According to the Swiss Federal Act on Direct Federal Taxes (DFA) legal entities with a public or charitable purpose are exempted from taxes on the profit that is irrevocably dedicated to such purposes. Business activities are, in principle, not deemed to be charitable (art. 56 let. g. DFA). Cantonal laws contain analogous provisions. The Swiss Federal Tax Authorities SFTA have specified the conditions for the tax exemption in more detail in a circular letter (circular letter no. 12 of July 8, 1994). The Swiss Tax Conference (association of Swiss tax authorities) has published practice guidelines for the cantonal tax authorities. With respect to a so-called holding foundation the Swiss Federal Supreme Court decided in 2021 on a specific case about the tax exemption.
Pursuit of charitable objectives
An essential condition for a legal entity to be exempted from taxation is the pursuit of charitable objectives. This can be, inter alia, a humanitarian, health promoting, ecological, educational, scientific or cultural purpose. The purpose must be irrevocably stipulated in the articles of association of the tax exempted institution. In addition, it must not be possible that any financial assets can be repaid to the founder or any members of the institution. It is therefore required that in the event of liquidation any financial assets of the tax exempted institution will be transferred to another tax exempted institution with a similar purpose.
Furthermore, it must be ensured that the assets of the tax exempted institution will be used solely for the charitable activities. It is not allowed that assets are used for non-profit purposes or that assets are used in the self-interest of the institution, their members or their founders.
Acting in a general interest and without self-interest
Acting with a charitable purpose means both acting in a general interest and acting without self-interest.
A general interest is only given if the circle of possible beneficiaries is open. If the purpose of an institution is focused on a too restricted number of beneficiaries, the tax exemption cannot be granted. This could be the case if only the members of a family, the members of the institution or the members of a certain profession are beneficiaries. On the other hand it is possible to geographically restrict the beneficiaries. It is also possible to extend the circle of beneficiaries to countries or regions outside of Switzerland.
To benefit from the tax exemption an institution must act without self-interest, i.e. altruistically. The own interests of the institution and of its members need to be subordinated. The focus shall be the support of the beneficiaries in accordance with the purpose of the institution and such beneficiaries need to be independent from the institution. An association with the main purpose to support or promote its own members acts not without self-interest and can therefore not become tax exempted. The same applies to institutions with predominant entrepreneurial activities and only minor charitable activities; they cannot become tax exempted. Foundations directly carrying out business activities as sole purpose of the foundation can only benefit from the tax exemption in extraordinary situations. On the other hand, tax exempted institutions can carry out limited business activities if such activities are subordinated to the charitable activities.
There exist various holding foundations in Switzerland, i.e. foundations which hold significant participations in subsidiaries. It is explicitly acknowledged in Swiss tax laws that holding foundations can also be tax exempted under certain conditions.
Firstly, tax exempted holding foundations must not carry out managing activities in their subsidiaries. In practice the tax authorities require that the organisation and personnel of the board of the foundation and the board of the subsidiary is separated. In the maximum one “liaison person” from the foundation can also be a board member in the subsidiary. This shall prevent the foundation or its representatives from having a significant influence on the business activities of the subsidiary; otherwise there would be a risk that the charitable activities of the foundation become negligible.
Secondly, it is required by law that the interest to maintain the business of the subsidiary is subordinated to the charitable purpose of the foundation. This means that the holding foundation must prioritise the charitable activities. According to the practice of the tax authorities the holding foundation must therefore receive regular distributions from its subsidiaries. With these payments the holding foundation is supposed to pursue its charitable purpose.
In a recent decision in the year 2021 the Swiss Federal Supreme Court has interpreted the requirement of the priority of charitable activities of holding foundations even more broadly. In the relevant case, the essential part of the assets of a holding foundation were the participation in a subsidiary and a significant loan to the same subsidiary. The Swiss Federal Supreme Court was of the opinion that the foundation was so closely linked to the success of the subsidiary due to the financial involvement that the interest to maintain the business of the subsidiary was no longer subordinated. Therefore, the court decided that the foundation did not qualify for a tax exemption. However, the court indicated that with a broader diversification of the assets of the foundation the tax exemption could have been possible.
If the requirements for the tax exemption are not fulfilled the profit and capital of charitable institutions are subject to taxation. The tax rates for foundations and associations are considerably lower than the tax rates for companies. However, foundations and associations cannot apply the so-called “participation exemption” with which companies can avoid the taxation of dividends from participations. Therefore, holding foundations should endeavour to qualify for the tax exemption. Otherwise, assets planned to be used for charitable purposes will have to be used to pay taxes.
Our tax advisors and lawyers would be happy to support with any further questions you may have regarding this topic.