THE SWISS LUMP-SUM TAXATION REGIME: A NATURAL EVOLUTION

Transcription

1 Reprinted from The Journal of International Tax, Trust and Corporate Planning 2013 THE SWISS LUMP-SUM TAXATION REGIME: A NATURAL EVOLUTION Philippe Pulfer and Olivier Sigg * INTRODUCTION Swiss tax law offers foreign taxpayers the possibility to opt for taxation according to expenditure, instead of the ordinary income and wealth taxation, if certain conditions are met. Such taxation, known as the lump-sum taxation regime, is a simplified assessment procedure of the basis on which regular taxes are levied. In principle, lump-sum taxation is only available to foreign nationals who are residents in Switzerland without carrying out any gainful activities in Swiss territory. Recently, the lump-sum taxation regime has been the subject of various legislative proposals and changes. In a few cantons the lump-sum taxation regime has been abolished because the local population regarded it as unfair. A popular initiative, 1 branded Stop the tax privileges for millionaires (abolishment of lump-sum taxation) 2 (the federal initiative), is calling for the lump-sum taxation regime to be abolished throughout Switzerland. This article describes the current situation and the possible changes in the near future in the taxation of a significant number of foreign high net worth individuals in Switzerland. BACKGROUND The purpose of the lump-sum taxation regime was to find a way of efficiently taxing wealthy foreigners. In particular, English aristocrats were spending a fair amount of time in the region of Lake Geneva at the end of the nineteenth century. These people were benefiting from the local Swiss infrastructures without contributing to their maintenance. The difficulty of assessing the tax basis of the wealthy foreigners created the need for a special and efficient form of taxation, which was not intended to be a privilege. The tailor-made system of the lump-sum taxation regime was first introduced in western Switzerland in 1862, attracting many foreigners retiring to the region of Lake Geneva, and became popular across the country in the first half of the twentieth century. The canton of Vaud was the first canton to implement this tax regime. In 1948 all Swiss cantons entered into a concordat regarding the lump-sum taxation regime, the purpose of which was to set up some basic rules (the concordat). In 1949, the Confederation, namely the federal state, joined the concordat. Currently, less than 0.1% of taxpayers in Switzerland are taxed under the lump-sum taxation regime. There are approximately 5,400 foreigners benefiting from lump-sum taxation, the majority of them living around Lake Geneva in the cantons of Vaud and Geneva. Other popular places for such foreigners are located in the cantons of Valais and Ticino. 1

2 BASIS OF SWISS TAXATION Switzerland is a federal state which provides for different levels of taxation. There are three levels of taxation, namely: federal, cantonal and communal. Income taxes are levied at federal, cantonal and communal levels, whereas wealth taxes are levied at cantonal and communal levels only. While the legal framework of the most important cantonal direct taxes has been harmonised through the Federal Act on the Tax Harmonisation (FATH), the cantons (and, as the case may be, the municipalities) remain free to set their tax rates or establish new taxes. The primary authority to levy taxes is vested in the individual cantons. The sovereignty of the cantons is, however, limited by the powers delegated to the Confederation by the Federal Constitution. Subject to double tax treaties, all persons resident in Switzerland are liable for taxation on their worldwide income and assets. In most cases, worldwide movable assets and related income are taxed in Switzerland, and immovable assets located outside Switzerland and related income are not subject to Swiss taxes. In principle, capital gains on privately held movable assets are tax free. A special capital gain tax is levied on individuals selling immovable property located in Switzerland. LUMP-SUM TAXATION: DE LEGE LATA When a taxpayer meets the requirements for lump-sum taxation, he has a legal right to be taxed accordingly. However, there is no obligation to opt for the lump-sum taxation regime; should the taxpayer elect not to be taxed according to the lump-sum taxation regime, he is taxed on an ordinary assessment basis. The lump-sum taxation regime may be very attractive to wealthy taxpayers given that the ordinary tax rate only applies to a portion of the taxpayer's worldwide income and assets. As a consequence, the tax burden may be reduced significantly. The tax due on the agreed lump sum nevertheless continues to be assessed on the basis of the ordinary income tax rates applicable to that amount (Art 4 para 1 of the Ordinance on Lump-Sum Taxation in Federal Direct Tax; OLST). In addition, in some German-speaking cantons, the ordinary wealth tax rates are applicable to the assessed wealth, calculated by capitalising the above-mentioned agreed lump sum (in principle, the lump-sum is multiplied by five). Conditions of the lump-sum taxation regime Foreign nationals taking up tax residence in Switzerland may benefit from the lump-sum taxation regime if, and as long as, they do not exercise any gainful occupation in the country (neither as an employee nor as self-employed). As a general rule, the relevant assessment basis for the lump-sum taxation shall be no less than five times the annual rent paid or, for home owners, the deemed rental value, or at least double the costs for lodging. The requirements that an individual must satisfy in order to be eligible for the lump-sum taxation regime are, in more detail, as follows. Subjective conditions Entitled persons: According to Art 6 FATH and Art 14 of the Federal Act on Direct Federal Tax (FADT), lump-sum taxation is only available to private individuals, not to legal entities. Tax residence: The individual willing to be taxed under the lump-sum taxation regime needs to be a Swiss taxpayer. 2

3 An individual staying 90 days or more in one taxable year in Switzerland is deemed to be resident in Switzerland for tax purposes. An individual is also deemed resident for tax purposes if the centre of his interests is in Switzerland. Key factors are where an individual has his permanent home and where his family lives. Taking up residence: The lump-sum taxation regime is only available to taxpayers taking up residence in Switzerland for the first time or following a 10-year absence. Absence of gainful activity: In order to be subject to lump-sum taxation, the taxpayer must not engage in any gainful occupation, whether as an employee or in an independent capacity in Switzerland. However, gainful occupation abroad does not, in principle, preclude the lump-sum taxation regime (cantonal exceptions may exist). Swiss nationals and foreign nationals: As a general rule, both Swiss nationals and foreign nationals can opt for the lump-sum taxation regime. However, Swiss nationals are eligible for the special regime only until the end of the year in which they take up Swiss residence or return to Switzerland (see above). For foreigners, lump-sum taxation can last for an unlimited period of time, as long as the conditions for such taxation are met. Persons holding a foreign nationality in addition to Swiss citizenship do not qualify as foreign nationals within the meaning of Art 6 FATH and Art 14 FADT; the acquisition of Swiss citizenship terminates the taxpayer's right to the lumpsum taxation regime. Consequently, Swiss dual nationals might be subject to the lump-sum taxation regime for up to 1 year (as described above). Married couples: In principle, each spouse individually needs to meet the requirement of the lump-sum taxation in order to be able to be taxed under that regime; the fulfillment of all requirements by only one of the spouses does not enable them both to apply for taxation under the lump-sum regime. It is however possible for one spouse meeting the requirements to be taxed on the basis of expenditure, whereas the other spouse is taxed under the ordinary regime. As an exception to the above, when one of the spouses has Swiss nationality, and should the other conditions be met, both spouses are entitled to the lump-sum taxation regime. This is provided by the guidelines of the Swiss Federal Tax Administration (Circular no 9 of 3 December 1993 on lump-sum taxation). Objective conditions In addition, the lump-sum taxation regime is subject to the following conditions. Basis of assessment: The basis of assessment for lump-sum taxation includes the living expenses of the taxpayer in Switzerland and abroad and those of the persons depending on him and living in Switzerland. The expenditure includes, in particular: accommodation expenses, including in particular, expenses for maintenance, heating, cleaning, gardening, insurance, and interest on a mortgage; maintenance costs of real property abroad; all expenses for the taxpayer's staff in Switzerland and abroad; general expenses for food (including restaurants), clothes, medical treatment and healthcare, insurances (medical, civil liability); expenses for travelling, holidays, entertainment, sport, expensive domestic animals (such as horses); 3

4 maintenance and operating costs of cars, motor or sailing boats, planes in Switzerland and abroad; and all other living costs. Rent paid as basis of assessment: It is often difficult to determine a verifiable amount of living expenses, which is why the amount of rent paid or the deemed rental value of owned property are frequently used for calculating the tax base. However, living expenses have to equal at least five times the amount of the annual rent paid or the deemed rental value, or at least double the costs for lodging. Shadow calculation': According to Art 6 para 3 FATH and to Art 14 para 3 FADT, the assessment basis according to the above methods (see above) is subject to a control calculation; the results obtained have to be compared with the taxpayer's income earned from Swiss sources, in particular: real estate located in Switzerland; securities issued by a company incorporated in Switzerland; interests on Swiss bank deposits; pensions and annuities from Swiss sources; and foreign income on which the taxpayer claims tax relief based on applicable double tax treaty (see below the so-called modified lump-sum taxation). The taxable amount deriving from lump-sum taxation must not be less than the taxable amount deriving from Swiss sources normally due under ordinary taxation. Should this be the case, the taxpayer would be liable to pay tax on the basis of the control calculation (Art 6 OLST). Modified lump-sum taxation: The double tax treaties concluded by Switzerland with Austria, Belgium, Canada, Germany, Italy, Norway and the USA provide for a so-called modified lump-sum taxation'. If a taxpayer is willing to benefit from a double tax treaty with one of those states, he must declare in Switzerland all income from sources within the relevant treaty state and be taxed in the ordinary way on this income. According to the treaty concluded with France and the exchange of notes between France and Switzerland of 19 February 1968, until very recently France recognised lump-sum taxation if the assessment basis was increased by 30%. Procedure for obtaining lump-sum taxation First, the prospective lump-sum taxpayer typically determines where he wishes to take up residence in Switzerland and secures Swiss accommodation (whether as tenant or owner). Purchase agreements may be subject to the condition that a valid residence permit is issued. Lump-sum taxation has to be negotiated with the local cantonal authorities who will then eventually confirm the arrangement by way of a tax ruling. Such a ruling is usually valid for 5 years and then needs to be renewed. The ruling remains valid as long as there is no substantial change in the taxpayer's standard of living and if so a renewal is normally granted without difficulty. Furthermore, foreigners taking up residence in Switzerland must apply for a residence permit. Compulsory social security Since foreign taxpayers subject to lump-sum taxation cannot engage in gainful activities on Swiss territory, they have to contribute to social security as unemployed persons until they reach the statutory retirement age. The maximum contribution for unemployed persons in 4

5 Switzerland currently amounts to CHF24,000, plus approximately 5% of this amount for administrative costs. Lump-sum taxation expiration Once granted, lump-sum taxation will generally stay in place but may be subject to adjustment on material changes in the taxpayer's financial circumstances or expire altogether if he acquires Swiss nationality, gives up residence in Switzerland or engages in gainful activity (independent or employed) in Switzerland. Further remarks Significant differences exist between the cantons, in particular, regarding the taking into account of the taxpayer's assets, and also whether wealth tax is included in the taxation. Certain cantons have established minimum thresholds for either the tax base or the tax revenue due. The lump-sum taxation regime provides for a high degree of privacy to the extent that income from Swiss sources only needs to be reported. THE END OF THE LUMP-SUM TAXATION REGIME? Pressure from the inside In Switzerland, the lump-sum taxation regime is subject to political debate. Some people consider that it is a disingenuous means to privilege wealthy taxpayers, which, from a legal point of view, contravenes the fundamental principles of equal treatment of all taxpayers and taxation based on economic capacity. Various cantons have seen a wave of protest rising against this tax system. In the German-speaking cantons Citizens in the canton of Zurich voted against the lump-sum taxation regime in a popular vote in 2009, and the practice was abolished at the beginning of January Since its abolishment by a popular initiative in the canton of Zurich, lump-sum taxation has come under pressure in other cantons as well as at federal level. In four other German-speaking cantons (Schaffhausen, Appenzell Ausserrhoden, Basel-City and Basel-Land), this lump-sum taxation regime has also been abolished. It is fair to say that none of these cantons ever had lump-sum taxpayers contributing substantially to the cantonal budget. Moreover, the trend is not uniform in all German-speaking cantons. In the cantons of St Gallen, Lucerne and, more recently, Berne and Nidwalden, initiatives aiming at abolishing the regime were rejected. These cantons have, however, implemented stricter rules. In particular, the population of the canton of Berne who was conscious of the potential negative economic consequences of the abolition of the regime if wealthy foreigners moved their residence elsewhere 3 has recently decided to maintain the lump-sum tax regime. In the municipality of Saanen, where Gstaad is located, 92% of the population rejected the proposal of abolishing lump-sum taxation. In the canton of Geneva On 28 September 2011, the Socialist Party of the canton of Geneva launched an initiative calling for the abolishment of the lump-sum taxation regime within the canton. The required number of signatures was collected within the deadline, which lapsed on 30 January The Geneva initiative still needs to be approved and discussed by the cantonal parliament. This process is expected to last at least two years, so a public vote is not expected to take 5

6 place before Should the initiative be accepted by public vote, the lump-sum tax regime would be abolished at the cantonal and municipal levels from the tax year following the vote. At federal level At federal level, the federal initiative was deposited on 20 November More than 100,000 valid signatures were collected for the federal initiative to be presented to popular vote. The federal initiative was launched by an alliance including the alternative left wing party, supported by the Socialists, the Green Party and the Federation of Trade Unions. Three-quarters of the signatures were collected in urban regions, particularly in the Germanspeaking part of Switzerland; the federal initiative gathered much less support in the Frenchand Italian-speaking regions. Interestingly, in regions where fewer taxpayers benefit from this tax system, there has been greater support for its abolishment. Whereas while the lump-sum taxation regime has been criticised, in particular, in certain regions of German-speaking Switzerland, it has not been confronted with fierce political opposition in French-speaking Switzerland (with the exception of the canton of Geneva). Should the initiative be accepted by popular vote, the lump-sum taxation regime will be abolished at federal and cantonal levels on the basis of a change in the Federal Constitution. The federal initiative provides for a new constitutional Art 127, para 2 bis which states: Tax privileges for natural persons are illegal. Taxation based on the expenses is forbidden'. Pressure from the outside By way of a recommendation, the Organisation for Economic Co-operation and Development (OECD) last January called on Switzerland to abolish the lump-sum taxation regime. The OECD's recommendation should however be relativised given that similar taxation methods exist in Europe, in particular in the UK. The resident but not domiciled' taxation regime which benefits some high net worth individuals in the UK is a tax regime providing non-domiciled taxpayers with the option to pay taxes on their UK sourced income and on foreign income to the extent that such foreign income is remitted into the UK. After a number of years of UK tax residency, this tax regime is subject to an annual remittance basis charge of GBP30,000 or GBP50,000. Furthermore, since 1 January 2013, the French tax authorities no longer apply the benefits of the 1966 double tax treaty with Switzerland to French nationals who are taxed in Switzerland under the lump-sum taxation regime. The modified lump-sum taxation (see above) is no longer deemed to be a valid taxation; only French nationals who are ordinarily taxed in Switzerland are now able to claim treaty benefits. LUMP-SUM TAXATION: DE LEGE FERENDA Despite the foregoing, the lump-sum taxation regime enjoys the full support of the Swiss federal government (the Federal Council). The Federal Council and the Conference of the Cantonal Finance Directors recommend maintaining the lump-sum taxation regime given its positive effect on the Swiss economy. The Federal Tax administration considers that more than 22,000 jobs directly or indirectly derive from the lump-sum taxation regime, particularly in remote regions and mountain resorts. This special tax regime attracts wealthy and mobile taxpayers to Switzerland. In order to improve the wide acceptance of the lump-sum taxation regime, the Swiss federal parliament (both the chambers of the parliament) has approved the following legislative amendments (applicable from 2016). 6

7 The minimum tax base will be increased. For both federal and cantonal income tax purposes, the new tax base shall be no less than seven times the annual rent paid or, for home owners, deemed rental value, or at least three times the costs for lodging. The minimum tax base will not be less than CHF400,000 for federal income tax purposes. The cantons will have to set thresholds for minimum taxable income too, but will remain flexible in determining the relevant amounts. It is highly likely that the cantons of Vaud and Geneva, 4 for instance, will set the minimum threshold at CHF400,000 as well. Therefore, the following amounts will have to be taken into consideration in the future: living expenses incurred both in and outside of Switzerland; seven times the amount of the accommodation costs (or three times the costs for lodging); the gross amount of the shadow/control calculation; and the new minimum tax base of CHF400,000 for federal income tax and respective thresholds for cantonal income tax purposes. The highest amount will serve as the tax base. Lump-sum taxation will no longer be possible for mixed couples': both spouses will have to be foreign nationals and each of them will need to meet the eligibility criteria. The lump-sum taxation regime will no longer be available to Swiss nationals in the year of their arrival/return to Switzerland. Tax will have to be paid based on the foreign taxpayer's wealth in all cantons. The cantons will have to take into account wealth as well, but are free to determine the respective methods. The cantons will have to implement the new law within a period of 2 years (following the changes in the federal legislation). A transitional period of 5 years will be granted to taxpayers already subject to lump-sum taxation when the new law enters into force. Existing rulings will remain applicable for a period of 5 years after the entry into force of the new legislation. In addition to the above-mentioned stricter rules, the cantonal authorities are expected to exercise more control over foreign taxpayers benefiting from lump-sum taxation and check whether these taxpayers are effectively resident in Switzerland, ie whether they actually maintain their center of life interests in the relevant canton. CONCLUSION Rather than a privileged tax regime, the lump-sum taxation regime is a specific method designed to assess the tax base. This method is justified by practical reasons: control regarding the actual income of some foreign taxpayers living in Switzerland would otherwise be extremely difficult. 5 The lump-sum taxation regime, which is intended to address the taxation of specific taxpayers with different tax situations from most people, is not in breach of the principles of equal treatment of all taxpayers and taxation based on economic capacity; only equal situations should be treated equally. Moreover, a pragmatic approach needs to be taken. The possibility of being taxed according to living expenses rather than worldwide income and assets has attracted a significant number of wealthy foreigners who have moved their residence to Switzerland. If the lumpsum taxation regime was abolished many of these wealthy foreigners would simply leave 7

8 Switzerland for the UK or other places where their specific tax situation would be addressed in a more sensible way. The result of this would be a direct loss of revenue for the Swiss tax authorities and for the Swiss economy as a whole. Adjusting the lump-sum taxation regime following the Swiss authorities' proposals appears to be a responsible approach towards tax fairness in Switzerland. Phillipe Pulfer, Partner and Oliver Sigg, Associate Froriep Renggli 4 rue Charles-Bonnet CH-1211 Geneva 12 Switzerland *Partner and associate, respectively, Froriep Renggli, Geneva. 1. Any Swiss citizen has the right to propose new legislation by launching an initiative. If he manages to collect 100,000 valid signatures in support of the proposal, it must be put to a nationwide vote. 2. In French: Halte aux privilèges fiscaux des millionnaires (abolition des forfaits fiscaux)'. 3. Following the popular vote in Zurich in 2009 against the lump-sum taxation regime roughly half the canton's taxpayers benefiting from that regime left. 4. In Geneva the minimum tax base is currently CHF300, X Oberson, Droit Fiscal Suisse (Helbing Lichtenhahn Verlag, 4th edn, 2012), p 93, n 65. 8