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La Riforma III dell’imposizione delle imprese tra compatibilità e competitività

SUPSI, La Riforma III dell’imposizione delle imprese 25 September 2014

René Matteotti Professor of Law, Attorney at law Chair of Swiss, European and International Tax Law University of Zurich Tax Counsel, Baker & McKenzie Zurich

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Table of Content

• A brief introduction to the Corporate Tax Reform III
• Which «international standards» apply?
• Which repercussions does international standards have on the design of

an IP-Box?

• «Step up» and «grandfathering» as the silver bullets?
• Conclusions

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A brief introduction to the Corporate Tax Reform III

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Overview

Actionplan Code of Conduct BEPS Prohibition of State Aid

Legal certainty through international acceptance Enhancement of international competitiveness (Attractiveness of Switzerland)

Harmful Tax Practices EU OECD Compensating measures Reduction of corporate income tax (cant.)

• IP-Box (promotion of R&D)
• Interest adjusted corporate tax

Further measures

• Step-up
• Issuance tax on equity capital
• Participation exemption
• Capital tax
• Unlimited loss carry-forward
• etc.

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Memorandum of Understanding with EU

Which international standards? Prohibition of state aid? When will «the regimes in question» be regarded as abolished?

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Press release of Federal Department of Finance on 20 June 2014 “New tax measures should be in line with international standards. In return, the EU member states confirm their intention to lift corresponding countermeasures as soon as the regimes in question have been abolished. “

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Consultation on Corporate Tax Reform III

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On 22 September 2014, Federal Council started consultation on CTR III and published legislative draft. Key points:

• Abolishment of cantonal tax regimes, federal tax practice re principal

companies and Swiss finance branches

• New regimes to be implemented
• IP-Box (based on British model)
• Interest-adjusted corporate tax (notional interest deduction on safety-

equity)

• Reduction of corporate income tax rates on cantonal level (falls into

cantonal autonomy)

• Selection of further measures to improve the tax legislation system
• Comprehensive rules for the disclosure of hidden reserves (step-up)
• Abolition of issuance tax on equity capital
• Adjustments to participation exemption
• Unlimited loss carry-forward
• etc.

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Which «international standards» apply?

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Overview

Actionplan Code of Conduct BEPS Prohibition of State Aid

Legal certainty through international acceptance Enhancement of international competitiveness (Attractiveness of Switzerland)

Harmful Tax Practices EU OECD Compensating measures Reduction of corporate income tax (cant.)

• IP-Box (promotion of R&D)
• Interest adjusted corporate tax

Further measures

• Step-up
• Issuance tax on equity capital
• Participation exemption
• Capital tax
• Unlimited loss carry-forward
• etc.

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OECD Base Erosion and Profit Shifting Guidelines for the Corporate Tax Reform III International Coherence

• Zero- or low taxation

Harmful Tax Practices (Action 5)

• Qualification conflicts

Hybrid Missmatch Arrangements (Action 2)

• Ring-fencing

Harmful Tax Practices (Action 5)

• Allocation of tax base

Conformity of TP with substance (Action 8-10)

Transparency

• Clear legal framework
• Mutual administrative assistance in

relation to companies

• Disclosure of aggressive tax planning

(Action 12)

• TP documentation and CbC-Reporting

(Action 13)

Counter-Measures

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Potential measures to combat the distorting effects of harmful tax competition

• Denial of deductions, exemptions or tax credits on payments to companies

which are resident in countries with harmful tax measures

• Increased disclosure requirement in relation to transactions in which countries

with harmful tax measures are involved

• Effective CFC legislation
• Refusal of tax credits or tax exemptions for dividends received from

companies resident in a country with harmful tax measures

• Source tax on payments to persons resident in a country with harmful tax

measures

• Termination or suspension of DTT

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Overview

Actionplan Code of Conduct BEPS Prohibition of State Aid

Legal certainty through international acceptance Enhancement of international competitiveness (Attractiveness of Switzerland)

Harmful Tax Practices EU OECD Compensating measures Reduction of corporate income tax (cant.)

• IP-Box (promotion of R&D)
• Interest adjusted corporate tax

Further measures

• Step-up
• Issuance tax on equity capital
• Participation exemption
• Capital tax
• Unlimited loss carry-forward
• etc.

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EU Code of Conduct / Actionplan of the EU Zero- or low taxation Potentially harmful tax measures (PHTM)

Significantly lower effective level of taxation and non-taxation in comparison to the general level of taxation in the relevant EU Member State The general level of taxation can be measured through the nominal tax rate, the tax base or other relevant factors

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EU Code of Conduct Criteria

1. Benefits are only granted to foreigners or for transactions with foreigners 2. Benefits are completely isolated from the domestic economy so that they have no impact on domestic tax basis 3. Benefits are granted regardless of actual business activity and business substance in the member country granting the tax benefits 4. Deviation from internationally accepted principles, in particular from the tax principles set by the OECD 5. Lack of transparency Ring- fencing

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European State Aid Prohibition Legal Basis

• Art. 107 Treaty on the functioning of the European Union (TFEU, ex-Art. 87

TFEC) (1) Save as otherwise provided in the Treaties, any aid granted by a Member State

• r through State resources in any form whatsoever which distorts or

threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.

• Art. 23 Free Trade Agreement between Switzerland and the EU

(1) The following are incompatible with the proper functioning of the Agreement in so far as they may affect trade between the Community and Switzerland,(…) iii) any public aid which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods.

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De facto Selectivity

May result from requirements or

• bstacles that prevent

certain companies from claiming a benefit

De jure Selectivity

Results directly from legal criteria to grant a benefit that is restricted to formally determined companies

Substantive Selectivity

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European State Aid Prohibition Selectivity

Regional Selectivity

Selectivity

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Which repercussions does international standards have on the design of an IP-Box?

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IP-Box (proposed system)

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• Qualifying entities
• Legal entities which are owner or beneficiary of a qualifying IP
• Legal entities with exclusive license on qualifying IP
• Qualifying IP
• Patents
• Supplementary protection certificates
• Exclusive license to a patent and the so-called first to file protection in

accordance with Article 12 of the Swiss Law on Therapeutic Products

• Substance requirements
• Qualifying entity must make a significant contribution to the development
• r further development to the invention underlying the qualifying IP
• Calculation of the relevant profit based on the so-called residual method
• Tax relief
• Maximum 80% of the boxes success may be excluded from the tax base
• Cantons may grant further tax relief in justifiable cases

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Legal uncertainty regarding the European state aid rules and Code of Conduct

• 1. Decision of the Commission regarding the Spanish R&D regime 2008
• Broad definition of royalty payments, less selective
• 2. EFTA-decision regarding the Liechtenstein R&D regime 2011
• No selective differentiation since all companies may benefit
• 3. Decision of the Commission regarding Gibraltar 2013

Is already the differentiation between types of income selective?

• 4. Press release of the Commission regarding Luxembourg R&D 2014
• Mobile companies as particular type of company?
• 5. Preliminary examination of the EU Code of Conduct Group regarding

the UK patent box 2013

Substance requirements regarding R&D activities?

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European State Aid Rules Selectivity – Spanish R&D Regime (February 2008)

Commission, N 480/2007, cipher 15

„[…] the measure does not strengthen the position of any particular class of undertakings in relation to others competing in intra-Community trade and applies without distinction to all economically active persons. [...] tax measures which are open to all economic agents

• perating within a Member State are in principle general measures.“
• 50% of the income from qualifying IP are taken into account
• Deductible maximum amount: six times manufacturing costs

„In particular, the category of secret formulas or processes is so wide and horizontal in nature that it does not result in favouring undertakings which are in a legally or factually comparable position in the light of general policy objective pursued by the measure in question“

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European State Aid Rules Selectivity – Liechtenstein IP Regime (June 2011)

EFTA Surveillance Authority, Press release dated 1 June 2011 „The Authority considers that no aid is involved as the tax deduction is available to all businesses, irrespective

• f size, legal structure

and sector. Therefore, the scheme does not favour any product or services.”

• Deduction of 80% of the total positive income from IP
• In case of own / internal use the deduction is to apply on the income from IP

that would have been generated in case of a remunerated third-party use.

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European State Aid Rules Selectivity – New tax system in Gibraltar (October 2013)

• Territorial tax system (tax basis only income from domestic sources)
• Dividend, royalty and interest income are not taxable regardless of source of income

(exception: interest income from group internal loans)

„Given that companies are exempted from taxation on the basis of the type of income, i.e active (i.e. profits) vs. passive (interest, dividends or royalty), the exemption differentiates between certain kinds of income and must at this stage be considered prima facie selective.“

Commission, SA.34914 (2013/C), cipher 34 f.

„[...] the derogation in question differentiates between companies which, in light of the objective intrinsic to that system, are in a comparable factual and legal situation. Considering the

• bjective of the Gibraltar tax system which is to tax all companies generating income

accruing in or derived from Gibraltar [trerritotal principle], companies in receipt of passive interest, royalty or dividend income are in a similar legal and factual situation as other companies falling into the scope of the Gibraltar tax system. The passive income exemption therefore seems to be prima facie selective.“

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European State Aid Rules Selectivity – Luxembourg Tax Practice (March 2014)

• In a pending state aid procedure Luxembourg only provided general information about its

tax rulings.

• Luxembourg also refused to deliver certain information on the usage of the IP tax regime,

including the details of the 100 largest companies falling under the regime. Press release (IP/14/309) dated 24 March 2014 Over the last ten years, several Member States have also introduced special tax regimes for IP rights that are supposed to stimulate innovation and investments in new

• technologies. [...] In 2008, the Commission reviewed such a regime in Spain and

concluded that the scheme did not constitute aid [...] Since then, however, the Commission has received indications that special tax regimes seem to mainly benefit highly mobile businesses and do not trigger significant additional research and development activity. The Commission is therefore gathering information to assess whether the regimes grant a selective advantage to a particular group of companies, in breach of EU state aid rules.

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EU Code of Conduct Substance requirements – UK-Patentbox (1/2)

„The relevant elements of this measure are the development condition and the active ownership or management condition.“ […] The development condition requires the performance of a significant amount of development activity in relation to the IP. In most cases fulfilment of the development condition will require real economic activity and a substantial economic presence. However there is no provision requiring such activities to be located in the UK. If the company claiming the benefits does not itself satisfy the development condition (e.g. it is satisfied by another company in the group) it can still claim the benefits if it fulfils the active ownership or management requirement. This states that the company must perform a significant amount of management activity in relation to the IP. However a company's decision making processes do not necessarily require real economic activity and a substantial economic presence in the UK.”

Code of Conduct Group (Business Taxation), 22 October 2013

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EU Code of Conduct Substance requirements – UK IP box (2/2)

CoC-Group (Business Taxation), 22 October 2013 „Although the fulfilment of both the development condition and the active

• wnership or management requirement may involve real economic activities

and a substantial economic presence in the UK, this does not always have to be the case. Tax advantages may be granted even in their absence.” Determination of substance?

• Transfer Pricing Approach function-related
• Value Creation Approach added-value-related
• Nexus Approach expense-related

But: Contradiction to the freedom

• f establishment?

Decision C-39/04 of the ECJ on 10.3.2005

Draft legislation regarding CTR III

≈

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Nexus Approach

(based on OECD report of 16 September 2014 on action 5)

• Calculation of income receiving tax benefits under nexus approach
• Taxpayers have ability to prove that more income should benefit from IP regime

(if direct link between respective income and qualifying expenditures to develop IP asset)

• Qualifying IP assets: patents and other IP assets that are functionally equivalent

to patents, if legally protected and similar approval and registration processes apply

• Qualifying expenditures: incurred by taxpayer itself and directly connected to

qualifying IP asset

• Outsourcing: to unrelated parties (+) / to related parties (-)

Qualifying expenditures incurred to develop IP assets Overall expenditures incurred to develop IP assets Overall income from IP assets Income receiving tax benefits

x =

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Everything is still open...

Requirements for alternative measures for existing tax regimes (OECD country report not yet published)

• The IP boxes that had been accepted still in 2011 are now being criticized
• Trends:
• Appropriate measure to bring about a substantial increase of innovations

and investments

• Substance- and added-value-related allocation of profits deriving from the

transfer and use of IP

• Nexus requirement?

Focus on nexus approach for determination of substance Specific criteria for harmful tax measures until December 2015 Development of the European state aid rules is in constant flux Unnecessary preemptive obedience of Switzerland?

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«Step up» and «grandfathering» as the silver bullets?

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Grandfathering (based on OECD report of 16 September 2014 on action 5)

Grandfathering in connection with abolishment of current tax regimes

• Forum on Harmful Tax Practices will draft guidance on

gandfathering (building in particular on the OECD report of 2004)

• Based on the OECD report 2004 harmful tax regimes should be

treated as abolished if: (1) no new entrants are permitted into the regime, (2) a definite date for complete abolition of the regime has been announced, and (3) the regime is transparent and has effective exchange of information

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Step-up Isolated approach

privileged taxation

• rdinary

taxation

• rdinary taxation

Tax-neutral or partially taxed disclosure of hidden reserves/goodwill

Selective? Collection system / System immanence? Legal basis necessary? Collection of tax spread over 10 years

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Offsetting of loss upon change of status of a holding company Decision of the Swiss Supreme Court on 12 March 2012 (2C_645/2011)

Opinion of the Swiss Supreme Court

• According to the dispatch of the Federal Council to the StHG, it is the responsibility of the

cantonal legislator to determine the tax consequences in the event that a corporation loses its holding privilege

• Interpretation based on the wording and historical interpretation do not lead to any result
• Question of equal/unequal tax treatment of gains and losses at the time of change of status

Tax-neutral disclosure of hidden reserves created during the holding company tax regime

Loss Profit

No later offsetting of losses incurred during the holding company tax regime Tax-neutral disclosure of hidden limited to the acquisition cost

Loss

Admissibility of later

• ffsetting of losses

incurred during the holding company tax regime

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Step-up Consideration – European state aid law

Step-up

• Tax systematically justifiable Protection of trust, legal certainty and

proportionality

• Creation of additional amortization substrate (amortization period = 10 years)

Result-oriented consideration under the prohibition of state aid: Selectivity?

• Privileged group of companies? Companies with cantonal tax privilege
• Deviation from collection system? Ordinarily taxed companies do not benefit
• Justification due to system immanence?
• Amount of allowable depreciation has to be in line with generally applicable rules

(additional risk of selectivity)

Does the step-up lead to a de facto continuation of a harmful tax regime in the sense of the MoU between Switzerland and the EU?

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Step-up In combination with transitional arrangement for license box

privileged taxation

• rdinary

taxed

privileged taxation

• rdinary taxation

privileged taxation

Tax-neutral or partially taxed disclosure of hidden reserves/goodwill Realization of hidden reserves on IP Realization of hidden reserves on IP

Selective? Collect system / System immanence?

Collection of tax spread

• ver max. 10 years

Payments of the tax liability spread over max. 10 years

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Step-up In combination with transitional arrangement for license box

Transitional arrangement

• Realization of hidden reserves on IP upon entry into box
• Hidden reserves on IP available at the level of ordinarily taxed companies
• In case of companies with priviledged tax status hidden reserves on IP have

already been disclosed tax-neutrally or partially taxed in the course of the step-up upon change to the license box no tax base is available Double selectivity?

• Privileged group of companies? Companies with tax privilege?
• Deviation from collection system? Ordinarily taxed companies do not

benefit in the same extent

• Justification due to system immanence?

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Conclusions

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Conclusions

• Special boxes solution for IP is in the medium term an element for CTR III
• Adaptation to constantly changing international standards
• Law of state aid grey area
• Cannot be the sole basis for a long-term corporate strategy
• Step-up is problematic from a state aid law perspective, but is strongly

needed and mainly corresponds to the cantonal practice already (which should be left in its competence, i.e., no explicit inclusion in the reform bill) careful tax planning is required!

• The focus should be on tax-systematically accepted and system-

inherent measures

• The long-term goal should be the general income tax reduction! The

potential for this is available!