Tax aspects of the establishment and development of the start-up

Case 1: Tax aspects at the level of the founders

1. facts- foundation

Franz Zahl (resident in Freienbach, SZ), a business economist, meets the biologist Franziska Baum (resident in Zug, ZG) and the engineers Fabiana Maschine (hardware engineer) and Felizitas App (software engineer) (both resident in Zurich, ZH) at a student event. From her studies, Franziska knows that plants make sounds that are not audible to the human ear. The sounds differ depending on the health of the plant. Together, the four decided to develop a sensor and an application that would convert the sounds into a technical warning system that could be read by humans. The goal is that any deficiency in the plant and a corresponding suggestion for action can be transmitted electronically. There are many possible applications, from houseplant lovers to renaturation organizations to primary producers. A crazy idea becomes reality. The young entrepreneurs succeed in creating a working prototype and prepare a patent application(Milestone 1). FZ, FB, FM & FA then jointly decide at the beginning of 2018 to found a stock corporation, F4 AG (logo "^F4", hereafter ^F4) with a capital of CHF 100,000 (cash foundation, 100,000 shares at CHF1), in which the four founders each hold a 25% stake. Zurich is chosen as the registered office of the company, since the development of the sensors is carried out in a rented laboratory in Zurich. Patent applications are filed by ^F4 . After graduation, each of the four founders takes a 50% job with a third party and works 50% for ^F4 on the development of the sensor and the application as well as on their marketing. In the start-up phase, the founders do not receive a salary, since no revenue is generated yet and the founders want to keep the loss as small as possible. In 2020, it becomes apparent that further funding is nevertheless needed to bring the system to market maturity (milestone 2). Franz creates a pitch deck and wins an investor who takes a 20% stake in the company for CHF 200,000. For this purpose, 25,000 shares with a nominal value of CHF 1 each are issued to Investor 1 at CHF8 in 2020.

Variant 1:

At the start-up, an employee is hired who is responsible for the design. In order to retain and motivate this employee, an employee participation program is introduced as part of the 2020 financing round. Franz sends a corresponding ruling to the tax authorities and agrees that the income tax value of the employee participation under the current plan will be determined according to the following formula: As long as EBIT is negative: CHF 300,000 per defined and achieved milestone, but at least substance value. Thereafter EBIT multiple of 7, but at least CHF 300,000 per defined milestone or at least substance value. In 2021, the product is ready for the market (milestone 2), but no sales are made yet. Further investments are necessary for marketing. In a further financing round in 2021, 25,000 shares with a nominal value of CHF 1 each are issued at CHF 16. All founders give up their previous jobs and from now on work 100% at F4 for a salary of CHF 5'000 gross each.

Variant 2:

No MA participation program and the product reaches market maturity in 2023 (milestone 2). First sales take place, EBIT remains negative. Further investments are necessary for marketing. In a next financing round in 2023, 25,000 shares with a nominal value of CHF 1 at CHF 32 are issued.

Option 3:

Basic facts, but registered office of the company is Zug, residential address of Franziska Baum. Franziska herself does certain administrative work from home, the board meetings take place at the registered office. The main activity, the development of the sensors, as well as the actual management takes place in Zurich.

Questions

• Founders' property tax in 2018?
• Founders' property tax in 2020? Variant 1 2020 and 2021?
• Founders' property tax in 2023 Variant 2?
• Income tax and social security of founders in 2018 - 2021?
• Potential problems in variant 3?

Case 2: Taxation of profits and handling of losses / STAF

1. facts of the case

Basic facts of case 1.

^F4 has generated losses since the year of its foundation. The costs for sensor development are not capitalized but recognized as an expense in the income statement.

The annual results as of 2018 are as follows (each as of 12/31):

• 2018: - CHF 20'000
• 2019: - CHF 25'000
• 2020: - CHF 60'000
• 2021: - CHF 80'000
• 2022: - CHF 50'000

Budgeted results for the current fiscal year 2023 and the following four fiscal years are as follows:

• 2023: - CHF 80,000
• 2024: - CHF 85'000
• 2025: - CHF 25'000
• 2026: - CHF 10,000
• 2027: CHF 0

Variant 1:

To ensure liquidity, all four founders contributed CHF12,500 each à-fonds-perdu to ^F4 at the beginning of fiscal year 2021.

Variant 2:

^F4 has already reached the break-even point in 2020 and will generate significant profits in the following fiscal years.

Questions

• ‍Whatis the basic tax situation?
• What courses of action does the ^F4 have with respect to the losses?
• Option 1: What are the tax consequences of the grant in fiscal year 2022?
• Variant 2: How should the tax situation be assessed? What are the options with regard to theSTAF measures?

Case 3: Financing models

1. facts of the case

Basic facts of case 1 and 2.

At the end of 2022, the balance sheet is as follows:

In 2023, an interim balance sheet as of the end of March is as follows:

50% of the FC is debt from operating activities and 50% is a shareholder loan from Franz, which bears interest at 2.5%.

Funds are again required for the further marketing of the sensors. Since the founders can no longer inject their own funds, the following options are available:

• In a next financing round, 25,000 shares with a nominal value of CHF 1 each at CHF 32 could be issued to Investor 2
• Debt financing CHF 800'000 by third party, annual interest rate of 3.5%.
• Debt financing CHF 800,000 by investor 1, annual interest rate of 3.5%.

Questions

• Is the company in need of reorganization before the financing round?
• Is there hidden equity?
• Tax consequences of self-funding/financing round?
• Tax consequences of third-party financing?
• Tax consequences of debt financing by investor 1?

Case 4: Value added tax

1. facts of the case

F4 AG (cf. previous cases) has borne significant initial investments since its foundation in 2018. The first sensors are not expected to be sold until the fifth financial year at the earliest.

The following costs, among others, are incurred:

• Formation costs (CH)
• Electronic components for sensors (CH and abroad)
• Sensor housing (abroad)
• Equipment for the assembly of the sensors (CH)
• Indoor greenhouse for sensor test (incl. plants and maintenance) (CH)
• Total IT infrastructure (CH)
• Rent (CH)
• Patent attorney (CH and abroad)
• Trust company (CH)

Questions

• How should this situation be assessed from a VAT perspective in general?
• What should be recommended to F4 AG from a Swiss VAT perspective?

Case 5: Change of structure and expansion

1. facts of the case

In 2023, ^F4 (cf. Case 1) is looking for ways to reduce manufacturing prices for the start of mass production and decides to outsource the sensor production previously carried out in Switzerland to Germany. The current production capacity in Switzerland is maintained in particular for the purpose of further development of the sensor. In addition, the sales market in the EU (via Germany) is to be better developed. The following options are under discussion:

• Production by third-party contractors in Germany
• Establishment of production in Germany without own legal entity (branch office)
• Establishment of production in Germany via subsidiary
• Distribution via a subsidiary in Germany

The sensor housings are manufactured by an Italian third-party company. As before, it is not intended to produce the housings itself. ^F4 acts as purchaser vis-à-vis the Italian third-party company.

The electronic sensor components are also purchased from the ^F4 . Nothing is to change in this respect either.

Before distribution is structured via the sales subsidiaries, this is done centrally by ^F4. For distribution within the EU, ^F4 maintains a warehouse in Germany.

Variant 1:

The German production subsidiary is only making losses in the first three years due to necessary investments.

Variant 2:

Starting in the third fiscal year, the German production subsidiary will itself purchase the electronic sensor components and enter into the contractual relationship with the Italian housing producer. However, the electronic components may only be purchased from suppliers authorized by ^F4. Also, the maximum purchase prices are set by the ^F4. All sensors are purchased by the ^F4 (purchase guarantee).

Option 3:

^F4 intended that the German subsidiary would also take over tasks in the area of research & development (contract research). In previous years, ^F4 applied for reductions for STAF measures (patent box and the additional deduction for research & development) in its tax return.

Questions

• Does the outsourcing of production to a German third-party company have tax implications for the ^F4?
• What tax issues arise when outsourcing production to a German branch?
• What tax issues arise when outsourcing production to a German subsidiary?
• How can sales be structured?
• Is there a need to prepare transfer pricing documentation?
• How should the purchase of sensor housings and electronic components be assessed from a VAT perspective?
• Variant 1: Does the subsidiary's loss have to be compensated by ^F4 ?
• Variant 2: What impact does the adjusted functional profile of the German production subsidiary have on its compensation?
• Variant 3: What is the impact of starting R&D activities in Germany on STAF instruments?