Weakening of Swiss Safe-Harbor Protection
On 11 Juli 2024, the Federal Supreme Court of Switzerland (“FSCS”) ruled on the applicability of the Swiss safe harbor interest rates. This ruling increases the need for substantial analyses where taxpayers deviate from the published rates. Thus, Swiss taxpayers with related-party loans should review their transfer pricing (“TP”) and possibly consider risk mitigation.
Swiss Interest-Rate Safe-Harbor
The Swiss Federal Tax Administration (“FTA”) publishes safe harbor rates for controlled financial transactions. The respective annual circular covers especially the rates for real estate loans and business loans from related parties. Conceptually, they are similar to the Applicable Federal Rates of the American Internal Revenue Service. Swiss taxpayers apply them regularly for cross-border intra-group loans.
Facts of the Case
The case addresses the interest on financial transactions of a Swiss taxpayer during 2014 and 2015. Specifically, these were a loan and a credit line from a related party in another canton. The annual interest payments had been set at 2.5% and 3% respectively. In 2019, the Zurich Cantonal Tax Office challenged this, determining an arm’s-length interest rate of 1.08% for both loans. This interest rate was derived by adding a small margin on the taxpayers’ external financing cost.
Not accepting the adjustment, the taxpayer appealed to the courts. In 2022 the Zurich Administrative Court revised the adjustment and applied the maximum rates of the FTA circular. For the two covered years, these were 2% and 1.5% respectively, thus reducing the volume of the adjustment significantly. Refuting the applicability of the FTAs circular to domestic transactions, the tax office appealed to the FSCS.
Ruling of the Federal Supreme Court
Firstly, the FSCS reconfirmed the general protection provided by the FTA circular’s safe-harbor rates for Swiss tax purposes. Furthermore, it clarified that FTA’s safe-harbor rates are only a means to simplify compliance with the arm’s-length standard. They are no evidence of actual arm’s-length pricing. Where they are applied, an assumption takes hold that the transaction is at arm’s length. This allows for simplified administration of controlled financial transactions.
Where the taxpayer deviates, the arm’s-length assumption for the safe-harbor rates does no longer hold. Central argument here is that in such cases an economic analysis to evaluate the applied rate is needed anyhow. Consequently, the tax administration is no longer bound by them but can estimate arm’s-length results with appropriate analysis.
Consequences for Transfer Pricing
The FTCS explicitly refutes the argument that the FTA safe-harbor rates could only be relied on for federal tax purposes, not for cantonal and municipal taxes. This provides Swiss taxpayers with increased assurance where they apply these rates to domestic transactions.
For the pricing of cross-border loans between group companies, the impact should in principle be limited. Very likely, the partner-jurisdiction will already require a detailed TP-analysis for the transaction. Only where the other jurisdiction, too, allows for the application of safe-harbor rates, it becomes necessary to confirm their compatibility with the Swiss rates.
The Swiss tax authorities enjoy now more leeway when a taxpayer ignores the safe-harbor but has no standard-compliant analysis. Then, the examiners can substitute their estimate directly, without being limited by these safe-harbor rates. As the FTA rates are overall quite generous, this increases the monetary TP-risk substantially. Therefore, the ruling further emphasizes the need for a professional economic analysis. As mentioned, this will typically be required by the jurisdiction of the foreign related party anyhow.
References
The ruling can be found on the portal of the Federal Supreme Court of Switzerland here. The Circulars of the Federal Tax Administration on related-party interests are available here.