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Tax Review — June 2014: scope of succession to protection rights under tax rulings issued for legal predecessor; and more
1 July 2014
Switzerland has sometimes been perceived as insular as far as regulation of its financial system is concerned. That view is in need of revision.
Switzerland has entered into various bilateral agreements with the EU, recently deciding to extend them to the 10 new accession states by way of popular vote. They cover a wide area, including in particular free movement of persons and the taxation of savings income. What is more, international procedural assistance and effective anti-money laundering regulation have long been a matter of course. The era in which funds from dubious sources could too easily benefit from Swiss banking secrecy laws is a thing of the past.
Residence in Switzerland
EU nationals have the right to take up residence in Switzerland, provided they are in gainful employment or otherwise able to finance their own living expenses. Limited quota restrictions still apply to nationals from the EU's 15 states until 2007. More severe restrictions still apply to nationals from the new accession states, which will gradually decrease until disappearing altogether in 2014.
Lump sum taxation and estate tax
Foreign nationals taking up residence in Switzerland may apply for taxation under the lump sum regime, under which tax is levied on the basis of a predetermined income. A successful application is conditional on the foreign national taking up primary residence in Switzerland (often entailing a minimum duration of stay), not having had Swiss residence in the 10 years preceding relocation to Switzerland and having no gainful activity in Switzerland. Any gainful activity outside Switzerland is permissible and some cantons will allow limited activity in Switzerland as a company administrator.
Under that regime, tax is levied both at cantonal and federal level on the basis of a predetermined income. This will normally be equivalent to five times the cost of Swiss accommodation (rent paid or the deemed rental value of owned accommodation). The amount of tax payable may not be lower than the tax that would be due by application of the ordinary tax rate to the taxpayer's Swiss income and any treaty-favoured income.
Disclosure will normally be required merely of the agreed living expenses, the Swiss income and the foreign income for which treaty relief is claimed.
Estate taxes (inheritance and gift tax) are levied at cantonal level only on the life or death transfer of assets of a person resident in Switzerland. Transfers to spouses and to descendants are, with minor exceptions, generally exempt.
Recognition of trusts
Trusts have long been accepted as a reality by Swiss courts and ratification by the Hague Convention of trusts is imminent. The taxation of trusts and their settlors and beneficiaries is still a matter of considerable uncertainty. Generally, Swiss tax authorities will accept the trust assets as being excluded from the beneficiary's estate, hence income arising in the trust will not be taxed. Distributions to an individual subject to ordinary taxation will normally give rise to income tax, while those to lump sum taxpayers do not. While it is widely accepted that this uncertainty is in need of being remedied, it nevertheless affords the cantonal authorities a fair deal of freedom, not necessarily to the detriment of the taxpayer's interest.
Taxation of savings income
Earlier this year, the agreement on taxation of savings income between Switzerland and the EU (savings tax agreement) came into force.
Under its terms, EU residents with assets in Switzerland may choose between tax retention on interest payments or voluntary declaration of those assets to the tax authorities of the relevant EU state. Tax is retained on all interest payments made by a Swiss paying agent to such EU residents at a rate of 15 per cent until 2008, 20 per cent until 2011 and 35 per cent thereafter. Thus, Switzerland ensures that the EU directive on the taxation of savings income cannot be circumvented by the mere parking of assets in Switzerland and, at the same time, maintains the fiscal banking secrecy.
It is noteworthy that, as part of the savings tax agreement, taxation at source on payments of dividends, interest and licence fees between affiliated companies in Switzerland and EU states was abolished (dividends paid by UK subsidiaries to Swiss holding companies are no longer subject to UK withholding tax).
As in other jurisdictions, Switzerland distinguishes between judicial and administrative assistance (direct cooperation between administrative authorities).
As regards judicial assistance, Switzerland adheres to the 1959 European Convention. The country enacted a federal statute based on which Swiss judicial authorities may render international assistance in the absence of any bilateral or other agreement. Accordingly, Switzerland will generally agree to render judicial assistance provided the usual conditions are met, including especially the requirement of double criminality and of restricted specific use of the information requested and transmitted (speciality). Mutual assistance requests are routed through a federal authority in Berne.
International administrative assistance may only be rendered on the basis of specific legislation. Currently, specific provisions allow for international assistance to be rendered by supervisory authorities in the field of banking, stock exchange, investment funds and money laundering and, in the near future, auditing (the enactment of new auditing legislation is expected in 2006).
When approached for international assistance in fiscal matters, Swiss authorities will generally distinguish between tax evasion (when a tax return is not submitted or is incomplete), which is sanctioned by a fine at administrative level, and tax fraud (eg tax evasion by means of falsified documentation), which is considered a crime that would be prosecuted by the criminal authorities. In accordance with the above principles, international assistance may only be rendered in criminal matters - that is, in cases of tax fraud, but not tax evasion. This also applies under the terms of the savings tax agreement and double tax agreements concluded with EU member and other states.
This choice to sanction tax evasion on an administrative level and punish only tax fraud as a crime may be perceived as odd. A main motive, therefore, which underlies the entire Swiss tax system is the notion that enforcement of tax laws is most efficient when applying moderate tax rates and levying fairly heavy withholding tax on income of assets (currently at a rate of 35 per cent).
Money laundering legislation
In fighting money laundering, Switzerland relies on three main pillars - namely its Penal Code, the Money Laundering Act (MLA) and, based on long tradition in the banking industry, self-regulation. In addition, Switzerland has taken part in, and actively contributed to, various international initiatives such as the 40 recommendations of the Financial Action Task Force.
The scope of the MLA is substantial. The MLA applies to all so-called financial intermediaries (FIs). Next to banks, and insurance and securities dealers, anybody dealing with third-party assets in their capacity as a professional, including in particular trust providers and lawyers, qualifies as an FI. Under penalty of heavy fines, any FI must first identify the contracting party and establish the identity of the beneficial owner of the assets beyond any doubt; second, they must report any assets potentially deriving from criminal activity to the Federal Office for Police's Money Laundering Reporting Office.
Offshore jurisdictions are commonly associated with lack of taxes, loopholes in financial supervision and money laundering regulation, and confidentiality (arguably bordering on a lack of cooperation). While it is fair, and indeed right, to say that Switzerland may seem attractive to foreign taxpayers in several respects, it is obvious that Switzerland is not an offshore financial centre to the extent that the term implies a fragmentary or inadequate regulatory environment.
Although it would not appear to be a problem for Swiss financial institutions, awkward issues could arise in other jurisdictions where clients elect to pay the withholding tax rather than make a declaration to the tax authorities in the relevant state. Banks could be placed in a dilemma - would this (perhaps with other factors) tip the balance in favour of filing a suspicious activity report? Clear guidance will be required from the relevant regulatory authorities to avoid inconsistency in approach. n Pressure from the Organisation for Economic Cooperation and Development (OECD) regarding the application of the EU Savings Directive, and the allied negotiations between the EU and Switzerland, have created a situation where, in the OECD's attempt to level the EU tax recovery playing field and to reduce tax leakage by the use of structures taking advantage of some member states' tax benefits, tax advantages have been highlighted in states such as Luxembourg, Ireland, the Netherlands and Denmark.
The regimes have differed. For example, Luxembourg provided a good general tax-friendly regime, whereby full use could be made of its extensive double tax treaty network to minimise withholding taxes on payments made from other member states to Luxembourg, and utilising tax rulings to permit onward distribution of such receipts at a minimal tax cost. A similar type of regime applied in the Netherlands, where the use of Dutch companies and Dutch Antilles holding companies permitted a convenient route for the transfer of profits out of EU countries at a 4.2 per cent maximum tax rate.
Many of these structures were used for corporate tax planning, but such structures were also used in significant numbers by private client investors to mitigate their European tax liabilities, particularly in relation to royalties and real estate investment. For example, taxation arising from real estate investment in France and Germany could be reduced significantly by using the 'double Dutch' route.
The tax authorities in those countries became increasingly concerned at the loss of tax caused by such arrangements, and the introduction of legislation and alterations to the double tax treaties reduced the effectiveness of such structuring - although ever-inventive tax practitioners would usually discover some new method of mitigation as soon as a particular route was closed down.
Except for some very specific double tax treaty use, the offshore centres such as the Isle of Man and the Channel Islands were not particularly involved in these arrangements other than being, perhaps, the ultimate recipients of the funds realised. From a UK perspective, because of its capital gains tax regime, which does not tax non-residents, the use of onshore European structures was usually not necessary, except where royalties or similar income arose in the UK.
As a result of the pressure brought by the EU's Code of Conduct Committee to reduce 'harmful tax practices', the EU Savings Directive countries within Europe are being forced into reorganising tax regimes that discriminate between taxpayers. For example, exemptions or reliefs which have a specific geographical limit, such as the Dublin scheme, are no longer regarded as appropriate, with the result that Ireland has abolished such special treatment and in 2002 introduced a general low rate of corporation tax of 12.5 per cent, applicable to all Irish companies. Similarly, Cyprus, which had an attractive 4.5 per cent tax regime for its offshore companies, has introduced a general 10 per cent tax rate for companies; but in the case of Cyprus, it has introduced a number of reliefs and exemptions which reduce significantly the impact of what might otherwise have been a substantive increase in the tax liabilities of such companies.
This has been mirrored in the offshore jurisdictions by, for example, Jersey, Guernsey and the Isle of Man deciding that they will move to a zero per cent corporate tax regime for all companies so that there is no differential between tax paid by local companies and tax payable under their offshore regimes. However, many of the Caribbean jurisdictions remain undecided as to how to proceed.
Generally, EU countries have been moving towards lower corporate tax, and the introduction of holding company legislation in a number of jurisdictions, the UK being a prime example, has increased the attractiveness of those jurisdictions.
Allied to the above has been the finalisation of the terms on which the EU Savings Directive will be applied, which has enabled Luxembourg in particular to retain its bank secrecy rules by imposing a withholding tax of 15 per cent where disclosure of beneficial ownership is not a route that the customer wishes to take. This provides EU countries with the same possibility as that which applies to Switzerland, which now governs the retention or otherwise of the internal EU tax-friendly states.
This has enabled Luxembourg to retain its full complement of tax-efficient corporate entities, although it has altered some of the exemptions applicable to 1929 holding companies (Luxembourg companies exempt from all tax - including withholding taxes - other than capital duty and the annual 'taxe d'abannement') to make them less aggressive. The use of those companies within the EU can still provide a very attractive route for minimising tax, and Luxembourg (despite its high costs) has once again become the principal player in the onshore taxation game.
An example of the increasing low tax competition is the attempt by Denmark (never a big player in this field) to become more heavily involved as a tax-efficient jurisdiction. Some years ago, Denmark abolished withholding tax on distributions from Danish companies. By making use of Denmark's extensive double tax treaty network, it is possible to transmit funds from other European jurisdictions through Denmark without suffering any further tax charge. Very recently, Denmark has legislated to provide that Danish companies no longer pay capital gains tax on foreign real estate, and in conjunction with its other benefits (including income tax exemption in such circumstances) it is moving up the scale of jurisdictions which should be included in any consideration of tax-efficient structures.
No doubt there will be much debate in the future as to the political correctness of EU member states seeking to override the spirit of the principle of an all-equal and transparent EU taxation regime, but it is clear that there are significant tax advantages still to be obtained from taking steps to structure trades and investments by the use of entities set up in carefully chosen EU jurisdictions. Indeed, there is a continuing thrust by a number of countries to maintain and expand their shares of the market for such tax-efficient structures, and there will be continuing opportunities for practitioners and their clients to be creative in their pursuit of reduced taxation.
Michael Fischer is an associate with Froriep Renggli and Collingwood Thompson QC is a barrister at Seven Bedford Row