Switzerland joins new corporate tax landscape

The OECD and EU want to put an end to multinational corporations such as Starbucks, Apple, Google or Fiat making use of legal loopholes to limit the amount of corporate tax they pay Mike Blake / Reuters

It’s about to get a lot harder for multinationals to avoid paying taxes, with numerous international bodies working on new global standards. Switzerland intends to play its part by putting an end to tax breaks for foreign companies.

From 2017, multinationals will have to pay taxes in the countries where they actually operate and will not be able to resort to sleight-of-hand to avoid paying tax. That’s the goal of Base Erosion and Profit Shifting (BEPS), a project of the Organisation for Economic Cooperation and Development (OECD) supported by the G20 group of industrialised and emerging economies and the European Union (EU). 

The project, which would represent a massive leap forward in international tax cooperation, seeks to introduce worldwide standards to stop gaps in legislation at national level.

Currently, those often allow multinationals to reduce or avoid tax, eroding many countries’ tax bases. In the EU’s view, about €1 trillion (CHF1.2 trillion) more should be going into European tax coffers every year.

After having held out for ten years against pressure from the EU, which regards Swiss cantons’ special tax regimes as state subsidies that distort free competition, Switzerland has also signed on to the new BEPS standards.

“BEPS is indeed highly ambitious,” says René Matteotti, who teaches international tax law at the University of Zurich.

“With this huge package of measures, the OECD intends to drastically alter the basis of the international tax system. It remains to be seen to what extent the project can be actually implemented, given that there are attempts to water it down, especially from the American side.”

Accounting tricks

Currently, the taxation of transnational companies is regulated by over 3,000 different kinds of bilateral agreement around the world. Originally, those agreements were developed to avoid double taxation of multinationals. But now, according to the OECD, they are often used by such corporations to “optimise” their tax burden or indeed to dodge taxes in both of the countries involved.

While domestic companies in member states pay between 20% and 30% of their profits to the taxman, multinationals – which have sophisticated mechanisms for tax planning  – generally pay only 5%.

To achieve this, they rely on a series of accounting tricks, 400 of which the OECD has documented. Those include exporting profits to jurisdictions with low tax rates, creating hybrid corporations and financial instruments (used to exploit the lack of coordination between different countries’ legislation), and routing direct investments through tax havens.

In addition, multinationals engage in tax optimisation through artificial “transfer pricing” (the prices charged for goods, services, patents or other benefits between companies belonging to the same corporate group).

In September, the OECD announced an initial package of measures intended to harmonise taxation principles and establish a new kind of convention against double taxation. It would plug the current loopholes and prevent profits being shunted from one country to another. The project also aims to create more transparency on cross-border activities, tax structures and operations within groups by the multinationals.

Harmful tax practices

“The aim is to tax value added and thus the profits of multinationals in the countries in which their products are actually made,” says Matteotti. “The problem right now is that tax authorities do not have enough information about this.

BEPS is designed to introduce greater transparency: on the one hand, companies will have to supply information on their tax structure in other countries automatically, and on the other hand, states are to exchange this information and give each other administrative assistance without having to be asked.”

The action plan also takes aim at “harmful tax practices” followed by states which offer tax breaks to attract multinationals. The OECD has been taking a careful look at “rulings” – preliminary agreements between states and corporations which provide for special rates of taxation – as practised by Ireland, Holland and Luxembourg, considered among the main offenders.

Also coming under scrutiny are “patent boxes” or “IP boxes”, taxation regimes that give preferential tax treatment to profits derived from patents and other intellectual property. That method is used by Britain, Holland and Belgium.

For some time, the OECD and the EU have also been casting a critical eye on Swiss tax practices. They are particularly wary of the tax privileges individual cantons give to holdings, mixed companies and foreign management companies that operate abroad and only carry out their administrative work on Swiss territory.

Profits made by these companies elsewhere in the world are taxed at a much lower rate than those earned by companies actively operating in Switzerland. Thanks to these preferential arrangements, quite a few Swiss cantons are able to offer some of the most attractive corporate tax environments in the world.

Pragmatic solution

In late September, the Swiss government presented its latest proposal on corporate tax reform, in which it recommends giving up the preferential regimes. And in mid-October, the Swiss government signed an accord with Brussels promising to abolish cantonal tax regimes as long as EU members refrain from any of the retaliatory measures that had been threatened.

Only a few years ago, such a concession would have raised a chorus of protest from cantons, business organisations and business-friendly political parties. But now, as in the case of banking secrecy, it seems clear to all that Switzerland can no longer remain aloof with regard to the new international standards, supported by the world’s major economies.

Sanctions from the EU were imminent and would have done serious damage to the operations of Swiss-based companies in its member states.

“From a strictly legal point of view, Switzerland could defend its tax sovereignty and opt for arbitration by the World Trade Organisation (WTO) in case of retaliatory measures by other countries,” Matteotti say. “But from a political and economic point of view, Switzerland cannot put at risk the security of law and the guarantees of stability which are needed by companies domiciled on Swiss territory.”

“The government’s decision to give up the preferential regimes, as long as the new standards hold for all countries, is a pragmatic step in the right direction.”

BEPS

The BEPS (Base Erosion and Profit Shifting) project is being regarded as the most substantial update to the international tax system in upwards of a century. Standards for international tax law were developed under the auspices of the League of Nations in 1923. Since then, there have been only minor changes, and the standards have not developed in step with the activities of multinationals.

In recent decades, these corporations have been able to step up their transnational activities due to the progress of telecommunications, the liberalisation of trade, and increasing capital flows. In September, the OECD presented an initial package of measures as part of BEPS, aimed at harmonising the international tax system by 2017. The complete action plan is due by 2015.

New tax reform

The Swiss government’s latest corporate tax reform draft legislation includes a proposal to give up three preferential tax regimes offered by the cantons to holding companies, mixed companies and foreign management companies.

To avoid an exodus of these corporations, the government is proposing that the cantons lower their tax rates on profits across the board for all companies, whether Swiss or foreign. The government also recommends introducing other measures, including the “patent box” (or “IP box”) idea used by some other European countries.

It will also compensate any losses of tax revenue by the cantons to the tune of CHF1 billion per year. The government’s own loss is to be offset by introducing a tax on capital gains. The draft legislation has been put out for consultation until the end of January 2015. The timing for the presentation of a bill to parliament depends on international developments, in particular how the BEPS project progresses.

(Translated from Italian by Terence MacNamee)