Switzerland is a federal democracy. As such, the Swiss Federal Constitution grants both the federal government and the cantons the power to levy direct taxes. Federal income tax and corporate income tax are levied in accordance with the Federal Income Tax Act (FITA) of 14 December 1990. The cantons enact their own laws concerning cantonal income tax, wealth tax, corporate income tax and corporate capital tax, but these laws must conform to the Federal Tax Harmonisation Act (FTHA) of 14 December 1990.
The Federal Tax Administration is, however, competent to levy indirect taxes, such as withholding tax in accordance with the Withholding Tax Act (WTA) of 13 October 1965, stamp duties in accordance with the Stamp Tax Act (STA) of 27 June 1973 and value added tax (VAT) in accordance with the Value added Tax Act (VATA) of 12 June 2009.
As a member of the Organisation for Economic Co-operation and Development (OECD), Switzerland has accepted the Transfer Pricing Guidelines developed by the OECD and is actively implementing the recommendations of the OECD's Base Erosion and Profit Shifting (BEPS) project.
Switzerland relies heavily on the Transfer Pricing Guidelines because it has no specific transfer pricing regulations. Accordingly, the Federal Tax Administration has instructed cantonal tax administrations to apply directly the OECD Transfer Pricing Guidelines for all questions related to transfer pricing.2
In Switzerland, transfer price adjustment is based on the principle of the prohibition of harmful profit shifting between related parties. According to settled case law of the Swiss Federal Supreme Court,3 a transfer price can be adjusted when the following conditions are met:
- a company provided a benefit without receiving an adequate consideration in return;
- the benefit was provided to a shareholder or related party;
- the benefit would not have been granted to a third party; and
- the disproportion between the benefit and the consideration was recognisable for the company.
If all of these conditions are met, the tax authorities will consider that harmful profit shifting has occurred. Therefore, an adjustment would be justified without having to prove that it was the parties' intention to evade paying taxes.
As previously mentioned, Switzerland does not have a specific piece of legislation defining and addressing transfer pricing. However, certain Swiss federal and cantonal tax laws address related issues, such as the arm's-length principle and hidden equity. Such provisions for transfer price adjustment are included in most Swiss tax Acts governing income tax and corporate income tax,4 withholding tax5, stamp duties and VAT.6
Article 58 of FITA forbids the deduction of unjustified expenses, meaning that all transactions with shareholders and related parties must comply with the arm's-length principle. For tax purposes, these unjustified expenses may be reintegrated into the company's taxable profits and profits realised due to insufficient transfer prices may be requalified as hidden dividend distributions. Shareholders are subject to income tax or corporate income tax on any constructive dividends.
Furthermore, hidden dividend distributions executed by a Swiss entity trigger a withholding tax of 35 per cent (in accordance with Article 4, Paragraph 1, letter (b) WTA); if the withholding tax is not borne by the beneficiary, then the withholding tax is levied at the gross-up rate of 54 per cent. Beneficiaries of the constructive dividends may nevertheless request a total or partial reimbursement based on Swiss internal law (Article 24 WTA) or an applicable double tax agreement. A notification procedure to notify instead of paying the withholding tax may also be available under certain conditions.
In the event of a hidden capital contribution, the capital contribution may be subject to stamp duty tax of 1 per cent (Article 5, Paragraph 2, letter (a) STA).
The Federal Tax Administration also issues directives in the form of circulars and circular letters that provide guidance on transfer pricing and related topics. These cover safe-harbour rules (thin-capitalisation and interest rates),7 service companies,8 evidence of commercially justified expenses in foreign businesses9 and restructuring.10
The VAT Act of 12 June 2009 is the only legislation that explicitly requires that transactions between related parties be at arm's length. It also defines the notion of 'related parties' for VAT purposes as:
- the owners of at least 20 per cent of the nominal or basic capital of a business or of an equivalent participation in a partnership, or persons associated with them; or
- foundations and associations where there exists a particularly close economic, contractual or personal relationship (pension schemes are not regarded as concerning related parties).11
The Swiss Federal Supreme Court has defined the notion of 'related parties' as entities or persons with a close commercial or personal relationship,12 which it interprets very broadly. In particular, the Court considers that the granting of a service under unusual terms or conditions that do not reflect the market is an indication that there is a close relationship between the parties.13 It is thus vital to determine whether the transaction was conducted under certain conditions due to the parties' close relationship, or if the same conditions would have been required between independent parties.
Broader taxation issuesi Diverted profits tax, digital sales taxes and other supplementary measures
Under Swiss tax law, there is no specific regulation about transfer pricing issues. Tax authorities should, however, follow OECD Transfer Pricing Guidelines as disclosed under Circular No. 4 of the Swiss Federal Tax Administration, dated 1997, revised in 2004. This Circular provides a general application of the arm's-length principle to determinate taxable income of service companies. These general principles have not been supplemented by any other domestic regulations.
Switzerland is actively involved in the OECD discussions on taxing the digitalised economy. The implementation of these future rules is currently unknown.ii Tax challenges arising from digitalisation
New rules discussed at OECD level on taxing the digitalised economy involve a modification of the profit allocation mechanism (Pillar One) and a minimum tax rate for groups (Pillar Two). A multilateral approach is privileged by Swiss authorities against domestic measures that could create uncertainty on the taxation of digitalised businesses. In particular, it is expected that these new rules may reduce profits allocated to Switzerland. While supporting the introduction of both Pillars, Switzerland is thus actively engaged in the discussions to ensure a fair application of these new rules.20
Under Pillar One, and as profits may shift to market jurisdictions, the Swiss authorities indicated that the future set of rules shall comply with the arm's-length principle and shall focus on value creation. Regarding Pillar Two, a recommendation of a modest minimum rate would be acceptable for Swiss authorities. However, domestic tax rates shall be considered under this new set of rules, in particular for small jurisdictions such as Switzerland.iii Transfer pricing implications of covid-19
The Swiss authorities have not amended the current Swiss regulation due to covid-19. Cantonal and federal tax authorities have, however, published a list of frequently asked questions on their respective websites to help taxpayers and explain the covid-19's implications on the applicable tax law.
As a rule, the tax authorities should follow the OECD guidelines and apply the updated OECD guidance on the tax treaty applications issued in January 2022. There is, however, no certainty that this guidance will be followed by Swiss authorities, in particular the cantonal tax authorities, because their practice may differ depending on the case at hand. Extraordinary circumstances should, however, be taken into account when reviewing any potential tax liability.
Switzerland has concluded agreements with other countries, such as France,21 to mitigate the creation of permanent establishments by employees who work from home.iv Double taxation
Switzerland has concluded double taxation treaties (DTT) with over 90 countries. If double taxation occurs with a country Switzerland signed a DTT with or if there is a risk of double taxation occurring, Swiss resident taxpayers, both individuals and corporations, can ask the Federal Department of Finance in Bern to initiate a mutual agreement procedure.
In accordance with the OECD Model Tax Convention on Income and Capital (OECD MC), taxpayers can initiate a mutual agreement procedure within three years of the first notification of the action resulting in double taxation (Article 25, Paragraph 1 OECD MC). Most DTT concluded with Switzerland provide this three-year time limit, but each double taxation treaty must first be reviewed.
An arbitration procedure is also available under a number of double taxation treaties concluded with Switzerland. In general and in contradiction with mutual agreement procedures, taxpayers can only file a request for arbitration with one of the competent authorities, for example, if an agreement has not been reached under the mutual agreement procedure after two years (Article 25, Paragraph 5 OECD MC).
To avoid double taxation, taxpayers can also request a ruling with the Swiss tax authorities before a transfer pricing transaction occurs. Swiss taxpayers generally choose this route; however, provided a foreign country decides to adjust a transfer pricing transaction, double taxation may still occur. In this respect, APAs can also be chosen by Swiss taxpayers to confirm the tax treatment under the relevant double tax treaty, and obtain an agreement between Swiss tax authorities and foreign tax authorities.v Consequential impact for other taxes
Transfer pricing adjustments are generally analysed from an income tax and withholding tax perspective but VAT consequences also need to be addressed. Under the Swiss Federal VAT Act, the arm's-length principle also applies to transactions between related parties. Consequently, an adjustment required by the tax authorities may have an impact on the tax levied. Penalties and interests may also apply if an adjustment is discovered during an audit conducted by the Federal Tax Administration.
Outlook and conclusions
Even if Switzerland does not have any specific transfer pricing legislation, Swiss authorities, including both the administration and the courts, are increasingly influenced by the OECD, which includes, as mentioned, the BEPS project and the taxation of digital economy. This means that any taxpayer active in Switzerland should remain extremely cautious when dealing with transfer pricing issues and should always take into account the OECD Transfer Pricing Guidelines, including the most recent OECD development related to covid-19 or multilateral instruments that aim to mitigate harmful profit shifting.