Article 2011 Bulletin for international taxation (IBFD)


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Article 2011 Bulletin for international taxation (IBFD)

  1. 1. Markus Frank Huber* Switzerland and Eric Duvoisin**Federal Supreme Court on Treatment ofExchange Differences and Environment forInternal Group Financing ImprovedIn this article, the authors analyse two recent to exclude the forex gain from taxable profit. The 2002and important developments with regard to assessment, which already excluded the forex translationinternational corporate tax in Switzerland, loss, was confirmed.namely, the Federal Supreme Court’s decision onthe accounting and tax treatment of exchange 1.2. Supreme Court’s findingsdifferences and the improvements to the fiscal The basis for determining the taxable income underenvironment in respect of internal group Swiss tax law is the financial statements drawn up in linefinancing. with commercial law. The income determined under commercial law is, therefore, primarily relevant for1. Federal Supreme Court on Treatment of income tax purposes, unless tax law includes an explicit Exchange Differences1 rule that would require an adjustment for tax purposes.1.1. Facts and judicial proceedings The Supreme Court deliberated on the anticipated and ongoing changes with regard to Swiss accounting rules.Company C domiciled in Geneva prepared its (statu- These changes have the objective of bringing Swisstory) financial statements in US dollars (the functional accounting law closer to international accounting stan-currency). Company C primarily dealt in US dollars and dards, i.e. International Financial Reporting Standardshad, therefore, in line with generally accepted account- (IFRS) or US GAAP. The Supreme Court also noted thating principles (GAAP) selected the US dollar as its func- the application of Swiss Accounting and Reporting Rec-tional currency. US dollar financial statements must be ommendations, IFRS or similar accounting standards isconverted into Swiss francs at the year-end. This conver- already common for a significant number of Swiss-sion resulted in a foreign exchange (forex) gain of CHF based companies and even mandatory for certain entit-4.7 million in the financial year 2001. However, in the ies being active in specific areas – for example, in thefinancial year 2002, the company recorded a forex loss in ordinance on telecommunications services. Accordingly,the amount of CHF 25 million. it is not unreasonable if the tax authorities take interna-In 2001, the relevant cantonal tax authorities included tional accounting standards into account in arriving at athe forex gain in the taxable profits of Company C, but, solution with regard to accounting 2002, denied the deduction in respect of the forex loss The financial statements at the year-end must be pre-for income tax purposes. Company C appealed against sented in Swiss francs according to the Swiss Code ofthe assessment for the year 2002. The Cantonal Tax Obligations (Swiss commercial law). However, there isAppeal Commission of Geneva (Commission cantonale no obligation to maintain the books in Swiss francs dur-de recours en matière administrative, previously Commis- ing the year. The financial accounts can be kept in anysion cantonale de recours en matière d’impôts) accepted other currency, generally referred to as the functionalthe deduction of the forex translation loss. currency.The cantonal tax administration appealed the case to the Under these accounting standards, translation differ-Administrative Court of the Canton of Geneva (Tribunal ences are recorded in the equity section and not in theadministratif), which partially adopted the opinion of the profit and loss account. The Swiss Manual of Auditors,tax authorities. Specifically, the Court decided that forex which was referred to by Company C, adopts a differenttranslation differences, as they reflect only unrealized approach, depending on whether forex differences ariseincome or losses, should not be considered for income in the ordinary course of business or are differences aris-tax purposes. Accordingly, the Court referred the 2001 ing from the translation of the financial statements (intax assessment back to the tax authorities to exclude the the functional currency) to the financial statements pre-forex translation gain from taxable income.Company C ultimately filed an appeal with the SwissFederal Supreme Court (Tribunal fédéral). The Supreme * PhD (law) and Partner, Ernst & Young, Zurich. The author can be con-Court largely accepted the position of the cantonal tax tacted at and held that positive as well as negative ** MAS in Business Law and Master in Law, and Manager, Ernst & Young,forex translation differences should not be considered in Geneva. The author can be contacted at determination of the taxable income. The 2001 1. Federal Supreme Court, 2nd Chamber of Public Law, Decision No.assessment was, therefore, returned to the tax authorities 2C_897/2008 (1 October 2009).© IBFD BULLETIN FOR INTERNATIONAL TAXATION FEBRUARY 2011 113
  2. 2. Markus Frank Huber and Eric Duvoisinpared in Swiss francs. Such forex translation differences subject to the following two main reservations: (1)must be separated from conventional exchange differ- adjustment of the net income per the profit and lossences. The latter arise from transactions undertaken in account if this is not drawn up in conformity with Swissthe ordinary course of business (in an operational cur- commercial law (the commercial correction); and (2)rency that diverges from the functional currency) and adjustment of the net income per the profit and lossmay reflect real gains or losses. In contrast, forex transla- account in line with the specific provisions of Swiss taxtion differences have nothing to do with the ordinary law (the fiscal correction). The authors are of the opinioncourse of business of the company, but, rather, arise from that the decision reflects a commercial correction. Tax-the conversion of the accounts from the functional cur- payers affected by the Supreme Court’s decision should,rency into Swiss francs. This is also evidenced by the fact therefore, initiate discussions with the relevant statutorythat such forex translation gains or losses are only auditors to address the treatment of translation differ-included in the financial statements drawn up in the ences.statutory currency, i.e. Swiss francs, and not in the finan- The authors also consider that the decision itself is far-cial statements prepared in functional currency. On the reaching, as the Supreme Court entirely denied theother hand, exchange differences based on real transac- application of the solution per the Swiss Auditors Man-tions are included in both sets of financial statements. ual, which is usually the reference basis for the interpre-Swiss tax law and commercial law are silent regarding tation of Swiss accounting law, in favour of those pro-differences arising from forex translations, whereas vided for by a foreign international accounting standardInternational Accounting Standard (IAS) 21 includes (for example, IFRS).detailed rules for the translation of financial statements Many unanswered questions remain after the Supremeinto another currency. These rules require that transla- Court’s decision, including, but not limited to:tion differences are recorded in equity and not in theprofit and loss account. The Swiss Manual of Auditors (1) Will there be a uniform application of this leadingreferred to by Company C presents a different solution case by the tax administration in all of the differentfor forex translations compared to IAS 21. However, the cantons? As the Supreme Court’s decision was givenSwiss Manual of Auditors must, from a legal perspective, in respect of federal direct tax, this could theoreti-be classified as an interpretation of law, i.e. a reference cally provide leeway to the cantons with regard toand its rules are not binding on the tax administration. the cantonal and/or communal income tax. BasedAccordingly, there are no reasons that prohibit the tax on informal soundings, it appears that the cantonsadministration preferring an interpretation which is intend to apply the decision on a consistent basis allbased on IFRS. over Switzerland. At a meeting of 17 June 2010 with all of the federal and cantonal tax representatives,Company C also argued that there was a similarity the Forum of the Group of the Tax Authorities dis-between forex translation differences and forex cussed the decision. One of the outcomes of thatexchange differences, as both had an effect on the eco- meeting should be a draft of a guideline. The draftnomic capacity of an enterprise. The Supreme Court guideline is supposed to cover the following twoheld that net income should reflect a real increase or main issues: (a) confirmation that translation differ-reduction in the values of an enterprise over a certain ences are not taxable and not deductible for incomeperiod of time. However, according to the Supreme tax purposes, respectively; and (b) guidance thatCourt, forex translation differences do not result in an translation differences are to be taken into accounteffective change in the economic capacity of an enter- for annual equity tax purposes. However, no circu-prise, but, rather, only represent a mechanical calculation lars or guidelines from the federal and/or cantonalfor accounting purposes. Forex translation differences tax authorities are yet available, even in draft ver-have, therefore, no influence on the economic capacity of sions based on the information available to thean enterprise and should not be considered for income purposes. In contrast, exchange differences arecaused by concrete and realized economic transactions (2) How are transitional questions to be dealt with? Thethat result in an effective change of the financial position Supreme Court’s decision is not helpful regardingof an enterprise. such questions, for example, in respect of the treat- ment of translation differences included in alreadyIt should also be noted that the Supreme Court did not filed, but not finally assessed tax returns and the taxshare the taxpayer’s view that the application of IAS 21 treatment of Swiss taxpayers benefiting from a taxwould result in a violation of the prudence or imparity ruling in respect of such translation differences.principles that are cornerstones of Swiss commercial law. (3) What is the effect of the Supreme Court’s decision on1.3. Comment the preparation of audited financial statements? The Swiss Institute of Certified Accountants and TaxThis decision is of great importance for Swiss corporate Consultants has continued with the current versiontaxpayers acting in a functional currency environment of the Swiss Manual of Auditors (the 2009 version),other than Swiss francs. In this respect, there is consen- which in brief states that unrealized translationsus that income tax is levied on the basis of the net losses should be booked in the profit and lossincome per the statutory accounts stated in Swiss francs,114 BULLETIN FOR INTERNATIONAL TAXATION FEBRUARY 2011 © IBFD
  3. 3. Federal Supreme Court on Treatment of Exchange Differences and Environment for Internal Group Financing Improved account, whilst unrealized translation gains (or at est payments on loan agreements or current account least most of them) should be accrued in the balance relationships between companies pertaining to the same sheet. Consequently, the yet to-be-adopted reform of group of companies (meaning all companies that must the Swiss accounting law, which more widely author- be fully consolidated according to GAAP) should no izes reference to international accounting standards, longer be subject to withholding tax.3 will have a key role in the future. 2.2. Comment(4) What is the treatment of the translation difference for (cantonal and/or communal) annual capital tax The new regulation improves the fiscal environment for purposes? According to an unpublished practice, the internal group financing activities, of which predomi- Geneva tax authorities have indicated that, for can- nantly small and medium-sized Swiss group companies tonal and/or communal annual capital tax purposes, with central cash management as well as foreign groups translation differences should be fully taken into searching for an attractive cash management site account. As noted in (1), the Forum of the Group of together with low tax rates may benefit. the Tax Authorities should follow the approach of The amendment, however, includes a significant caveat. the Geneva tax authority in this respect. The new rules do not apply to groups in which a Swiss(5) What will be the prospective application of the group entity guarantees a bond issued by a foreign group Supreme Court’s decision? The decision has given company. Accordingly, internal group financing activity rise to some uncertainty in this respect. For instance, with more than 20 group entities may, de facto, be diffi- it is not known which solution should be applied by cult to achieve for such groups. The intent behind the tax authorities should the IFRS be amended with caveat is to avoid the situation that, in each case, the tax regard to translation differences. authorities must trace the source of the funds (i.e. group- internal funds as opposed to funds derived from third2. Fiscal Environment for Internal Group parties by way of the bond guaranteed by one of the Financing Swiss entities). If a Swiss company guarantees a bond or debenture issued by an affiliated foreign company, such2.1. Background and details of the changes that the bond is not deemed to be issued by the SwissWhilst interest payments on loans payable by a Swiss entity providing the guarantee, the funds raised may notborrower are generally not subject to Swiss withholding be diverted to a Swiss entity. Because of this, the taxtax, a Swiss borrower may, nevertheless, be subject to authorities regard themselves as unable to scrutinize andwithholding tax if a legal entity borrows (by way of loan audit as to whether or not some of the proceeds from aagreement or by accepting monies on current accounts) foreign-issued bond have been remitted to and used infrom more than 10 to 20 non-bank lenders and the Switzerland. This could be deemed to be tax avoidance.aggregate amount exceeds CHF 500,000.2 Exceeding this Based on the new provisions in the law, it is not clearthreshold could mean that, in the case of loan agree- how, or, more precisely, for how long after the guarantee,ments where they are issued simultaneously to raise these restrictions would apply should a Swiss groupfunds and the conditions are exactly the same and the entity have previously guaranteed a bond issued by a for-number of non-bank lenders exceeds 10, the loan may be eign group company. It may, however, be assumed that asclassified as a bond. Accordingly, the interest paid would soon as the Swiss group entity no longer guarantees abe subject to withholding tax. A similar reclassification bond issued by a foreign group company, the restrictionas a bond may arise if the total amount exceeds CHF should be lifted. Overall, the new regulation should be500,000 and the loan agreements are issued on a contin- welcomed by all groups carrying out, or interested inuing basis and contain similar conditions and the num- undertaking, intra-group financing activities in Switzer-ber of non-bank lenders exceeds 20. Again, the interest land.paid would be subject to withholding. Last but not least,an entity may be classified as a “bank” within the mean-ing of the withholding tax law if the entity borrows on a 3. Conclusionscontinuing basis from more than 20 non-bank lenders The decision of the Swiss Supreme Court regardinggenerally by way of current accounts and the total forex translation differences will primarily adverselyamount borrowed exceeds CHF 500,000. In this case, all affect international trading groups based inof the interest paid to non-bank lenders would be subject Switzerland – not only because it will increase theirto the 35% withholding tax. These rules were perceived overall Swiss tax liabilities, but also because theto be burdensome and a hindrance particularly within application of the court decision will give rise tothe context of internal group financing, such as cash major legal uncertainty. Accordingly, the authorspooling arrangements or intra-group loans. advocate a swift reaction from tax authorities toConsequently, there were numerous proposals at a polit-ical level to abolish the rules and to institute a more prac-tical approach to group financing activities. Theapproved revision of the withholding and stamp tax 2. Circulars Nos. S-02.122.1 (4.99) and S-02.122.2 (4.99) issued by the fed-ordinances implies that, from 1 August 2010, most inter- eral tax administration (April 1999). 3. Art. 14a Withholding Tax Act.© IBFD BULLETIN FOR INTERNATIONAL TAXATION FEBRUARY 2011 115
  4. 4. Markus Frank Huber and Eric Duvoisin mitigate the effects of the court decision by way of have a Swiss finance company. Whilst the new law published practices. provisions remove some obstacles, the caveat in the law, whereby a Swiss group entity guarantees a bond With regard to the improvement of Swiss tax rules on issued by a foreign group company, will be a costly internal group financing, the authors trust that this law administrative burden not only because it will have to amendment will be positively received by be monitored upfront by any Swiss financing international groups seeking a location to set up a structure, but also on a regular basis throughout the finance company or even by those groups that already life of the Swiss financing scheme.Cumulative Index[continued from page 106] Anshuman Chaturvedi: South Africa Permanent Establishments and Force of Annet Wanyana Oguttu:Tax Treaty Monitor Attraction: Some Implications of TD The Challenges of Tax Sparing: A Call Securities, in General and from an Indian to Reconsider the Policy in SouthCanada Perspective 75 Africa – available online atAnshuman Chaturvedi: Establishments and Force of Annet Wanyana Oguttu:Attraction: Some Implications of TD The Challenges of Tax Sparing: A Call Tax Treaty Case Law MonitorSecurities, in General and from an Indian to Reconsider the Policy in SouthPerspective 75 Africa – available online at United Kingdom Brian Cleave:India UK Special Commissioners Decide theAnshuman Chaturvedi: Luís Eduardo Schoueri and Oliver-Christoph Resolute Case Concerning the TaxationPermanent Establishments and Force of Günther: of an Ex Gratia Termination Payment asAttraction: Some Implications of TD The Subsidiary as a Permanent Employment Income 21Securities, in General and from an Indian Establishment 69Perspective 75 United States OECD Brian Cleave:International Brian J. Arnold: UK Special Commissioners Decide theBrian J. Arnold: An Introduction to the 2010 Update of the Resolute Case Concerning the Taxation– The Taxation of Income from Services OECD Model Tax Convention 3 of an Ex Gratia Termination Payment as under Tax Treaties: Cleaning Up the Employment Income 21 Mess 59 Edward Barret:– The Taxation of Income from Services Aspects of the 2010 Update Other than under Tax Treaties: Cleaning Up the Those Relating to Article 7 of the OECD Mess – Expanded Version – available Model Tax Convention 13 online at Luis Nouel: The New Article 7 of the OECD Model Tax Convention: The End of the Road? 5116 BULLETIN FOR INTERNATIONAL TAXATION FEBRUARY 2011 © IBFD