Global Tax Alert | 10 May 2013

Swiss federal tax administration clarifies its practice and requirements for Principal companies

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Since the publication of federal guidelines applicable to Principal companies in 2001, the practice of the Swiss tax authorities towards international structures centralizing functions and risks for regional markets has been regularly evolving over the years. These developments remained unpublished and to address the need for a harmonized practice and understandable requirements, a working group was established with the aim to refine and clarify the rules. The resulting conclusions have not yet been communicated officially by the Swiss federal tax administration but it is expected that they will apply starting in June after approval by the competent authorities.

Once approved, this ¨new¨ practice should apply immediately to pending and new tax ruling requests filed with the Swiss tax authorities; rulings previously granted may also be reviewed by Swiss tax authorities.

Summarized below are the clarifications and developments which may offer opportunities or require immediate actions to ensure compliance with the new rules.

¨Current¨ practice

¨New¨ practice

Mutual Agreement Procedure (MAP) and Advanced Pricing Agreement (APA)

(i) If corresponding transfer price adjustment was requested in Switzerland further to a tax re-assessment of an affiliated distributor in a foreign jurisdiction, the taxable income of the Swiss Principal resulting from transactions conducted with the said distributor could not benefit anymore from the “Principal taxation” rules.

(ii) If an APA was negotiated with a foreign jurisdiction, taxable income of the Swiss Principal resulting from transactions conducted with affiliates in the foreign country could in some cases be denied the Principal taxation.

(i) In case of a tax re-assessment in the jurisdiction of a local distributor, corresponding TP adjustment can now be claimed by the Swiss Principal through the MAP with no jeopardy of the Principal taxation.

(ii) Swiss Principal companies can negotiate APA with local countries (e.g. distribution network) and still benefit from the Principal taxation.

Profit margin of limited risk distributors (LRDs) and commissionaires

Routine scrutiny of the Swiss tax authorities regarding the transfer pricing set-up during tax ruling negotiations and tax audit process.

Increased scrutiny and new safe harbor rule in Switzerland: compensation of a distributor may not exceed the higher of:

(i) 3% of its revenues, or (ii) its costs.

In case of a higher compensation of its foreign distributors, the Swiss tax treatment of the Swiss Principal may be adversely adjusted. Sound economic justification of higher compensation should however be acceptable.

Auxiliary activities of LRDs and commissionaires

In some instances, the Swiss tax authorities would request affiliated distributors to be “exclusive” so that the transactions with the Swiss Principal would qualify for the Principal taxation.

An affiliated distributor may now be involved in other activities provided that at least 90% of its profits relate to the Swiss Principal business.

Outsourcing of key functions

Substance and functions were required in Switzerland but outsourcing of certain key functions was tolerated.

Depending on facts and circumstances, outsourcing key functions might lead to a reduction of the Swiss tax benefits.

Immediate actions/recommendations

  • Opportunity for entering into MAP and APA: Immediate need to review and identify opportunities to claim corresponding Transfer Pricing adjustment in Switzerland via MAP further to tax audits conducted against affiliated distributors in foreign jurisdictions before potential forfeiture. Applicability of the Principal taxation rules to be considered where APA and roll-overs have been negotiated.
  • Profit margin of LRDs and commissionaires: Review and proactively prepare supporting documentation for distributors' margin/commission.
  • Activities deployed by the LRDs and commissionaires: Identify structures where the distributors may be conducting various activities which would not fall within the accepted threshold.
  • Outsourcing of key functions: Review allocation of roles and responsibilities and identify key functions outsourced.

For additional information with respect to this Alert, please contact the following:

EY (Switzerland), Zurich
  • Daniel Gentsch
    +41 58 286 3613
  • Rainer Hausmann
    +41 58 286 3193
EY (Switzerland), Geneva
  • Jean-Marc Girard
    +41 58 286 5890
  • Markus Frank Huber
    +41 58 286 3189
Ernst & Young LLP, Swiss Tax Desk, New York
  • Karen Simonin
    +1 212 773 8442
  • Eric Duvoisin
    +1 212 773 3091

EYG no. CM3427