Robert Waldburger University of St. Gallen Tax competition in Europe National Report Switzerland I. General aspects of the domestic tax situation 1. The notion of 'tax competition' in domestic legal and economic science Tax competition in Switzerland has not as yet been the subject of research in legal science. Several economists have, however, worked on the effects of tax competition between the cantons and came to the general conclusion that tax competition has positive effects on the economic development of the country. No 'race to the bottom effects were identified. For many years a code of conduct on harmful tax competition has existed in Switzerland in the form of an agreement between the cantons addressing issues such as tax holidays for newly established enterprises or the prohibition of individual tax arrangements between tax authorities and tax payers 1. Another element which limits tax competition to a certain extent is the federal law on tax harmonisation, which had to be implemented by the cantonal legislative bodies by the end of 2000 2. This law contains provisions setting up a framework for the establishment of the tax base and therefore limiting tax competition between cantons in this area. In accordance with the constitution however the cantons continue to be free to set tax rates and tax competition between cantons may therefore be seen as a Constitutional principle in Switzerland. 2. The political attitude of the government towards tax competition As far as inter-cantonal tax competition is concerned, the federal government has always supported the harmonisation of the tax base, yet at the same time it has emphasised the importance of tax competition on the level of tax rates. The position of cantonal governments depends by nature of the competitive position of the respective cantons. High taxing cantons are rather critical, whereas governments of low taxing cantons tend to consider tax competition between cantons more favourably. With regard to international tax competition, in 1996 the Swiss federal government signed the mandate given to the OECD Committee on Fiscal Affairs to counteract harmful tax competition. However, for a variety of reasons (see published statement in the 1998 report 3 ) the Swiss government abstained from the report adopted by OECD on 27. April 1998. This abstention was subsequently (indirectly) approved by the federal parliament (National Councillor Rudolf Strahm (BE) wanted parliament to give the government a mandate to adopt all recommendations in the 1998 report not related to banking secrecy; this initiative was rejected in parliament by a large majority) and this abstention was confirmed by the government for subsequent work of the OECD Forum on Harmful Tax Competition (renamed in 2001 to the 'Forum on Harmful Tax Practices ) and is therefore still valid. 3. The distinction between fair and unfair competition 1 Article 1 paragraph 2 Interkantonales Konkordat über den Ausschluss von Steuerabkommen vom 10. Dezember 1948 2 Article 72 Bundesgesetz über die Harmonisierung der direkten Steuern der Kantone und Gemeinden vom 14. Dezember 1990 3 OECD, harmful tax competition, annex II, pages 76-78 C:\Eigene Dateien\e-mails Eingang\Switzerland.docQ:\IFF\RECHT\Waldburger\PUBLIKAT\TaxCompetitionEurope final version.doc
2 Apart from the rules laid down in the 'code of conduct agreed upon by the cantons (mentioned in para. 1 above) no legal rules are existing which would allow a legal distinction between fair and unfair competition. 4. Economic effects of tax competition in Switzerland 4 Compared to other European countries Switzerland has rather low taxes. This is true of personal income taxes, as well as corporate taxes. This might be one result of tax competition in Switzerland, although the political system of direct democracy might be a second important reason. Within Switzerland there is a large degree of variation between the different cantons with respect to their welfare situation: There are rich cantons such as Zug or Zurich and poorer ones such as Appenzell or Jura. Although the correlation is not perfect, the rich cantons generally have lower tax rates than the poorer ones, but sometimes more public expenditure per capita. Apart from the last few years perhaps, there is no indication that this variation has increased over time, or that a race to the bottom has taken place with respect to personal income and corporate taxes. Nevertheless, in recent years political demands for fiscal equalisation have increased. Although the tax share of GDP is lower than in other European countries, there is no indication of an under supply of public goods. Moreover, despite tax competition between the cantons there is still a considerable amount of income redistribution within the cantons due to the progressive nature of cantonal income taxes. On the other hand, in addition to the cantonal income taxes there is a highly progressive federal income tax (direct federal tax) and the first pillar of the old age pension system, which is highly redistributive, is also federal. Thus, major parts of the redistributive system are assigned to the federal level. The Swiss welfare system is well-developed and taken as a whole certainly not less developed than in many other Western European countries. The picture is different with respect to special parts of the welfare system; there is still no general insurance for maternity leave, for example. The reason for this, however, might be found in the Swiss system of direct democracy rather than in the system of tax competition within Switzerland. II. Elements of tax competition in the domestic tax system 1. Tax rates Without exception, all corporate revenue is subject to direct federal tax at the statutory tax rates. In addition, businesses organised as legal persons are subject to withholding tax of 35% on all profit distributions, whether such distributions are officially approved by the general shareholders meeting or whether they are made hidden. Consequently, at federal level, no preferential regimes exist. As mentioned in Part I, the cantons are free to set their own tax rates. However, they do not distinguish between foreign and domestic investors. Both are treated equally. 2. Tax accounting At the direct federal tax level no specific rules for tax accounting exist. Though the valuation rules and practices can be regarded as generous from the taxpayer's point of view. But these rules are applied equally, whether a company is domestic or foreign owned, whether it is generating income from domestic or foreign sources. The situation at cantonal level may be summarised as follows: The federal law on tax harmonisation provides that the entire profit of a company has to be taxed. An artificial definition of the tax base is therefore not allowed. Art. 28 of the federal law on tax harmonisation, however, provides for special treatment of socalled 'holding, administrative and mixed companies. 4 The author thanks his colleague, Prof. Gebhard Kirchgässner for drafting this section
3 Holding companies are not subject to cantonal taxes at all, whereas the foreign sourced income from administrative and mixed companies enjoys partial relief from cantonal taxation. However, such relief is granted to all companies whether domestic or foreign owned. Due to the fact that there are no preferential regimes at federal level and since any profit distribution is subject to the 35% withholding tax, the Swiss government is of the view that no harmful regimes exist in Switzerland. Even the 1998 OECD report on harmful tax competition recognises that the starting point of the harmful regime test is 'low or no taxation. Since the Swiss system excludes such situations of no or low taxation, its corporate taxation cannot represent harmful tax competition in the sense of the 1998 OECD report 5. 3. Double taxation relief and other advantages for cross-border business The Swiss tax system is based on capital import neutrality. The law on direct federal tax therefore provides for the exemption of profit generated in foreign branches of Swiss companies. Although the federal law on tax harmonisation does not address the international allocation of business profits, the cantons grant tax relief on profits from foreign branches as well. Consequently, dividends from both domestic and foreign subsidiaries are tax exempt in Switzerland. These measures against double and multiple taxation are applied irrespective of the ownership of the companies. Income from inbound investment is treated in the same manner as income from domestic corporations. In the area of transfer pricing, Swiss legislation without exception is based on the dealing at arm s length principle. Although there is no specific legislation or regulation on transfer pricing of multinational enterprises, Swiss tax authorities generally respect the principles worked out by the OECD Committee for Fiscal Affairs. As far as the international exchange of information is concerned, Switzerland has made a reservation to Art. 26 of the OECD model convention. With the exception of the convention with the United States of America and the revised conventions with Germany (signed) and Norway (initialled), Switzerland only grants information to foreign tax authorities which is necessary for the correct application of the tax convention, but not information regarding the correct application of the internal law of the foreign country. Consequently, Switzerland is also prevented from requiring such information for its own taxation purposes. In cases of tax fraud committed in another country, Switzerland does provide legal assistance based on the 'International Mutual Assistance Act of 1981 6. Following the report of the OECD Committee for Fiscal Affairs on improving access to banking information for tax authorities (published in April 2000), the Swiss government gave the Federal Tax Administration a mandate to negotiate clauses in bilateral tax treaties providing for the exchange of information for enforcing internal tax laws in cases of tax fraud under Swiss legislation. At present negotiations have been started with Belgium, Ireland, Italy, Japan, Spain and the UK and have been completed with Germany and Norway. 4. Procedural advantages Switzerland has a long tradition of open dialogue between tax authorities and taxpayers and therefore informal rulings are available in many instances. However, this dialogue is not limited to specific situations e.g. foreign investors. At federal level, rulings in the formal, legal sense are only available for VAT, withholding tax and stamp duties, but not for direct federal 5 In the OECD progress report of 2001 entitled 'Towards global tax co-operation Switzerland has however accepted that administrative companies and service companies taxed on a fixed cost-plus basis were listed as 'potentially harmful. This was due to the fact that the Forum on Harmful Tax Competition had not defined the term 'no or low taxation but listed all preferential regimes of its member countries as potentially harmful. Switzerland preferred to be listed together with regimes of almost all OECD member countries rather than being isolated. Whether its regimes are actually harmful has not yet been decided. Due to its abstention from the 1998 report, Switzerland is in any case not bound by the view of the OECD Forum on Harmful Tax Practices. 6 Article 3 paragraph 3 Bundesgesetz über internationale Rechtshilfe in Strafsachen vom 20. März 1981
4 direct tax (exception: rulings on the existence of tax liability). Whether legal rulings are available for cantonal tax depends on the respective cantonal tax laws. If the term tailor-made decisions used by the general reporter? were to mean decisions not in line with applicable law, such decisions if they were ever issued would be illegal. III. Measures against 'unfair competition in the domestic tax system 1. General anti-avoidance rules Generally, tax laws do not contain specific anti-avoidance provisions (exception e.g. Art. 21 para. 2 of the law on withholding tax). Tax avoidance schemes are however not accepted by courts, based on the general rule against abuse of laws. 2. CFC legislation Switzerland has not introduced any kind of CFC legislation. 3. Residence Rules Swiss residence rules reflect the international standard in this area. Companies are treated as resident and are therefore subject to unlimited tax liability if they are incorporated in Switzerland or if effective management is exercised here. Individuals are deemed resident for tax purposes if they have their residence in the country according to civil law or if they have a qualified presence in Switzerland (90 days without and 30 days with employment). 4. Restrictions of deduction of payments to tax haven entities Provided the payments are economically justified, they are deductible irrespective of the location of the recipient. Therefore the only restriction is a lack of economic justification. Should economic justification be lacking, the deduction is denied irrespective of whether the recipient is located in a country with high taxes or a so-called 'tax haven. 5. Other As long ago as 1962, Switzerland enacted unilateral rules against the misuse of its tax conventions. These rules basically prevent foreign and Swiss owned corporations from channelling income through Switzerland into a foreign country which benefits from tax conventions. This domestic legislation, together with rules of application, have been introduced into the tax conventions with Belgium, France, Germany 7 and Italy. The convention with the United States of America contains a specific limitation on benefits clause. IV. Measures against 'unfair competition at international level 1. Double taxation conventions Apart from the clauses against the abuse of tax conventions mentioned in Part III para. 5, no provision against 'unfair competition may be found in taxation agreements concluded by Switzerland. 2. EC As Switzerland is not a member of the EU, it is not directly affected by the code of conduct on enterprise taxation. 3. OECD 7 Once the revised treaty is in force, the missuse clause will be deleted
5 As mentioned above, both the government and (indirectly) the parliament have abstained from the OECD report on harmful tax competition adopted in 1998 and Switzerland is not supporting the respective work of the Forum on Harmful Tax Competition (renamed in 2001 to 'Forum on Harmful Tax Practices ).