The Federal Supreme Court has ruled that fines and other penalties of a criminal nature are not tax deductible for legal entities, as they are not deemed to be business-related expenses. Tax deductibility is granted only insofar as penalties aim at disgorging illegally obtained profits. The ruling, which was rendered in a competition law violation case, has far-reaching implications.
The Federal Supreme Court had to decide on the deductibility of a €348,000 fine issued by the European Commission in 2009 on a Swiss company for carrying out administrative activities in connection with cartel agreements. Subsequently, the company provisioned Sfr460,000.
In 2013 the Zurich Tax Appeals Commission admitted the deduction of the provisions from the taxable net profits and net equity, which was confirmed by the Zurich Administrative Court. On appeal by the Zurich Tax Authority, the Federal Supreme Court reversed the cantonal court's decision.
Under Swiss law, business-related expenses are tax deductible for legal entities. Therefore, the key question before the court was to determine whether the fine in question qualified as a business-related expense. As for tax fines, the law explicitly determines non-deductibility for income tax purposes.
Initially, the court reasoned that the non-deductibility of fines and other financial penalties of a criminal nature imposed on legal entities (eg, stock companies and other capital companies, cooperatives, associations and foundations) on their personal responsibility results from an interpretation of law. If said fines are tax deductible, the community would indirectly be held responsible for a part of the fine imposed on a legal entity which would run afoul of the intended punitive effect. For consistency and uniformity, the influence of tax law on criminal law is not intended.
The court held that, as the existing law stands, payments made for corruption purposes are not tax deductible and corruption is itself a criminal act. It would be paradoxical to deny tax deductibility for such payments, but to admit it with respect to fines for corruption actually committed. The court also stated that as it had decided in previous decisions that fines imposed on self-employed individuals are not deemed to be business-related expenses, a privileged treatment of legal entities is not justified, particularly because competition law fines are imposed regardless of the legal or organisational form of the penalised person. Thus, if the fine imposed due to an identical infringement was deductible for a legal entity, but not for a self-employed individual, the principle of equal treatment would be violated.
Finally, the court held that the non-deductibility of fines and administrative penalties of criminal nature was compatible with the principle of taxation based on economical capacity.
However, the court admitted that fines or penalties aimed at disgorging illegally obtained profits are deemed to be business-related expenses and are thus tax deductible. Such a penalty does not have criminal or punitive purposes, but aims at correcting an unlawful situation.
In this case, the matter was referred back to the lower court in order to examine whether the fine was of a purely criminal nature or whether part of it represented a profit disgorgement penalty.
According to this case, for income tax purposes it is essential to distinguish fines of a penal nature from those which aim to disgorge illegally obtained profits. However, the court provided no specific guidance on how to distinguish one from the other.
The principle established by the court is likely to apply to other penalties issued by Swiss or foreign authorities (eg, those under the US-Swiss banking programme, Financial Market Supervisory Authority fines or Swiss antitrust fines). In this context, Parliament intends to establish an explicit legal basis for this question. A draft bill submitted to Parliament for discussion provides that financial administrative penalties of a criminal nature and the related cost of proceedings will not be deductible, while profit disgorgement penalties of a non-penal purpose will be deductible.
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