Federal Supreme Court Denies Tax Deductibility of Provisions for Unused Holidays

In a recent court decision (9C_192/2024, in French), the Federal Supreme Court dealt with the question of the tax deductibility of provisions for unused holidays. It remains to be seen whether this rather short and controversial decision will lead to a change in the practice of certain cantons.

Fact Pattern

A company domiciled in the canton of Geneva recognized a provision of CHF 250,000 in fiscal year 2021 for unused holidays by its employees and claimed the provision as a tax-deductible expense in its income tax return. However, the Geneva tax administration disallowed the deduction on the grounds that the provision was related to a future obligation and was intended solely to optimize the profit or gross margin of the current period.

Legal Background

According to art. 63 para. 1 lit. a FDTL (German/French), provisions recognized under commercial law are tax-deductible if they are based on an existing obligation in the financial year. Various cantons have the practice that provisions for unused holidays (but also overtime) are tax deductible, e.g., the cantons of Appenzell-Ausserhoden (link), Lucerne (link) or Zurich (StE 1993 B 72.14.1 Nr. 10).

Decision

As a general remark, it should be noted that both the facts and the technical justification of this decision are relatively short. The Federal Supreme Court ruled in favour of the canton of Geneva and denied the tax deductibility of the provision for unused holidays, both for Direct Federal Tax and for Cantonal and Municipal Taxes of Geneva. With reference to art. 63 par. 1 lit. a FDTL, the judges argued that such provisions are not necessary under commercial law and that there is no existing legal obligation in the current financial year in which the provision was recognized. It is merely a reserve for future obligations.

Deloitte’s View

If an employee receives a monthly salary and has a contractual relationship (employment contract) that has not been terminated, unused holidays do not result in an immediate financial obligation. According to employment law, unused holidays would be carried forward by granting additional time-off in a future period. Thus, the employee can take the holiday in the following year(s) against salary costs owed with regard to the respective period. However, if the contract is terminated, the employee has a legal right to be paid for the unused holidays (if it is not possible to use them until the final day of work). Although there is no financial obligation in the current financial year in the absence of termination, in practice a provision or accrual for unused holidays is regularly recognized in the financial statements for all employees. This is also provided for in the "Handbuch der Wirtschaftsprüfung" / "Manuel d'Audit" (paragraphs 512 and 760). IFRS also requires that an accrual be recognized for unused holidays (IAS 19.13a).

The Federal Supreme Court has adopted a very strict interpretation of art. 63 para. 1 lit. a FDTL, whereby all provisions relating to items other than current assets would need to meet two requirements:

• The commercially justified financial obligation must have been triggered in the respective financial year; and
• There is a high likelihood of the financial obligation to materialize.

According to a position taken by the court in an earlier ruling this year (9C_469/2023, in French), provisions related to expenses that a company has to bear only in later period due to its activities would constitute a reserve that is only tax deductible in the period where the company has to bear such costs. Burden of proof with regard to the deductibility would lie with the company recording the provision.

The decision relates to a specific individual case and the fact pattern is very rudimentarily described in the decision. It cannot be excluded that other aspects impacted the decision in the case at hand. The technical explanations are also relatively brief. Nevertheless, this decision could be interpreted to mean that unused holiday balances do not trigger a financial obligation for employees in a non-terminated relationship and that such provisions are therefore not tax deductible (in deviation from the "tax follows accounting" principle). 

It is possible that some cantons will change their current practice and that provisions for unused holiday will no longer be generally accepted as tax deductible in the future. Considering the recent court decision, provisions – like provisions for unused holidays – should be viewed more critically in the future.

Authors

• Thomas Hug - Partner, National Tax Office
• Manuel Angehrn- Director, Business Tax
• Loris Lipp - Senior Manager, Business Tax