Over the past decade, Switzerland, more than elsewhere, attracted many footloose foreign companies – and their earnings. Between 1999 and 2009 alone, gross profits taxed in Switzerland rose by 72% to SFr95bn. Almost half the amount stemmed from the 20,000 groups which, via holdings and other structures, count as so called “tax privileged companies”.
The group is dominated by the sales operations and corporate headquarters of multinationals. As a share of Switzerland’s gross domestic product, corporate profit taxes have doubled from 1.5 to 3% in a decade. Avenir Suisse’s latest estimates show tax privileged companies faced an average 10.7% levy. By contrast, the roughly 275 000 companies taxed conventionally paid a significantly higher 22.4%. Among such companies are all those which operate exclusively in Switzerland.
But in spite of their lower fiscal burden, the SFr4.6bn received from the fiscally privileged band accounted for no less than 28% of Switzerland’s total corporate profit tax take. So from a revenue point of view, a tax privileged company is six times more fruitful than a normal one. And tax privileged companies can’t be criticised for contributing significantly to rising land prices or immigration: after all, having a restricted footprint in Switzerland is one of the conditions for obtaining special status.
Switzerland’s appeal to international companies has prompted rising pressure, notably from the EU, which has denounced cantonal tax systems. The European Commission claims the tax breaks are tantamount to state aid and contradict the implicit “code of conduct” underlying fair competition as understood by the EU. Such claims are legally and economically moot. But the political pressure remains – whether in the form of latent threats to discriminate against Swiss companies or to cancel double taxation agreements.
Under EU pressure
Switzerland’s appeal to international companies has prompted rising pressure, notably from the EU, which has denounced cantonal tax systems. The European Commission claims the tax breaks are tantamount to state aid and contradict the implicit “code of conduct” underlying fair competition as understood by the EU. Such claims are legally and economically moot. But the political pressure remains – whether in the form of latent threats to discriminate against Swiss companies or to cancel double taxation agreements.
Last May, the Swiss federation and the cantons responded with plans to prevent an exodus of tax privileged companies come the (likely) abolition of their benefits. Since publication, the proposals have been tightened, with priority going to new tax models lowering rates on earnings from innovation, including research and development, but also on licences, patents and intellectual property. The approach is understandable: patents, intellectual property and the like count among multinationals’ most “mobile“ earnings and would probably be the first to be booked elsewhere.
But Switzerland’s strategy has its perils. Although the EU itself allows special tax treatment for licences, the OECD – the tax trendsetter for the G20 group of richest countries – and heaviweights like Germany disagree.
A further possible reform, not so far pursued by Bern and the cantons, would be to grant special treatment to R&D spending. Financial experts like Christian Keuschnigg have already suggested companies should be allowed to offset such spending at 130% against tax – reducing their average tax bills. That would let Switzerland both continue attracting multinationals with “mobile” R&D operations and stimulate those companies already here to beef up research outlays. Given the positive impact of R&D on the broader economy, few other tax breaks can be better justified.
Better treatment for capital
Economically speaking, allowing a notional interest deduction on equity capital should also be encouraged. It would let companies claim tax relief not only on interest payments to banks and other debtholders, but also on part of their equity capital. The reform would reduce the incentive for borrowing (rather than using own funds) – a benefit that could be particularly relevant to banks, which, arguably, relied excessively on debt, increasing their vulnerability during crises.
Even more important: such tax relief would eliminate the double taxation of investments that are currently financed from a company’s own resources. As matters stand, companies fund their investment from resources that have already been taxed (eg. reinvested profits). However, earnings from such investments are then taxed a second time via the bottom line. So notional interest deduction on own funds would level the playing field for investment decisions – no small matter.
What’s fallen into the background, however, is lowering headline tax rates, although this is the least controversial and most lasting reform. Ireland, for example, tenaciously defended its 12.5% corporate tax, even during the darkest days of the financial crisis and against the wishes of its EU partners (and rivals). True, reducing taxes in the cantons where tax privileged companies are concentrated (Geneva, Vaud, the City of Basel and Zug) would lead to a big drop in revenues at first. One can already imagine the party political mudslinging that would follow!
But it’s always worth remembering corporate profits taxes are among the most damaging weapons in the fiscal arsenal. Taxing receipts on capital lowers the incentive to create capital – in other words, to save and to invest in equipment and innovation. That can dampen overall economic growth – which is in no one’s interest. Such research, pioneered by Christophe Chamley und Kenneth Judd, altered radically economists’ thinking about company taxation – but hasn’t, sadly, had the same impact on politicians.
This article was first published in German in "Finanz und Wirtschaft" on 2nd november 2013.
