New Swiss tax reform on the horizon

Author: | Published: 18 Mar 2015
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Grégoire Winckler and Jason Zücker of KPMG outline recent tax developments within the Swiss fund industry, including a proposed Swiss corporate tax reform

This chapter discusses various tax developments, all of which are of interest to the Swiss fund industry. On the Swiss investors' side, the Swiss Federal Tax Administration challenged the calculations of the taxable income per share made for exchange traded funds (ETFs) with synthetic replication following its latest practice developments. The time when no income in the profit and loss statement of an ETF meant no taxable income is over. On the Swiss fund managers' side, the new Fatca obligations resulted in the registration of numerous Swiss funds, fund managers and asset managers on the online portal of the US Internal Revenue Service (IRS). Purely from a Swiss tax point of view, the industry also needs to be aware of the proposals made under the future Swiss Corporate Tax Reform III.

Challenges to taxable income calculations for ETFs

Swiss resident individual investors who hold shares in a fund for private investment purposes depend on the disclosure of the fund's Swiss taxable income (and net wealth tax values) on the official tax information database of the Swiss Federal Tax Administration (SFTA) for the completion of their annual tax return. The key tax information published on the SFTA database is the taxable income per share. The calculation of this figure must follow the methodology outlined by the SFTA in its Circulars 24 and 25, which were published in 2009. The SFTA has also issued model calculation spreadsheets, in Excel format, as attachments to the Circulars. The calculation of income (which is taxable) and of capital gains (which is tax-free) in the hands of individual investors residing in Switzerland is based on the audited financial statements of a fund.


"The time when no income in the profit and loss statement of an ETF meant no taxable income is over"


In Switzerland, non-Swiss ETFs represent a large majority of the investments in ETFs held by Swiss investors. The Swiss investor base is large, since shares in ETFs are easily accessible on the Swiss retail market. ETFs are either structured with physical replication (physical ETFs) or with synthetic replication (synthetic ETFs) or a mix of both methods. A synthetic ETF is designed to replicate the return of a selected index (such as S&P 500) just like a physical ETF; however, instead of holding the underlying securities or assets directly, they use derivatives such as swaps to track the performance of the underlying index. Based on the rules outlined in the Circulars, payments received under a swap agreement and booked as net realised gains (or as net change in unrealised gains) are treated as tax-free capital gains and not as investment income for the determination of the Swiss taxable income. As a result, synthetic ETFs that follow the rules set out in the Circulars would generally have zero taxable income, whereas physical ETFs with an identical underlying index would show a net taxable income.

In the course of 2014, the SFTA started to systematically challenge the calculation methodology applied for synthetic ETFs for the tax period 2013. The SFTA deems that from an economic point of view, the swaps partially reflect dividend or interest payments and subsequently part of the payments generated under the swaps must be reclassified as taxable income (instead of tax-free capital gains) for private individual investors residing in Switzerland. In the SFTA's view, the annual net dividend yield (gross dividend minus withholding taxes on dividends) or the annual net yield of interest of the underlying index must be used to reclassify part of the swap payments received by a synthetic ETF as taxable income for the purpose of calculating the taxable income per share. On the other side, income booked in the profit and loss account of an ETF that reflects dividends or interest received from physically held investments and paid to the counterparty under the swap can be deducted from the income of the ETF.

The SFTA wishes to ensure that this practice is applied consistently to all ETFs using a synthetic replication strategy. As a result, the time when no income in the profit and loss statement of an ETF meant no taxable income is over.

To the objection that this practice development was never formally announced, the SFTA responded that the market should have known this, since it had been applied to several ETF providers in tax rulings issued from 2010 onwards. Further, in their view this practice was 'officially announced' in a letter addressed to the Luxembourg Fund Association (ALFI) in February 2012; a copy of this letter was sent to the Swiss Funds and Asset Management Association (SFAMA). Although the SFTA did not formally inform about these developments, there is no doubt in its view that this practice should apply. Lastly, the SFTA confirmed that these rules will be included in revised versions of its Circulars. It is not anticipated that they will be officially released in the next 12 months.

Fatca registration process

Switzerland has concluded an inter-governmental agreement for the cooperation to facilitate the implementation of Fatca (IGA) with the US, which entered into force on July 1 2014. Unlike most other countries, Switzerland chose the so-called Model II IGA, which requires that Swiss financial institutions (SFIs) register and enter into an agreement with the IRS and report certain information on their US clients and shareholders directly to the IRS.

As at the end of November 2014, a total of 4,613 SFIs had registered with the IRS. An analysis of the IRS list of registered SFIs shows that Swiss-domiciled investment funds account for almost a third of the Swiss registrations (Chart 1). The 1,294 Swiss funds registered represent 86% of the 1,511 Swiss funds approved by the Swiss Financial Market Supervisory Authority (Finma). Factoring in certain real estate funds and funds wholly owned by exempt beneficial owners, which do not qualify as SFIs for Fatca purposes, most, if not all, concerned Swiss funds are registered today. The IRS list does not give any insight into the registration status. However, the large majority of Swiss funds meet the conditions to qualify as non-reporting SFIs under the registered deemed-compliant status for collective investment schemes in the Swiss IGA, as all the interests in the funds are typically held by Fatca-compliant Swiss custody banks. It is therefore reasonable to assume that such funds have registered as deemed-compliant SFIs.

Chart 1: Registered Swiss financial institutions

Source: Finma, SAAM, IRS

Chart 2: comparison of registration by funds, fund managers and asset managers

Source: Finma, SAAM, IRS

For Swiss fund management companies and Swiss asset managers, which represent about half as many registrations as Swiss funds (Chart 1), the situation is not as homogenous. The reason for this lies with the contradicting registration requirements in the Swiss IGA and the Fatca regulations of the US Treasury Department. On the one hand, most Swiss fund management companies and Swiss asset managers meet the conditions to qualify as non-reporting SFIs treated as registered deemed-compliant SFIs under the Swiss IGA. On the other hand, the Treasury Department and the IRS subsequently added a new self-certified deemed-compliant status for certain investment advisers and managers to the US regulations. The timing of this release shortly before the registration deadline of July 1 2014 led to uncertainty and confusion on the Swiss market. Swiss fund management companies and Swiss asset managers were facing Swiss regulators and banks demanding a GIIN (Global Intermediary Identification Number) as proof of their registration under the Swiss IGA, while there was no such requirement under the amended US regulations. Ultimately, in their FAQ on the Swiss IGA, the Swiss Government clarified that Swiss investment advisers and managers in general may choose to either register as non-reporting SFIs under the Swiss IGA or claim the self-certified status under the US regulations and not register. Unsurprisingly, a comparison of the IRS list against the list of Swiss fund management companies and Swiss asset managers approved by Finma and the member list of the Swiss Association of Asset Managers (SAAM) shows that, in contrast to Swiss funds, just under 60% of Swiss fund management companies and little more than 50% of Swiss asset managers have registered with the IRS. The others presumably have chosen to claim the self-certified deemed-compliant status under the US regulations (Chart 2).


"If a capital gains tax is introduced, Swiss fund managers in particular will be affected if they hold investments in the funds they manage for private investment purposes"


What conclusions can be drawn from this analysis? Although not intended, there is today a roughly 50:50 split between registered and self-certified Swiss investment advisers and managers. Further, most Swiss funds, asset managers and advisers benefit from a non-reporting SFI status, which by definition will never have any reporting obligations under Fatca. This begs the question why these SFIs were required to register in the first place and obtain a GIIN intended only for Fatca reporting purposes? It will be interesting to see which registered Swiss asset managers and advisers, considering their self-certified peers, will delete their registration in 2015 to avoid the compliance obligations (such as periodical certification of Fatca compliance to the IRS) it entails.

Proposed corporate tax reform

In September 2014, the Swiss Federal Council began the consultation phase of Switzerland's Corporate Tax Reform III (CTR III), issuing a report that includes numerous proposals to significantly change Swiss corporate tax legislation. The driver behind these proposals was political pressure from the OECD and the European Union that Switzerland abolish the privileged tax regimes available for Swiss holding, administrative and mixed companies. Switzerland is looking to comply with this request while maintaining the competiveness of its tax system.

The CTR III proposals that could significantly impact Swiss resident fund and asset managers are:

  • Swiss companies pay Swiss corporate income tax at federal, cantonal and communal levels with the total effective tax rate varying from 13% to as high as 25% depending on the domicile. Companies with a privileged tax status can achieve an effective rate ranging from eight percent to 12%. The proposal calls for reduced total effective tax rates that would not exceed 15%.
  • Measures to abolish stamp issuance duty, a change to the loss carry-forward rules so that they can be carried forward indefinitely (rather than the existing seven year limit) and amendments to the participation deduction rules.

The privileged tax regimes do not usually apply to fund and asset managers, and as such, their removal should not be significant. As a consequence, the proposed reduction of tax rates and changes to loss carry-forward rules would be welcomed.

Authors

Grégoire Winckler
Partner
T: +41 58 249 34 95
E: gwinckler@kpmg.com

KPMG AG
Badenerstrasse 172
CH-8026 Zurich
Switzerland
Tel: +41 58 249 31 31
Web: www.kpmg.ch


Jason Zücker
Director
T: +41 58 249 35 99
E: jzuecker@kpmg.com

KPMG AG
Badenerstrasse 172
CH-8026 Zurich
Switzerland
Tel: +41 58 249 31 31
Web: www.kpmg.ch

Of course, there is no such thing as a free lunch: the proposed measures to keep Switzerland an attractive tax environment for doing business have a price. The CTR III proposes the introduction of a capital gains tax on the disposal of securities for individuals residing in Switzerland. Swiss individuals holding movable assets for private investment purposes are not, under existing regulations, subject to any capital gains tax. Under the proposal, 70% of the gains on the disposal of securities would be subject to the ordinary progressive income tax rates while capital losses could be offset against capital gains. In addition, the transfer of residence outside of Switzerland would trigger an exit tax.

If a capital gains tax is introduced, Swiss fund managers in particular will be affected if they hold investments in the funds they manage for private investment purposes. In addition, the Swiss tax reporting rules will need to be amended to consider the portion of capital gains generated upon the disposal of interests in investment funds, which is tax-free for individual investors residing in Switzerland holding their investment for private purposes, but which may become taxable under the proposed new regime. The IT systems for Swiss investment funds will have to be upgraded to reflect any new capital gains tax regime.

The consultation procedure for the legislative draft will last until January 2015, after which the Swiss Federal Council will prepare the final proposal for discussion in the parliamentary chambers and commissions. Initial reactions to the proposals suggest that most changes will be subject to a referendum. As a result, it is very unlikely that any significant changes will occur before 2017.