Swiss Federal Tax Administration’s new Q&A on transfer pricing

On 23 February 2024, the Swiss Federal Tax Administration ("SFTA") launched a new website on which the administration published its transfer pricing practice for the first time in the form of a Q&A. The website is initially available in German and French. This launch goes hand in hand with the recent transfer pricing paper published by the Swiss Tax Conference (see our blog). Which topics does the SFTA address (and which not), and how do Deloitte's transfer pricing experts assess the SFTA's newly published practice?

General comments on the SFTA's new website

For the first time, the SFTA is making its practice on selected transfer pricing issues publicly available on its new website in the form of a Q&A (four topics - 41 questions). This is a new approach, as such information is usually provided in the form of formal circulars ("Rundschreiben" or "Kreisschreiben"). It is unclear whether this practice applies only to direct federal tax and withholding tax or also to other taxes such as VAT. It is also unclear whether this information is also addressed to the cantonal tax administrations, which would be welcome. Unfortunately, the practice of cantonal tax administrations is often inconsistent. The SFTA points out that the practice outlined only applies to cross-border transactions. As transfer pricing issues are increasingly arising in intercantonal arrangements as well, a broader application of the Q&A would be welcome. A clarification of the scope and formal content of this Q&A would be desirable (e.g., taxes covered, addressees).

Applicability of the OECD Transfer Pricing Guidelines

The SFTA correctly points out that although the OECD Guidelines are not legally binding on Switzerland, they are often used by tax administrations and courts as a source of interpretation of the arm's length principle. This statement once again emphasises that the SFTA will align its practice even more closely with the OECD Guidelines in the future, which is to be welcomed. As the OECD Guidelines are regularly updated, the SFTA could have commented on the applicability of new versions to older transactions. For example, since the 2022 update, the Guidelines contain new provisions on financial. It is unclear whether these would also apply to situations arising in 2021 or earlier.

Cost-plus method (Questions 1 – 9)

The SFTA begins by commenting on the cost-plus method and explaining how it works. Unfortunately, the SFTA remains imprecise and does not distinguish between the cost-plus method and the transactional net margin method (“TNMM”). While the cost-plus method is based on a gross profit mark-up (mark-up on purchase or production costs), the TNMM is typically based on a net profit mark-up (mark-up on total operating expenses). What is typically referred to in Switzerland as a “cost-plus method” (e.g., compensation of services) is actually a TNMM. This inaccuracy repeatedly leads to misunderstandings in discussions with TP experts from abroad.

The SFTA points out in its Q&A that the cost mark-up must be derived from an arm's length comparison. It is particularly important that the comparable transactions and the controlled transaction have the same cost basis. The SFTA points out that the comparable transactions regularly do not include non-operating costs (e.g., taxes, financing costs). The previous Swiss practice of including taxes in the cost base has thus been definitively abolished. This change in practice has already been confirmed orally by the SFTA (see our blog). Reference is also made, and rightly so, to pass-through costs for which, according to the OECD, no cost mark-up may be applied due to a lack of own functions performed and risks assumed. Finally, reference is made to the simplified approach proposed in the OECD Guidelines and adopted by Switzerland for low value-adding services (flat-rate mark-up of 5% without a benchmark study).

Withholding tax in the case of primary, corresponding, and secondary adjustments (Question 10 – 16)

The SFTA first emphasises that primary and corresponding adjustments are usually made by the cantonal tax administrations and typically relate to corporate income tax, with a corresponding adjustment generally requiring a mutual agreement procedure ("MAP"). If a primary adjustment results in a repatriation of profits, the withholding tax will only be waived if a MAP or an internal agreement under art. 16 StADG (German/French) exists.

Secondary adjustments, on the other hand, concern withholding tax and therefore fall under the responsibility of the SFTA. If not addressed in the MAP, the SFTA will levy the withholding tax. If addressed, the repatriation of profits must take place within 60 days of the conclusion of the MAP.

US Tax Court decision Altera v. Commissioner (Questions 17 – 20)

The SFTA then deals with cost sharing arrangements ("CSAs"), which are widespread in the US. Although the SFTA explicitly states that such arrangements are neither provided for in the OECD Guidelines nor do they exist in Switzerland (which is in fact not a correct statement), it refers to a US Tax Court judgement (Altera v. Commissioner, dated 7 June 2019) and declares its contents to be the practice of the SFTA. At first sight, this approach of applying the principles of a US court decision to Swiss fact pattern is surprising, but from the taxpayer's point of view it is to be welcomed. Since, according to the cited US judgement, share-based payments are also to be counted as costs of a CSA, they are regarded as tax-deductible expenses in Switzerland.

Intra-group loans (Questions 21 – 41)

The last and longest part of the SFTA deals with intra-group loans. First, the SFTA refers to its safe-harbour interest rate circular (see our blog). If this is complied with, the taxpayer does not have to benchmark the interest rates applied. However, the condition is that the transaction falls within the scope of the circular. A clarification of the scope would be welcome in a new version of the circular. For example, in a recent decision, the Cantonal Administration Appellate Court of Zurich (SB.2023.00014, in German) ruled that the circular does not apply to financial transactions with a maturity of less than 12 months. This is not immediately obvious from the circular. If the safe-harbour circular is not complied with, it is up to the taxpayer to prove that the interest rates are at arm's length.

In a benchmark study, the SFTA expects various elements of the financial transaction to be considered (e.g., maturity, start date, currency, rating, any guarantees/collateral). However, the rating should focus less on the rating of the debtor (issuer credit rating) and more on the rating of the financial transaction (issue credit rating). This also takes into account, for example, any collateral. In the absence of a rating from an independent rating agency, the taxpayer(s) concerned must determine the rating, for example by applying the same methodology as rating agencies or the use of rating software. The problem with software is, however, that the method used is often not verifiable. In addition, a potential implicit group support (also known as passive association) must also be taken into account. If an internal rating from a third-party bank is available, this can be used if it can be shown that it has also been used to determine the interest rate. If a loan is granted in a foreign currency, the SFTA expects a justification (e.g., foreign currency corresponds to the functional currency, more favourable conditions taking into account hedging costs). In addition, it must always be examined whether realistic financing alternatives would have been available to the borrower. It is assumed that the borrower would always choose the alternative that optimises its WACC. This proof that a group company could not have financed itself elsewhere on better terms has not been required much in Switzerland to date and increases the burden of proof on the taxpayer. In general, it can be observed that the SFTA will in future focus not only on whether the controlled loan carries an arm's length interest rate ("der Höhe nach"), but also on whether the financial transaction itself is at arm's length ("dem Grunde nach").

In a benchmark study, there is usually a range of possible values. The SFTA expects the intragroup interest rate to be within the interquartile range. It is not required, for example, that the interest rate be at the median. The priority is on the comparable uncontrolled price ("CUP") method, either with internal or external comparables (internal/external CUP). Alternatively, the cost of funds method or the use of credit default swaps are permitted as well. If no CHF comparables are available for an internal CHF loan, the currency difference must be adjusted using the interest rate swap rate (e.g., CHF/EUR). Mere bank opinions are not accepted, although the SFTA explicitly refers to an "opinion" ("Stellungnahme") rather than a binding offer.

Deloitte’s View

The SFTA's new website with its Q&A on transfer pricing is very welcome as it provides transparency on its practice, which is largely in line with the OECD Guidelines. It is to be hoped that this practice will also be adopted by the cantonal tax administrations. These new Q&As emphasise that transfer pricing is becoming increasingly important in Switzerland. This professionalisation is to be welcomed. At the same time, however, we expect that MNEs in Switzerland will increasingly be confronted with critical transfer pricing inquiries from the tax administrations. We would welcome it if the SFTA were to expand this Q&A further in the future, e.g. in relation to intellectual property rights or also on the question of whether Switzerland will apply the simplified and streamlined approach for baseline marketing and distribution activities (Pillar I - Amount B, see our blog).

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Authors

• Thomas Hug - Partner, National Tax Office
  
• Martin Krivinskas - Partner, International Tax & Transfer Pricing
  
• Markus Reese - Partner, Transfer Pricing and M&A
  
• George Galumov - Partner, Transfer Pricing Financial Transactions Leader