The draft Bill provides for the abolishment of the cantonal tax privileges as agreed with the Euro­pean Union. The Federal Council proposes the fol­lowing compensation measures: (a) mandatory in­troduction of a patent box by all cantons and (b) the voluntary introduction of additional deduc­tions for R&D expenses by the cantons. Further, the proposal provides for the possibility of a tax-neutral realization of hidden reserves (step-up), which were created during the old tax regimes or before an immigration to Switzerland. The Council of States had included the introduction of a no­tional interest deduction (which the Federal Coun­cil had dropped) into the draft Bill. But on the other General reductions of corporate income tax rates by the cantons are again not part of the draft Bill because the cantons may decide thereon in their own competence. In order to provide the cantons with more fiscal flexibility, the draft Bill provides for an increase of the canton’s share in the income from the direct federal tax. Certain cantons (such as the canton of Vaud, which reduces the com­bined effective tax rate from 22.1% to 14%) enact the reduction of corporate income tax rates already prior to the entry into force of the SV17.

We first highlight the three main elements of the draft Bill introduced or amended by the Council of States:

Introduction of a notional interest deduction

The Federal Council had dropped the notional in­terest deduction in the draft bill. The Council of States now reintroduced it in its decision of June 7, 2018. The draft Bill allows the cantons to introduce a notional interest deduction. They are not obliged to do so. The deduction will not be granted at fed­eral level. The cantons can thus introduce this ele­ment in order to retain and attract group financing activities. The canton of Zurich has in particular lobbied for this tool and is expected to introduce it.

Introduction of a 50:50% distribution rule for re­serves from capital contributions

Dividends distributions made out of reserves from capital contributions (RCC) are subject to neither dividend withholding tax nor income tax for Swiss resident individuals. The Council of States intro­duces a 50:50 distribution rule according to which distributions of RCC made by companies listed in Switzerland shall only benefit from the tax free treatment if and to the extent that the company distributes a taxable dividend in the same amount (provided that the company has distributable profit and retained earnings). This 50:50 distribution rule does not apply to RCC which have been created by way of a transfer of assets from abroad after December 31, 2000 or if the company has relo­cated to Switzerland. This rule does not apply to companies that are not listed at a stock exchange in Switzerland.

Increase of dividend taxation

The Council of States proposes that the dividend taxation for individuals with qualifying participations shall be increased to at least 70% at the federal and amount to at least 50% at the cantonal level.

The Federal Council intended to introduce an in­crease to 70% also at cantonal level. Currently, such dividends are only taxed to the extent of 60% on the federal level and in most cantons only to the extent of 50% (in some cantons such as Aargau it is only to the extent of 40%). This measure aims at financing the tax deficits connected with the SV17 (and the cantonal tax rate reductions).

The other elements of the Federal Council’s draft SV17 were not materially amended by the Council of States:

Abolition of cantonal tax privileges

With the Federal Act on the Tax Proposal 17, the legal basis for the cantonal tax privileges of hold­ing, domicile and mixed companies will be abol­ished. As soon as it is definitive that the SV17 is implemented (i.e. once it is clear that there is no referendum against the SV17 or once the SV17 has been accepted in a referendum by the Swiss voters), the cantons have time to adapt their can­tonal tax laws to the new federal requirements until the SV17 comes into force. The cantons are free to implement the abolishment of the cantonal tax priv­ileges already before the whole SV17 comes into force. As of the time of coming into force of the re­vised cantonal tax laws, companies which until then have benefited from a cantonal tax privilege will be subject to ordinary taxation. The SV17 pro­vides for a five-year transition period during which the realization of hidden reserves, which were cre­ated during the time of the tax privilege, are taxed separately. Alternatively, the hidden reserves of a tax privileged company may also be released tax-neutrally in the course of giving up the privileged tax status before the new rules come into force, and such released hidden reserves may then be amortized over the following years. Further, the special practices regarding the tax allocation of principal companies and finance branches will be abolished by the Swiss Federal Tax Administra­tion.

Pursuant to a statement of Federal Counselor Maurer, Switzerland agreed to an abolishment until 2019. Since the SV17 has yet to be debated in Parliament, the new law may come into force in 2020 at the earliest, and, therefore, an abolishment of the tax privileges until 2019 is impossible. This led the EU to include Switzerland in a «grey list». Furthermore, individual states may enact unilateral anti-avoidance measures.

Further, it should be noted that information on tax rulings regarding privileged tax regimes, which are still applicable on January 1, 2018, may be sponta­neously exchanged with other jurisdictions in the course of the spontaneous exchange of infor­mation. Even if the respective rulings are retracted before January 1, 2018, the privileged taxation may still be claimed by the taxpayer until the can­tonal tax laws are changed or until the tax privi­leged status is given up by the taxpayer, provided that the requirements for the privileged tax status are still fulfilled. In such case, no spontaneous in­formation will occur.

Patent box

A patent box shall be introduced with the SV17, which is mandatory for the cantons. This patent box provides that the taxable income derived from patents and comparable rights are taxed with a re­duction of up to 90% upon request. At the federal level such profits are taxed without a reduction. The patent box fulfills the requirements provided by the Organization for Economic Cooperation and Development OECD (so-called «modified nexus approach»). Pursuant to this modified nexus ap­proach, income from qualifying rights may only be subject to the tax privilege in proportion of the re­search and development expenses (R&D-ex­penses) allocable to the taxpayer to the overall R&D-expenses. The allocable R&D-expenses consist of the expenses for R&D performed by the tax­payer in Switzerland, the expenses for R&D per­formed by third parties as well as the expenses for R&D performed by group companies in Switzer­land.

Additional R&D-deductions

In the SV17, the cantons are authorized to provide an additional deduction from the tax base of the cantonal corporate income tax for R&D, which is performed in Switzerland. This additional deduc­tion must not exceed 50% of the qualifying R&D-expense.

Limitation on tax relief

As it was the case in the CTR III, the SV17 also proposes the introduction of a limitation on tax re­lief. The limitation on tax relief provides that a com­pany must always subject at least 30% of its taxa­ble profit before the application of any special re­gimes (patent box, additional R&D-deductions) to tax, and that no losses must result from the appli­cations of the special regimes.

Increase of cantonal share in direct federal tax

The SV17 aims at keeping the fiscal attractiveness of Switzerland for mobile activities – to the extent possible. However, the therein provided tax instru­ments only have an effect on certain kinds of mo­bile income. The profits not covered by these in­struments are subject to the ordinary corporate in­come tax rate after the abolishment of the current tax privileges. In order to avoid that the current companies with a tax privilege move out of Swit­zerland, the cantons must reduce – in certain cases drastically – their corporate income tax rates (cf. the planned corporate income tax rates in the annex). In order to provide the cantons with more flexibility in this regard, the SV17 provides for an increase of the cantonal share in the income from the direct federal tax from 17% to 21.2%. The re­duction of the cantonal corporate income taxes, which is possible by this measure of the SV17 as well as the revision of the intercantonal financial equalization, is by far the most important part of the SV17.

Relief for capital taxes

Companies with a tax privilege currently pay capi­tal tax at a reduced rate. In the course of the SV17, it is proposed that the cantons may provide for ap­propriate compensation measures to keep their lo­cal attractiveness.

Realization of hidden reserves

The SV17 provides for a tax-neutral realization of hidden reserves before an immigration to Switzer­land, and a tax-effective amortization in the follow­ing years. This creates a symmetry to an exit from Switzerland, which triggers the taxation of hidden reserves. The hidden reserves are not released in the tax balance sheet but are instead determined by the tax administration by way of decree. Alter­natively, it is possible to submit such reserves to a special rate.

Cantonal tax rate reductions

The reduction of cantonal corporate income tax rates is not directly part of the SV17. With regard to the CTR III most cantons, which had not already had a very low tax rate, planned such tax rate re­ductions. The cantons have thereby developed dif­ferent strategies based on their individual situa­tions (cf. the overview in the annex): cantons like Vaud or Geneva would have implemented the compensation measures only to a limited extent and would have instead substantially reduced the general tax rates. Other cantons like Zurich wanted to reduce the tax rate only to a relatively small ex­tent and instead make more extensive use of the possibilities of compensation measures. It is as­sumed that this will not be fundamentally different in the course of the implementation of the SV17.

With the increase of the cantonal share in the in­come from the direct federal tax as well as the changes in the intercantonal financial equalization, the cantons receive the relevant flexibility to be able to proceed with such tax rate reductions in a more or less fiscally neutral way.

Transposition

In the course of the changes of the tax laws, the SV17 further provides to subject all sales of partici­pation rights to a company in which the seller holds an interest of at least 50%, to the extent the con­sideration for such transfer exceeds the sum of share capital and capital contribution reserves. This also applies if several people act in concert with regard to the transfer and fulfill the 50% re­quirement together. A tax-free private capital gain is therefore no longer possible under the Tax Pro­posal 17 with regard to transfers of participation rights to a controlled company compared with the current provision, which only subjects transfers of at least 5% to a controlled company to taxation.

Timing for implementation and conclusion

The SV17 will be debated in the National Council in fall. In the absence of a referendum, the Federal Council will determine the date of entry into force. Afterwards, the cantons must adapt their cantonal tax laws to the new provisions of the Federal Act on the Harmonization of Cantonal Taxes (which typically takes 2 years). The provisions regarding the current tax privileges are, therefore, expected to continue to be in place for a few years. How­ever, as soon as it is clear that there will be no ref­erendum, the Federal Council can enact the new rules regarding special rate of existing hidden re­serves.

It is positive that the Council of States has intro­duced the notional interest deduction in the draft Bill. This new element is expected to attract group financing activities to Switzerland and has been in particular lobbied for by the canton and the city of Zurich. The price of the introduction of a 50:50 distribution rule for distributions of reserves from capital contributions (RCC) for listed companies is, however, significant.