Federal Supreme Court Ruled Fluctuation Reserves Not Tax-Effective

In a key decision taken in a five-member formation and intended for publication (9C_625/2023, in German), the Federal Supreme Court addressed the question of whether the accounting recognition of fluctuation reserves on assets with market values in accordance with art. 960b para. 2 of the Swiss Code of Obligations (“CO”) (German/French) is tax-effective. The decision could lead to a change in practice in various cantons.

A company can choose to measure assets with an observable market value (e.g., listed shares and bonds) in the financial statements in two options:

• Option 1: valuation at historical cost, taking into account any losses in value (“at cost”, art. 960a para. 2 CO, German/French)
• Option 2: valuation at market value at the closing date (“at market value”, art. 960b para. 1 CO, German/French).

The company must measure all assets with an observable market value either according to option 1 or option 2, and indicate the method chosen in the notes. If the company opts for option 2, it may (election right), in accordance with art. 960b para. 2 CO (German/French), additionally create a fluctuation reserve (“Schwankungsreserve” / “réserves de fluctuation”; in the sense of a value adjustment) to take account of future losses in value. However, this fluctuation reserve must not result in the net value of the assets (market value of assets less fluctuation reserve) being lower than the historical acquisition costs.
 

Fact Pattern
 

A legal entity domiciled in the canton of Zurich had a sizeable securities portfolio that was recognised and measured at market value. In the 2019 tax year, it achieved a book gain of around CHF 500,000 on this portfolio. The company increased the fluctuation reserve by the same amount, which – together with the balance from previous years – now totalled around CHF 1.6 million. The Cantonal Tax Administration Zurich offset the entire CHF 1.6 million on the grounds that the fluctuations in future years could also be positive and therefore the fluctuation reserve was not justified for business reasons. The case was submitted to the Federal Supreme Court for review.
 

Court Decision

The Federal Supreme Court first stated that such fluctuation reserves are permissible under commercial law and that there is no reason not to recognise losses in the value of securities in the accounts – comparable, for example, to bad debt allowances on client receivables or the flat-rate valuation allowance on inventories (“Warendrittel”). However, these differ in one important respect: impending future losses on securities are future events that have not yet occurred on the closing date and therefore do not justify any provision or value adjustment. In the case of bad debt allowances or value adjustments on inventories, a provision for presumably existing liabilities is determined on a flat-rate basis based on experience. Fluctuation reserves are therefore not justified for business reasons and must be offset for tax purposes. According to the Federal Court, the only exceptions are cases in which a short-term sale is excluded for legal or valid commercial reasons. In such cases, tax offsetting may be waived.

The Federal Supreme Court pointed out that in an earlier decision (2C_243/2012, in German), it had ruled that flat-rate value adjustments on securities, as known in certain cantons (e.g. Bern, Solothurn, formerly Zurich for banks; percentage of fair market value of securities), were permissible. This decision remains valid, according to the judges. However, there is no legal basis for such flat-rate value adjustments, which is why the cantons do not have to grant them.

Furthermore, the Federal Supreme Court does not see any violation of the “tax follows accounting”-principle. Such fluctuation reserves are an election right only. Nor does the Federal Supreme Court see any unequal treatment of companies that use option 1 for measuring.

Deloitte’s View

With this decision, the Federal Supreme Court has clarified that fluctuation reserves are not tax effective. The issue has been the subject of heated debates among experts for several years. The decision affects both Direct Federal Tax as well as Zurich Cantonal and Communal Taxes. We expect this decision to lead to a change in practice in various cantons. What is confusing about this decision, however, is that according to the Federal Supreme Court, fluctuation reserves determined on a flat-rate basis (percentage of market value of securities) should continue to be valid with reference to an earlier decision. This differentiation is incomprehensible. However, the Federal Supreme Court points out that there is no legal basis for these cantonal lump-sum practices. It remains to be seen whether the cantons concerned will adapt their lump-sum practices as well. If a company wants to avoid taxation of book profits until they are realised, there is only one option left: valuation according to option 1 (“at cost”).

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