases, the old rules were inconvenient for Swiss companies or branches of foreign groups, for instance:
- the impossibility for a foreign company’s Swiss branch to offset the residual WHT levied abroad against the relative Swiss tax;
- a lump-sum allocation of the flat-rate charge between the Swiss Confederation’s burden (1/3) and that of the Cantons / Communes (2/3). This fractioning (hereinafter, the “flat-rate allocation method”) could heavily disadvantage certain Swiss companies with cantonal privileged statuses (e.g. auxiliary or holding companies) until 2019.
The pursuit of enhancement of the Swiss competitiveness for businesses on the international stage has urged the Federal Council to adopt adjustments to the flat-rate tax credit ordinance, further alleviating the cross-border transactions’ burdens.
New rules since January 2020 in a nutshell
- Extension to foreign companies’ branches
Foreign companies may henceforth claim the tax credit for their Swiss branches. For that purpose, there must be a relevant DTA between the Swiss Confederation and the taxpayer’s residence state, and both must have a corresponding agreement with each of the source states concerned. However, the Swiss tax administration (hereinafter, the “STA”) shall only accept the smallest of residual WHT between the two treaties concluded with the relevant source state.
- Calculation of the maximum threshold
As of the fiscal year 2020, only the income subject to residual WHT from states parties to a DTA with Switzerland is taken into account, and this tax is calculated separately per each type of income (interests, dividends, license royalties and service revenues). Furthermore, the threshold now comprises church taxes.
- Allocation of the maximum amount based on the effective profit tax expense
As opposed to the old regime (i.e. flat-rate allocation method), an allocation based on the effective burden of profit tax according to the taxpayer’s economic situation is now possible, which reinforces equal treatment among them and reduces the potential international double taxation risk.
- New threshold / deductions
The minimum imputation value must attain at least CHF 100 per request – double the amount before reform. The maximum threshold corresponds to the entire Swiss tax on the net revenue concerned, this without proportional reduction for partial tax exemption on the cantonal or federal level, likewise considering the abolition of cantonal privileged statuses.
Regarding the deductions applicable in order to determine the maximum threshold, negative interests and other related expenses reduce it by a presumed lump-sum estimation of 5% on dividends, and – since fiscal year of 2020 – on interests received by companies. For IP licencing revenues exempt from tax in accordance with the newly introduced Nexus formula, such financial expenses are estimated at ½ of their gross licencing income. In either case, both the taxpayer and the authority may administer a proof of a notoriously different amount of the said expenses.
- Minimum equity tax
Multiple cantons absolve profit-generating companies from equity tax to the extent of their effective income fiscal burden. It is in this respect that it remains the minimum burden and may not be further offset by the tax credit.
As of the 2020 tax period, we advise companies having their seat or a branch in Switzerland to reconsider their strategy regarding their request to benefit from the foreign withholding tax credit in light of the new rules applicable from January 2020 onwards.
Taking into account the entry into force of the new TRAF measures (e.g. patent box, additional deductions for research and development) as well as the considerable cut in cantonal income tax rates, a significant reduction of the Swiss tax burden further favours legal entities present in Switzerland.
Article written by Virginie Perlotto and Andriy Chubatyuk