In a recent decision (9C_690/2022, in German), a five-judge panel of the Swiss Federal Supreme Court ("Bundesgericht") dealt with the question of the types of taxes to which the annual circular on safe harbour interest rates annually issued by the Swiss Federal Tax Administration ("SFTA") applies, and whether and to what extent the circular is binding on tax administrations. The court's decision provides clarity.

Fact Pattern

A foreign group company granted an unsecured loan of CHF 0.5 billion at an interest rate of 2.5% and a current account credit line of CHF 0.5 billion at an interest rate of 3.0% to a Swiss permanent establishment of another foreign group company. In the context of the assessment of the Direct Federal Tax as well as the Cantonal and Municipal Taxes of Zurich, the Zurich tax administration did not consider these interest rates to be at arm's length and accepted only 1.08%. Although the Cantonal Administration Appellate Court of Zurich (“Verwaltungsgericht des Kantons Zürich”) also considered the interest rates to be not at arm's length, it only made an adjustment up to the difference to the maximum interest rates in accordance with the SFTA's annual circular on interest rates (1.5% and 2.0% in the relevant tax periods).

Background

Each year at the end of January, the SFTA publishes two circulars containing the interest rates relevant for the calculation of deemed dividends (German/French). The purpose of these circulars is to simplify the application of the arm's length principle in the area of interest rates on intercompany loans. These rates are safe harbour rates. On the one hand, this means that if taxpayers follow these rules, the tax administrations will accept the interest rates. On the other hand, if they do not follow the safe harbour rates, the burden of proof is reversed, and the taxpayer must prove that the interest rates are still at arm's length.

Decision

In its decision, the Federal Supreme Court had to deal with two issues regarding the application of this circular.

First, the Zurich Cantonal Tax Administration argued that the SFTA circular only applies to Direct Federal Tax and Withholding Tax (federal taxes). The court disagreed. Since corporate income tax is formally harmonized in Switzerland, the circular also applies to Cantonal and Municipal Taxes (con. 6.1).

Second, the question arose as to whether the Circular was still binding on the tax administration in this particular case, which would have limited the profit adjustment to the difference between the maximum safe harbour rates instead of 1.08%. The Federal Supreme Court clarifies that if the taxpayer does not comply with the safe harbour rates, they are no longer binding on the tax administration. Various arguments of the taxpayer based on constitutional principles (e.g., protection of legitimate expectations, equal treatment) were not accepted (con. 6.2).

Deloitte’s View

The SFTA's annual circular is basically a pragmatic tool for setting interest rates for intra-group loans without a heavy administrative burden. The circular is very brief, and it is sometimes not always clear to a layperson unfamiliar with the subject matter under what conditions these rates can be applied. Various issues are unclear and not explicitly addressed. With this decision, the Federal Supreme Court provides clarity.

The decision clarifies that the interest rates also apply to Cantonal and Municipal Taxes. This clarification is to be welcomed and is in line with the legislator's intention to harmonize corporate income taxes at the federal, cantonal, and municipal levels. On the other hand, it also clarified the conditions under which the safe harbor rates are binding on tax administrations. The Federal Supreme Court took a «quid pro quo”-view: Only if the taxpayer complies with the rates are they binding on the tax administration. If the taxpayer does not comply, the tax administration can ignore the circular and determine an arm's length interest rate as part of the assessment. Like the taxpayer, they do not have to comply with the circular.

For taxpayers, this means that they will have to comply with the circular even more strictly in the future. If the interest rates are not complied with, the taxpayer will no longer be able to rely on the safe harbor rates during an audit or appeal.

Key contact

Thomas Hug - Partner, National Tax Office

Thomas is the leader of Deloitte Switzerland's National Tax Office. He has a proven track record of being at the forefront of international tax developments and analysing their impact from a Swiss tax technical perspective. Thomas has published thought-leading articles and books, and is frequently asked by industry groups, universities and tax and accounting associations to make presentations or lead seminars. He serves as a substitute judge at the Zurich Tax Court of Appeal.

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George Galumov - Partner, Transfer Pricing Financial Transactions Leader

George is a Partner within the Transfer Pricing team at Deloitte in Switzerland. George has more than 14 years of transfer pricing experience covering tax and transfer pricing aspects of various intra-group transactions, including business model and transaction flow design, M&A activity, as well as more mainstream transfer pricing documentation and planning engagements.

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