On 13 November 2019, the Swiss Federal Council approved three ordinances in connection with the Federal Act on Tax Reform and AHV Financing (TRAF) that will enter into force on 1 January 2020. The three ordinances provide specifications regarding the credit of foreign withholding taxes, the application of the patent box regime, and the notional interest deduction on surplus equity.
Ordinance regarding the credit of non-recoverable foreign withholding taxes
Foreign non-recoverable withholding taxes in connection with capital income (such as dividends, interests, royalties, and pensions) may be credited against income taxes due in Switzerland. Generally, such tax credit is available if the respective double tax agreement between Switzerland and the source state provides for such an option and if the respective income is subject to income taxation in Switzerland. However, the amount of tax credit is limited to the amount of Swiss taxes imposed. Due to the corporate tax reform, the following changes to the ordinance regarding the credit of non-recoverable foreign withholding taxes were made: The references to the special taxation regimes were removed, and new regulations regarding the patent box regime, R&D super-deduction and notional interest deduction on surplus equity were included. In addition, the method of calculating the maximum amount of tax credit as well as the rules regarding the allocation of the tax credit between federal, cantonal and communal level were amended. The amended ordinance also specifies the conditions under which Swiss permanent establishments of foreign companies may now apply for a tax credit on non-recoverable foreign withholding taxes. In particular, this requires three applicable double taxation treaties: A double taxation treaty between Switzerland and the source state, a double taxation treaty between the source state and the state of the domicile of the company, and a double taxation treaty between Switzerland and the state of the domicile of the company.
Patent Box Ordinance
The new ordinance regarding the patent box regime specifies the application of the new tax relief for qualifying income from patents and similar rights. It follows the standards set by the OECD and EU and should, therefore, be fully compliant with the international tax framework. The Patent Box is an instrument that should be introduced on cantonal and communal level mandatorily (not at federal level).
Upon request of the taxpayer, the qualifying income from patents and similar rights is taxed at cantonal and communal level with a maximum reduction of up to 90%. This reduced taxation applies from the beginning of the tax period in which the right is granted and ceases at the end of the tax period in which the right expires. The ordinance describes the calculation method of the nexus quota and net profit from individual patents and comparable rights.
To calculate the net profit from individual products involving patents, a detailed profit per product calculation is generally required. Previous and ongoing research and development expenses should be allocated to the different patents and products or groups of products. This is usually a time consuming and complex exercise, and it may lead to substantial practical difficulties in many cases. Therefore, the ordinance offers an alternative calculation method. According to this alternative calculation method, the entire net profit of the company may be used as a starting point from which all profits not connected to any products can be deducted (e.g., financial income, investment income, or real estate income). The remaining profit may then be distributed proportionately among the different products. Thereafter, the profit per product should be multiplied by the nexus quota.
Notional interest deduction
The Federal Ordinance regarding the Notional Interest Deduction specifies the rules for deducting imputed interest on a portion of potential surplus equity from the taxable profit. However, this instrument is only offered to those cantons whose cumulative tax burden on cantonal and communal level amounts to at least 13.5 percent. At present, only the Canton of Zurich meets these requirements. In any case, no such notional interest deduction is available at federal level.
The deduction is not granted on the entire equity, but only on the so-called surplus or safety equity. This is the part of equity that exceeds an appropriate (assumed) average level of self-financing. The ordinance defines an expected “appropriate” average ration for self-financing per category of assets, e.g., for cash 0%, domestic and foreign bonds 35%-45% or inventories 40%. In principle, these are the “reversed” values of Circular No. 6 of the Federal Tax Administration regarding the maximum permissible debt financing ratio per category of assets, taking into account a certain “markup”, as the calculation basis is not the minimum equity financing ratio but an “average” equity financing ratio.
Once the amount of surplus equity is established, the deductible interest expense is calculated based on an interest rate published by the Swiss Federal Tax Administration on an annual basis. This imputed interest rate should correspond to the yield on ten-year Federal notes on the last day of the preceding calendar year. However, due to the currently low interest rates, the tax benefit from the notional interest deduction would be rather limited if only such low interest rates could be used. Therefore, the ordinance offers an alternative option to apply an interest rate that is in line with the dealing at arm’s length principle on the part of the surplus equity that relates to receivables against related parties.
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