TAX UPDATE. FEDERAL LEGISLATION Bills, acts and amendments. June 2011 issue 1

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1 June 2011 issue 1 international TAX UPDATE FEDERAL LEGISLATION Bills, acts and amendments 1 Lump-sum taxation A Federal Council bill proposes to raise taxes for Swiss-domiciled foreign nationals who do not work in the country: The bill envisages raising the assessment basis for foreigners with their own household to seven times (previously five times) the living costs. The assessment basis for other foreigners is to be raised to three times (previously twice) the cost of board and lodging. In addition, a minimum taxable income is to be defined. While the Federal Council has set a limit of CHF 400,000 of taxable income, the cantons are at liberty to choose the amount. 2 Changes to tax laws on stock options Around six years ago, the Federal Council submitted a proposal to reform the taxation of employee participation schemes (options/shares). In December 2010, the reform finally went through parliament. That it took so long is mainly due to the problems surrounding the whole issue of taxing employee options. An option entitles its holder to purchase a share at a pre-defined price during a certain period of time. The recipient benefits from a certain leverage effect because if the price of the underlying share increases by say, 10%, the value of the call option will rise by a multiple of this figure. As personal capital gains are tax-free in Switzerland, the difference between the option s allocation and exercise values is essentially tax-free, provided that, in the case of employee options, the stock was valued at the time of allocation. Putting a specific value on such options is often a tricky matter for the tax authorities, especially when restriction periods apply to the shares as well. For this reason, the Federal Council is proposing to change the system. In the future, options whose values are difficult to determine i.e. restricted or unlisted shares, will not be subject to taxation until they are actually exercised, not when they are first allocated. The change has now been approved by both the National Council and the Council of States. There will be no tax rebates for options whose share price rises between the time of allocation and exercising as they are unfounded in terms of fiscal logic. Whether or not the change in the system will ultimately lead to a rise or fall in the tax payable on options depends on share price fluctuations, the restriction periods of the options, and swings in the share price between the allocation and exercising of the option. The change in the system of taxing employee options has forced companies to make a whole variety of adjustments. A particular problem is the treatment of internationally mobile employees. The change in the system means that in the future, even employee options featuring unlisted or restric- Dear Reader, We are pleased to introduce our first International Tax Update on behalf of BDO Ltd, Switzerland. This issue will give you a short update on international tax aspect with regard to Switzerland and focuses on new developments regarding the lump-sum taxation, the introduction of a new law on employment benefits in the form of shares or stock options and the newly published safe haven interest rates for intercompany or related party loans. Additionally, we highlight the new interpretation clause of the Federal Council regarding administrative assistance and the new double taxation agreements. Finally, this issue covers Liechtenstein s new tax law and gives you an update on developments with regard to the capital contribution principle. We wish you an interesting and pleasant read. Thomas Kaufmann Partner, Head of International Taxation BDO Ltd, Zurich thomas.kaufmann@bdo.ch

2 2 International Tax Update ted shares will not be taxed when they are first allocated but only when they are exercised. In some cases, however, the time between an option being received and it being exercised can be as much as ten years. Restricted periods of between two and five years are the norm, but even after this period has expired, it can take up to five years or more before the option is exercised. In the case of international companies, therefore, the question is what to do with those employees who relocate abroad in the period between receiving an option and exercising it. In accordance with the new Swiss law, which complies with the OECD standard, a form of pro-rata taxation would apply in this case, as the tax-payers were not resident in Switzerland for the whole period between receipt and exercising of the option. The problem - especially with small and medium-sized enterprises - is how to accurately monitor the residence and tax status of internationally mobile employees as there are many such cases. When an employee decides to exercise options received in Switzerland while resident abroad, the Swiss employer who initially granted the option is obliged to collect withholding tax. The withholding tax rate for federal direct tax is 11.5%. The cantons are at liberty to choose their own rate. The following interest rates apply as of 1 January 2011 (in CHF): Advances to stakeholders 2.25% if financing is equity-based, i.e. not based on a loan on which interest is being paid. 2.25% if financing is debt-based. Own costs +0.25% to 0.5% (0.5% up to and including CHF 10 million; 0.25% in excess of CHF 10 million). Advances from stakeholders Real-estate loans residential property, agriculture, industrial and commercial. 2%, up to the amount of the loan on the first mortgage, i.e. 2/3 of the market value of the property. 2.75% for the remaining amount. Business loans 4.5% in the case of commercial and manufacturing companies. 4% in the case of holding and asset management companies. ADMINISTRATIVE ASSISTANCE AND DOUBLE TAXATION AGREEMENTs Interpretation clause regarding administrative assistance The Federal Council is seeking authorisation from the National Council and Council of States to amend the double taxation agreements (DTAs) already approved by parliament in line with internationally applicable standards on administrative assistance in tax matters. The DTAs with Denmark, Finland, France, the UK, Qatar, Luxembourg, Mexico, Norway and Austria, approved by parliament on 18 June 2010, are to be supplemented with an interpretation clause. This clause states that the requirements for an administrative assistance request should not hinder an effective exchange of information. The Federal Department of Finance (FDF) should be authorised by parliament to bilaterally agree the interpretation clause in an appropriate form with these nine states. Switzerland and the respective contracting state will thereby be bound by the requirements set out in the agreement for an administrative assistance request not to be interpreted in a formalistic and restrictive manner interest rates for calculating payments in kind In accordance with Art. 4 para. 2 lit. b of the Federal Withholding Tax Act (VStG) and Art. 20 para. 1 of the Federal Withholding Tax Ordinance (VStV), payments in kind (hidden distribution of profits) are subject to 35% withholding tax and must be reported voluntarily using Form 102. Payments in kind include the granting of cash advances and loans, either interest-free or at an inadequate rate of interest, to shareholders, partners or close relatives and friends. The same applies to interest paid on assets held by stakeholders and their close relatives or friends. In accordance with the Federal Council decision of 13 February 2011, in future, indicating the name and address of the taxpayer and the information holder is no longer absolutely necessary for processing administrative assistance requests, provided that the identification occurs by other means and fishing expeditions are not involved. As this rendering of the interpretation clause was not available at the time of approval by parliament on 18 June 2010, it must be approved by the National Council and the Council of States in order to be constitutionally secure and viewed as being approved by the legislator in possible appeal proceedings in court. For each of these agreements, the Federal Council will thus submit a supplementary resolution to parliament on the interpretation clause and its definition. There will be a further supplementary resolution on the agreement with the United States, which was also approved by parliament on 18 June This agreement already contains the interpretation clause, which is why parliament only has to take a decision on its definition.

3 International Tax Update 3 In the view of the Federal Council, the amendments decided on 13 February 2011, regarding administrative assistance, should be agreed with all parties to the agreements with which the DTAs were negotiated in accordance with the Federal Council s parameters of 13 March 2009, on the new administrative assistance policy. With regard to agreements which are pending before parliament and which were negotiated in accordance with these parameters, the Federal Council has submitted a proposal for reconsideration. In the case of DTAs which have already been signed but have not yet been submitted to parliament for approval and which do not contain an interpretation clause, the required amendments should be carried out with the partner state on a bilateral basis. This also applies to initialled DTAs. Even after the amendments described, administrative assistance will be provided only in individual cases and upon justified request. Fishing expeditions remain impermissible. Identifying the taxpayer and the holder of the information in administrative assistance requests will generally continue to be by indicating the name and address in future as well. With the amendments, Switzerland is eliminating a foreseeable obstacle to the effective exchange of information in tax matters and thus reducing the risk of failure in the peer review process of the Global Forum on Transparency and Exchange of Information for Tax Purposes. New double taxation agreements Since deciding to broaden the scope of its administrative assistance in tax matters in March 2009, the Swiss Federal Council has entered into negotiations with more than 30 countries. The Council wants to achieve its aims by introducing an administrative assistance clause in line with current applicable international standards, i.e. Art. 26 of the OECD s Model Tax Convention. In the process, Switzerland has also been able to negotiate various benefits for the economy, such as reductions in withholding tax on dividends, interest and royalty payments, or the introduction of an arbitration clause. There now follows a brief overview of the various double taxation agreements (DTAs) concluded in 2011: DTA Switzerland-Germany On 27 October 2010, Switzerland and Germany signed a protocol to amend their double taxation agreement. Essentially, the revised agreement between the two countries will apply as from 1 January The protocol introduces several key changes, the most notable of which will see Switzerland providing administrative assistance in tax matters in line with current international standards. In addition, the relevant stake for a zero rate of withholding tax on intercorporate dividends will be reduced to 10% (previously 20%). The equal treatment article concerning the tax deductibility of interest and

4 4 International Tax Update On 1 January 2011, Liechtenstein s new tax laws came into force. Despite international calls for greater global compatibility and conformity with European legislation, the legislation borrows from the old tradition of low taxation. The reform attempts to establish an internationally competitive tax system while adapting to general domestic and foreign fiscal requirements. By offering attractive tax rates for companies and asset-management structures such as founroyalty payments was amended to bring it into line with the OECD standard. Thus, cross-border interest and royalty payments are now subject to the same deductibility criteria as domestic payments. Switzerland and Germany have also agreed to expand cross-border cooperation in fiscal matters and market access for banks. The two states signed a joint declaration to commence corresponding negotiations, which will focus on a flat rate withholding tax on future earnings (and on past untaxed income) and on providing enhanced administrative assistance in order to enforce these tax regulations. DTA Switzerland-Slovakia Switzerland and Slovakia signed the protocol to amend the double taxation agreement (DTA) in the area of taxes on income and capital on 8 February The revised DTA contains provisions on the exchange of information, in compliance with the internationally applicable OECD standard. Aside from the exchange of information, the two countries have agreed upon a withholding tax exemption for dividend payments from significant holdings (at least 10%) in the capital of the company making the payment, as well as for dividend payments to pension funds, the contracting states and their central banks. In future, the tax withheld at source on interest may not exceed 5%. An arbitration clause was also included in the agreement. 28 February The revised DTA contains provisions on the exchange of information, in compliance with the internationally applicable OECD standard. In addition, Switzerland was granted mostfavoured-nation status in the case of arbitration, and the countries agreed upon a withholding tax exemption for dividend payments and interest from significant holdings of at least 10% in the capital of the company making the payment, as well as for dividend payments to pension funds. DTA Switzerland-Singapore On 24 February 2011, Switzerland and Singapore signed a double taxation agreement (DTA) in the area of taxes on income which replaced the agreement dating back to The revised DTA contains provisions on the exchange of information, in compliance with the internationally applicable OECD standard. In addition, most-favoured-nation treatment of Switzerland was agreed in an arbitration clause, and the countries agreed upon a withholding tax of 5% on dividend payments from holdings of at least 10% in the capital of the company making the payment. In future, interest payments to the national banks of both countries, as well as interest payments between banks in Switzerland and Singapore will be exempt from withholding tax. DTA Switzerland-Malta Switzerland and Malta signed a double taxation agreement on 25 February 2011, in the areas of taxes on income and capital in order to supplement the currently applicable protocol with provisions governing the exchange of information in line with internationally applicable standards. In addition, Switzerland was granted mostfavoured-nation status in the case of arbitration, and the countries agreed upon a withholding tax exemption for dividend payments and interest in the case of related companies with a capital stake of at least 10% in the capital of the company making the payment. The DTA with Malta also contains a clause on abuse, so that the envisaged withholding tax reductions are not applicable to artificially arranged business activities. DTA Switzerland-Sweden Switzerland and Sweden signed the protocol to amend the double taxation agreement in the area of taxes on income and capital on DTA Switzerland-Romania Switzerland and Romania signed a double taxation agreement on 28 February 2011, in the areas of taxes on income and capital in order to supplement the currently applicable protocol with provisions governing the exchange of information in line with internationally applicable standards. In addition, Switzerland was granted most-favoured-nation status in the case of arbitration, and the countries agreed upon a withholding tax exemption for dividend payments from significant holdings of at least 25% in the capital of the company making the payment, as well as for dividend payments to pension funds. DTA Switzerland-Russia On 2 March 2011, Switzerland and Russia concluded negotiations on revising the existing double taxation agreement and initialled the revised agreement. Along with an administrative assistance clause in accordance with the internationally applicable standards, it contains various provisions that are beneficial to the Swiss economy. The precise contents of the revised agreement are currently secret as the agreement still needs to be signed before subsequently being presented to the National Council and Council of States for approval. LIECHTENSTEIN

5 International Tax Update 5 dations, institutions and trusts, Liechtenstein is aiming to position itself as an attractive industrial and financial centre. Attractive tax rates for companies The principle focus of the reform is attractive tax rates for companies. For example, legal entities engaged in business are liable only to income tax at a standard 12.5% rate. This will provide an incentive for high-added-value industrial corporations and SMEs to settle in the Principality. The low flat rate of taxation will be supported by abolishing capital gains tax and coupon tax on securities. In addition, the discrimination between debt and equity capital will be abolished by introducing a notional interest rate for equity capital. A collective form of taxation applies to group companies, which allows losses within national and international affiliates to be offset in the same period as they are incurred. Taxation of asset-management structures such as foundations, institutions and trusts The reform s second main aim involves providing asset-management structures such as foundations, institutions and trusts with tax breaks. Likewise, wealthy private individuals may use public limited companies as a vehicle for managing some of their assets. Private finance companies whose legal entities do not exercise any economic activity in Liechtenstein and exist solely for the purpose of managing the assets of private individuals are subject to a special tax regime. transfer from the legal reserves to the free reserves for immediate repayment to the shareholders out of the free reserves, based on a resolution of the general assembly making reference to reserves from capital contributions. The exception to the general rule stated above refers exclusively to a transitional period which ends at the end of the fiscal year 2011 (31 December 2011 in those cases where the fiscal year coincides with the calendar year). Until the end of the fiscal year 2011, the FTA will accept withholding-tax-exempt repayments of reserves from capital contributions to the shareholders from the free reserves without requesting that these reserves from capital contributions were transferred to the legal reserves because reporting the reserves from capital contributions is only required to be shown on the 2011 financial statements. It should be noted, however, in those cases where the reserves from capital contributions booked in the free reserves will (i) not be repaid to the shareholders in the fiscal year 2011 at all, or (ii) only partly, that all reserves from capital contributions will have to be transferred to the legal reserves by the end of the fiscal year For repayments in the fiscal year 2012, and years following, the procedural rules as stated above will apply i.e. either repayment directly from the legal reserves or transfer to the free reserves for immediate distribution. Additional information Abolishment of special corporation tax rate due to potential risk of breaching EEA ban on state aid. Introduction of a minimum income tax rate (to replace the special corporation tax rate ) of CHF 1,200 p.a. A desire to see more industrial and commercial corporations relocating to Liechtenstein is hampered by restrictive policies on the number of foreign nationals entering the Principality. The policy restricts the proportion of foreigners in Liechtenstein to a third of the total population. Companies are therefore forced to relocate staff to neighbouring countries, which is a major disadvantage. MISCELLANEOUS News regarding the capital contribution principle The Federal Tax Authority (FTA) has defined the following policy: As a general rule, reserves from capital contributions ( Reserven aus Kapitaleinlagen ) must be booked and reported in a special subaccount of the legal reserves as a prerequisite for the eligibility for withholding-tax-exempt repayments to shareholders (see below for exceptions). Repayments of reserves from capital contributions which, in accordance with the general rule, are booked in the legal reserves can be made in two ways: directly out of the legal reserves with a resolution of the general assembly explicitly stating that the repayment refers to reserves from capital contributions; or

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