Example 1: Tax expense in the cost base
Events Switzerland GmbH, based in Canton A (Events CH), supports its parent company, Events Global Ltd., based in the United Kingdom (Events UK), in the organization of various events (concerts, theatre, art auctions, etc.) that are held in Switzerland. As the main organizer, Events UK is responsible for marketing in connection with these events, performs the sales, issues the invoices and concludes the most important contracts itself. The entrepreneurial risk in connection with the events is borne entirely by Events UK. Events CH employs three people who are responsible for the administrative management of the events in Switzerland - among other things, they organize suitable exhibition sites, clarify all organizational aspects directly with the exhibition operators and also conclude the local rental contracts for the events. Events CH also acts as the local payment processor for Events UK. As a pure payment processing platform for Events UK, Events CH settles fees and charges due on the events revenues and forwards them to Events UK. Events CH also bears no entrepreneurial risk in this respect. Events CH is compensated for its administrative support activities and the payment processing function by means of CPM (cost-plus method) with a mark-up of 5%. This mark-up was supported by a benchmarking study as being in line with the arm's length principle.
Solution:
In accordance with OECD Transfer Pricing Guidelines, local tax expenses are not considered when determining the cost base, resulting in a service income of CHF 93’450 for Events CH:
Source: https://www.estv.admin.ch/estv/de/home/internationales-steuerrecht/verrechnungspreise.html
Example 2: Change in the terms and conditions of an intra-group loan
In 2021, the subsidiary of ABC Group (Company A) based in Switzerland receives a loan of CHF 1 billion with a term of 5 years from another subsidiary (Company B) of ABC Group. Based on a transfer pricing study, the contractually agreed interest rate for the loan between Company A and B is a variable interest rate corresponding to the 3-month LIBOR plus a margin of 100 basis points (bps). After the LIBOR rate was phased out in 2022, the interest rate of the intercompany loan under analysis must be adjusted. To this end, a new transfer pricing study is performed based on data that was available when the loan between A and B was concluded in 2021. Based on this new study, from 2022 onwards a fixed interest rate of 3% will be applied to the intercompany loan originally concluded in 2021.
Solution:
It is primarily a question of what independent companies would have agreed on in comparable circumstances. In this case, an independent bank would have only informed its customer of the replacement of LIBOR and the need to apply an alternative rate to the LIBOR rate for the loan agreement still in force, with the alternative rate corresponding to the reference rate validated by the national banks. In addition, the bank would also apply a spread validated by the national banks to ensure equivalence with the LIBOR rate.
Although a transfer pricing study was performed, the interest rate applied from 2022 (a fixed interest rate of 3%) for the loan negotiated in 2021 does not comply with the arm's length principle. In similar circumstances, independent companies previously bound by such a contract would have agreed to apply an interest rate in line with SNB's recommendations. This interest rate would correspond to the sum of the following rates/margins:
- The alternative interest rate chosen by the SNB (SARON). An illustrative interest rate of 0.90% is used for the example.
- An equivalent margin as defined by the ISDA and recommended by the SNB. The margin of 0.0031% shown in the table below corresponds to the margin determined by ISDA for a 3-month interest rate in CHF.
- The contractual margin (100 bps) to be applied to the reference rate and originally agreed between the parties when the contract was signed in 2021.
Based on the above, an interest rate in line with the arm's length principle is lower than the fixed interest rate of 3% applied from 2022. As a result, some of the financial expenses recognized are not justified from the 2022 tax period onwards. This results in a distribution of hidden equity or a benefit in kind, which is to be determined based on the following calculation:
Example 3: Termination of the intercompany loan agreement and entering into a new loan (early repayment of a loan
Facts of the case:
Based on the same facts as in example 1, Company A decides in 2022 to terminate the loan agreement with Company B due to the phase out of the LIBOR. This termination is made without a compensation. A new loan agreement with a term of 5 years is agreed between the same parties. This new agreement proposes a fixed interest rate of 3%. This interest rate was determined as part of a transfer pricing study based on data for comparable loans concluded in 2022 between independent companies for a term of 5 years.
Solution:
In this case, several aspects must be considered. First, it must be checked whether the contractual clauses permit early termination of the contract and, if so, under what conditions. As a rule, the LIBOR phase out does not belong to one of the conditions that is permissible for an early termination of the loan. Second, in the terms and conditions agreed between third parties, banks usually provide for a compensation in the event of early termination of the contract in order to prevent them from being harmed. Third, it must be determined whether early termination is economically justified.
In this respect, it is reasonable to assume that the borrower would not terminate the contract if the current market interest rates, after taking into account any compensation due, are not lower than the interest rate agreed when the contract was concluded. Based on these various elements, it can be concluded that an unrelated third party would not have terminated the contract under similar conditions.
Therefore, Company A's decision to prematurely terminate the contract between them and Company B does not withhold a third-party comparison.
Based on the above, the tax-deductible financial expense must therefore correspond to the one calculated on the basis of the interest rate provided for in the original contract, because the early termination is not justified. After the phase out of the LIBOR, the interest rate corresponds to the interest rate calculated in example 1 in accordance with the recommendations of SNB (0.90% + 0.0031% + 1.00% = 1.90031%). The amount of the hidden profit distribution or benefit in kind thus amounts to CHF 10’969,000 (CHF 1 billion * (3% - 1.90031%)).
Example 4: Application of an alternative interest rate that does not correspond to the recommendations of the national banks (alternative interest rates)
Facts of the case:
Based on the same facts as in example 1, Company B decides to replace the LIBOR rate with an alternative interest rate that corresponds to the interest rate swap rate (IRS) for 1 year in the contract between Company A and B. This IRS rate is 2% in 2022, while the alternative interest rate recommended by SNB is 1.5% after adjustment to a variable 3-month interest rate. In 2022, this IRS rate is 2%, while the alternative interest rate recommended by SNB (SARON) is 1.5% after adjustment to a variable 3-month interest rate. The interest rates shown in this example are purely illustrative.
Solution:
In this case, an independent bank would have followed SNB's recommendations and thus calculated an interest rate based on SARON and the margin of 100 bps agreed between the parties when the contract was concluded in 2021. The interest rate that should therefore be applied from 1 January 2022 is 2.5% (i.e. 1.5% + 100 bps). Consequently, part of the financial expense recognized for the 2022 tax period is not justified from a business perspective and must be adjusted. The hidden profit distribution or benefit in kind amounts to CHF 5 million (i.e. 0.5% * 1 billion), as the interest rate paid by Company A was 3% instead of 2.5% in accordance with the recommendations by SNB.
The SFTA also included four examples which are detailed here.
This outline is an unofficial translation of the Q&A that was published by the SFTA on its website during March 2024. The SFTA has indicated that it will periodically update the Q&A and there may be a delay between the SFTA updating the website and this page being updated. Unless otherwise stated it should not be assumed that this translation has been updated for the latest changes made by the SFTA. This version translation was last updated in March 2024. This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers AG, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. To the extent that there are any differences between this document and the original French or German versions of the SFTA Q&A, the French and German versions will take precedence.
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