Taxation of Cross Border Pension Provision National report of Switzerland by Urs R. Behnisch

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1 Taxation of Cross Border Pension Provision National report of Switzerland by Urs R. Behnisch 1. Summary of National Pension Provision 1.1. National Policy of Social Security System The Swiss social security system is based on three pillars : 1 st pillar: basic social security organised by the federal government for all residents working in Switzerland either as employees or self-employed. Contributions are based on employment income (or business income of a self-employed person) at a flat rate without an upper limit. Contributions on income above about Euro 50'000.- are treated as a tax, because they do not lead to a higher pension. At least half of the contributions have to be borne by the employer. Benefit payments are intended to be large enough to enable participants to cover the expenses necessary for a moderate living (housing, eating, basic medical insurance etc.). The range varies - according to the contribution made until the age of retiring - between Euro 8'000 per year and Euro 16'000 for a single person. For married couples, benefits amount to 150% of the single rate. The system is completely controlled by the state and financed from current contributions on a pay-as-you-go scheme. 2 nd pillar: private pension plan for all employees. For employees earning a yearly salary between approximately Euro 16'000.- and 50'000.- a pension plan is compulsory. Most employers provide a pension plan up to a higher limit (which can be defined by the employer). If such a plan exists, participation is compulsory for all employees. Self-employed persons have the opportunity to join one of the pension plans offered by several funds and insurance companies. Second pillar pension plans are funded together by the employer and the employee. The employer has to bear at least 50% of the contribution. Contributions are paid to pension foundations, which are separate legal entities. For every employee a separate account has to be kept which earns interest. The foundations are private organisations, which are controlled by (cantonal and federal) supervisory authorities. The aim of the second pillar is to enable people to continue their accustomed standard of living. Benefit payments can take place in three ways: (i) as a periodic, lifelong pension (usually monthly), (ii) as a lump sum or (iii) as a mixture of a pension and a lump sum.

2 2 3 rd pillar: private savings. To encourage people to save money the government has introduced a tax deductible savings plan: employees and self-employed are entitled to a tax deduction for savings of up to Euro 3'800.- a year, provided the money is paid to a qualified foundation. A self-employed person who does not take part in a second pillar pension plan is entitled to make contributions to such a foundation of up to Euro 18'500 a year. The qualified foundation is managed by banks and insurance companies. It invests in bonds, shares and other securities. Funds may not be withdrawn until (i) the retirement date, (ii) the date the individual ceases to be domiciled in Switzerland, (iii) the date the individual buys real estate in which he (or she) lives or (iv) startin an trade or business as a self-employed person. All investments other than in third pillar foundations have no connection with pension provisions, but generate dividend, interest or other income, and are beyond the scope of this survey. 1.2 National Tax Policy Regarding Pension Plans All contributions made by the employee and the employer to first and second pillar plans are fully tax deductible. Contributions by the employer therefore do not affect the income of an employee. If an employee who is also a major shareholder of the employer (or of a parent company of the employer) receives more favorable treatment than other employees, the payments may - under certain circumstances - be treated as a hidden distribution of profits rather than as a tax deductible expense of the employer. Payments from all three types of plan are fully taxable to the recipient (except for some individuals falling under a grandfathering clause for whom only 80% of the payments are taxable, because part of the contributions were not fully tax deductible when they were paid). A participant s interest in all three types of plan is not subject to the net worth tax. Second and third pillar funds (regularly organized as a foundation) are exempt from income and capital gains taxes except for capital gains on real estate. Such funds are further subject to (cantonal) transfer duty on real estate and subject to federal transfer stamp duties on the purchase and sale of securities (at least for the time being).

3 3 2. Tax Treatment of Cross-Border Pension Provision (and International Issues) 2.1 Employee Contribution As Switzerland is not a member of the European Union the freedom of workers and the freedom of movement of capital is not guaranteed by a multilateral treaty. As double taxation treaties normally do not deal with tax deductions, the treatment of contributions is subject to national law only. However, contributions to a pension scheme of a foreign entity are fully tax deductible in Switzerland if they are comparable to the Swiss pension schemes (cf. decision by the cantonal tax court of Aargau, StE 1989 B 27.1 Nr. 8). This means that the contributions must serve the same aims as contributions to a Swiss pension fund and that they can not be withdrawn except for very restricted reasons mentioned in the pension law (e.g. in case of old age, invalidity, self-employment, moving abroad and buying a house to live in). This result is based on the principle of equal treatment and the nondiscrimination clause of the double taxation treaties (if applicable). No complications have been caused so far. 2.2 Employer or Other Contribution For employers all payments to a pension fund are fully tax deductible as personnel expenses. There is no difference whether the payments are made to a national or foreign fund as long as the foreign fund is comparable to the Swiss pension foundations (compulsory contributions which are required to be held in the foundation until the age of retirement etc.). 2.3 Cross Border Treatment of the Fund Funds receiving dividends, interest or other income from abroad may benefit from the double taxation treaties. They may claim back withholding taxes according to the rate mentioned in the treaties, even though their income is exempted from Swiss (federal, cantonal and communal) taxes. 2.4 Benefit Payments as Pensions Payments to recipients resident abroad are subject to federal (art. 5 para 1 lit. d/e and art. 96 Federal Income Tax Code) and cantonal withholding taxes. The withholding tax covers pensions from the second pillar as well as from the tax privileged third pillar. Double taxation treaties may prevent Switzerland from levying

4 4 the withholding taxes. Most Swiss double taxation treaties follow the OECD approach so that only the resident state is entitled to tax the beneficiary. Special provisions can be found in the Switzerland-Canada treaty (state of source may levy a withholding tax of up to 15%), Switzerland-Sweden and Switzerland-Pakistan treaties. If the recipient country does not fully tax the pensions in such a case, distortions may arise. On the other hand, Switzerland as resident state will tax in full rents received from another state, even if the employee was not able to deduct the contributions. In this case an (economic) double taxation results which is not covered by the double taxation treaties. There are no special rules in Swiss tax laws dealing with such cases. Further, there are no special linkage rules or assumptions that operate differently when cross-border pensions are paid. No non-discrimination rules seem to be applicable. 2.5 Payment as a Lump Sum Payments to recipients abroad are subject to federal (art. 5 para 1 lit. d/e and art. 96 Federal Income Tax Code) and cantonal withholding taxes. The withholding tax covers benefits from second pillar plans as well as from the tax privileged third pillar plans. For lump sum payments the tax rate is calculated as if a lifelong pension were being paid. The same distortions may arise in cross border cases as mentioned above for pensions. 3. Tax Policy in Pension Provision Switzerland practices the EET system: contributions are fully tax deductible, the fund is exempted for (almost all its) income and the payments (pensions and lump sum payments) are fully taxable. Only approved funds are allowed to operate pension plans according to the social security law and consequently all approved funds are tax exempt. There is no unapproved fund offering pension schemes. 4. Conclusion As mentioned above Swiss EET system may lead to inconsistent tax consequences in cross border cases (e.g. if the other state practices a TTE or TEE system). This creates tax planning opportunities, but may also lead to unresolved discrimination for individuals moving from a TEE system to Switzerland.

5 5 5. Bibliography literature: - Bericht der Expertenkommission zur Prüfung des Systems der direkten Steuern auf Lücken (Expertenkommission Steuerlücken), erstattet dem Finanzdepartement, Bern 1998, S. 77 ff., mit Hinweisen - Locher Peter, Einführung in das internationale Steuerrecht der Schweiz, 2. A., Bern 2000, S. 462 ff. - Oberson/Hull, Switzerland - International Tax Law, IBFD Publications, Amsterdam 1996.