Global Tax Alert | 21 February 2014

Swiss Federal Tax Administration issues clarifications on taxation of Swiss principal companies

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Executive summary

The Swiss Federal Tax Administration (SFTA) is currently issuing instructions to the cantonal tax authorities on how to inform the companies concerned regarding the interpretation of the existing guidelines governing the taxation of Swiss principal companies at the federal level.1 The cantonal tax authorities are responsible for assessing and collecting the federal income tax in Switzerland.

The SFTA refers to the new interpretation as a “clarification” of the existing rules. According to the SFTA's communication, a comprehensive survey and several tax audits of Swiss principal companies in 2012 revealed that the existing guidelines have not always been applied correctly and consistently. As a consequence, the SFTA is promulgating the clarifications in order to ensure a consistent application of the existing circular no. 8 / 2001, which sets the guidelines for the taxation of Swiss principal companies for federal income tax purposes. These clarifications refer to:

  • Exclusivity of distributors;
  • Remuneration of distributors;
  • Outsourcing of principal functions; and
  • Mutual agreement procedures (MAP) and advance pricing agreements (APA).

The SFTA started to communicate the respective clarifications to the cantonal tax authorities at the end of January 2014. The clarifications shall be applied with immediate effect to all pending and new ruling requests and existing principal rulings shall be aligned with respect to future fiscal years. Existing Swiss principal companies should review their individual set-up in collaboration with their tax advisor in order to be prepared for the upcoming discussions with the Swiss tax authorities.

Detailed discussion

According to the communication of the SFTA, circular no. 8 / 2001 remains in force and should not be amended. The communication serves in the view of the SFTA as a clarification of the existing rules and to prevent the abusive application of the international profit allocation mechanism by Swiss principal companies. Irrespective of the communication, it is fair to assume that the clarifications may have an impact on the level of taxation for federal income tax purposes and in most cases will result in a dilution of the benefits available under existing principal rulings. As only federal tax is concerned, the effective tax rate (ETR) effect may be a 0% to 2.6% increase for principals with a toll or contract manufacturing arrangement or a 0% to 3.7% increase for pure trading principals.

As it is not expected that the clarifications will be officially published by the SFTA, this Alert summarizes the key elements of the new interpretation.

Exclusivity of distributors

The foreign distributors must be “exclusively” engaged in the distribution of goods for, or on behalf of, the Swiss principal or other principal companies within the group. According to the clarification regarding exclusivity, other activities of subordinate nature are allowed as long as at least 90% of the distributor's total income is derived in the long term from the sale of goods for affiliated principal companies.

As a consequence, each distributor individually should cumulatively meet the following requirements in order to be considered a “qualifying distributor” (referred to as entry test):

  • At least 90% of the distributor's total income must be derived from the sale of goods for principal companies within the group;
  • The distributor must be affiliated to the Swiss principal company and in order to qualify for the allocation mechanics must be domiciled outside of Switzerland; and
  • The distributor must act either as a commissionaire on behalf of the Swiss principal company or as a limited risk distributor (LRD).

Only trading income of the Swiss principal company that is derived from qualifying distributors will be eligible for the favorable principal allocation. If a distributor does not meet the 90% requirement or any other of the above mentioned criteria, the principal allocation should, according to the communication of the SFTA, be disallowed for trading income resulting from this particular distributor. Non-compliance with the 90% requirement in the short term should not be harmful. The evidence to prove the fulfillment of the 90% requirement must be provided by the Swiss principal company for each qualifying distributor in a respective excel sheet based on local financial statements as an enclosure to the tax return.

In its communication the SFTA indicated certain flexibility to allow for making the necessary operational changes within a reasonable time frame, should certain distributors no longer be able to meet the entry test as a result of the new 90% requirement.

Remuneration of distributors

As per the communication of the SFTA, it appears that in the course of the tax audits undertaken in 2012, in some cases some foreign distributors were generating unexpectedly high profit margins despite of their limited functions, responsibilities and risks. The SFTA argues that the remuneration of the qualifying distributors should be in line with their limited functional and risk profile and determined, by estimation, that the maximum remuneration of such distributors should be 3% of gross sales or the higher costs. The costs as defined by the SFTA comprises the operating expenses (such as personnel costs, amortizations and other operating costs) as well as taxes of all qualifying distributors and have to be determined on the basis of the local financial statements. According to the current thinking of the SFTA the 3% test is, in contrast to the entry test, not applied to each distributor individually but rather through an overall assessment taking into account all qualifying distributors on a consolidated basis.

If the total consideration of all qualifying distributors exceeds the given threshold (3% gross profit margin or higher costs), the allocation mechanism will be adjusted by recognizing, for purposes of the principal allocation, only a gross profit margin (or minimal commission) in accordance with the mentioned thresholds. In other words, any portion of the actual gross profit margin in excess of the applicable threshold would be excluded from the principal allocation mechanism and, thus, would finally increase the portion of the income that is subject to federal income tax at the level of the principal.

It is important to note that, according to the SFTA, the 3% test is neither considered to be a safe haven rule nor should it be considered a compensation for the commissionaires/LRDs in line with the dealing at arm's length principle. It is technically just a threshold to measure a maximum acceptable profit margin for the commissionaires/LRDs in order to influence the allocation mechanism. The payments made by the Swiss principal company to its related distributors should generally remain tax deductible to the extent they are commercially justified. It appears that the application of a fixed profit margin is, however, problematic as it may lead to discrimination of principal companies operating in high margin sectors, such as the pharmaceutical or high technology industry. One may question as to whether concerns regarding the distributors' adequate remuneration could be better addressed for economically justified higher returns by applying a certain limit as a safe haven threshold, which would allow for a more flexible and differentiated handling taking into account the actual facts and circumstances of each individual case including the specifics of the industry, the products and the customers.

The information regarding the remuneration of the qualifying distributors must be provided by the Swiss principal company based on a detailed calculation template as an enclosure to the tax return. The template must include all the relevant (consolidated) financial data derived from the local financial statements of the qualifying distributors to enable the review of any remuneration payments made in excess of the applicable threshold.

Outsourcing of principal functions

The SFTA puts an increased focus on the level of economic substance required to respect the contractual centralization of functions, responsibilities, and risks in the Swiss principal. According to the communication of the SFTA, the key principal functions should be performed in Switzerland and adequate economic substance must be available to ensure alignment of returns with value creation.

In the case of an outsourcing of some key operational principal functions, the SFTA takes the position that the profit generated by the foreign companies for carrying out those functions should be considered in the principal allocation mechanism (resulting in a reduction of the principal allocation amount by 50% of the outsourced profit). It is assumed that only outsourcing of trading related principal functions – in contrast to non-trading related functions such as manufacturing or financing – should adversely affect the principal allocation mechanism. The outsourcing of mere auxiliary functions should not be harmful.


The clarifications of the SFTA imply that a corresponding adjustment on the basis of a MAP or an APA should, from a Swiss perspective, not result in the disallowance of the principal allocation for the respective income. If intra-group transactions with a foreign distributor are subject to a profit adjustment abroad, a corresponding adjustment in Switzerland should be possible on the basis of a MAP or an APA without jeopardizing the principal allocation. As the 3% test is a threshold to measure a maximum acceptable profit margin for the commissionaires/LRDs, the SFTA is indicating that the 3% test should be applicable irrespective of the existence of an MAP/APA.

Next steps

According to the communication of the SFTA, the cantonal tax authorities are now supposed to inform the Swiss principal companies about the clarifications and to review and validate the alignment of all existing principal rulings with these clarifications.

In the communication of the SFTA it is mentioned that the review of existing principal companies should be done on a case-by-case basis and any particular actions, such as amending existing tax rulings or determining a timeline for necessary changes to align with the clarified rules, should be agreed upon based on the actual facts and circumstances and in consultation with the competent federal tax inspector at the SFTA. The tax authorities also indicated flexibility in terms of timing should a group be required to restructure its distribution affiliates in order to comply with the new requirements.

According to the communication of the SFTA, the clarifications are immediately applicable to pending and new ruling requests with the Swiss tax authorities. Principal companies, which already benefit from an existing principal ruling, should align to these clarifications with respect to future fiscal years.


Given the most recent developments as outlined above, each Swiss principal company should in close collaboration with their tax advisors review as soon as possible its centralized supply chain model in light of the mentioned clarifications of the practice guidelines and the upcoming discussions with the Swiss tax authorities. The scope of review should in particular include the following elements:

  • Ensure that the relevant facts as described in the tax ruling are consistent with the actual facts and circumstances;
  • Review the activities performed by the foreign distributors and ensure compliance with the entry test;
  • Review the gross margins of the qualifying distributors and examine to what extent a potential excess portion may dilute the principal allocation amount in future fiscal years;
  • Review nature, extent and impact of key principal functions outsourced to foreign companies, if any;
  • Adjust the effective tax rates for future tax provision calculations, if necessary;
  • Establish an appropriate internal documentation and reporting system for Swiss tax compliance purposes in order to be ready with the increased disclosure obligations in connection with the clarifications;
  • Consider mitigation strategies in case of non-compliance with the new requirements; and
  • Identify opportunities to claim a corresponding adjustment in Switzerland through a MAP or consider obtaining a bilateral APA for transactions with related distributors.


1. For additional information, see EY Global Tax Alert, Swiss federal tax administration clarifies its practice and requirement for Principal companies, dated 10 May 2013.

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

Ernst & Young Ltd., Zurich
  • Daniel Gentsch
    +41 58 286 3613
  • Rainer Hausmann
    +41 58 286 3193
Ernst & Young Ltd., Zug
  • Kersten A. Honold
    +41 58 286 3166
Ernst & Young Ltd., Geneva
  • Jean-Marc Girard
    +41 58 286 5890
  • Markus F. Huber
    +41 58 286 3189
  • Karen Simonin
    +41 58 286 5653
Ernst & Young LLP, Switzerland Tax Desk, New York
  • Thomas Semadeni
    +1 212 773 8442

EYG no. CM4190