Tax challenges of cross-border business activities for Swiss groups
Workshop on the occasion of the ISIS) seminar of 8 March 2018 entitled "Structuring Cross-Border Business Activities
Practical questions regarding the exchange of country-by-country reports (CbCR) of multinational corporations with Swiss parent companies
The Ino Tech Group is a multinational corporation whose parent company, IT Top AG, is based in Zug. The group has the following structure:
The Group's business activities consist of research and development (R&D companies) as well as the manufacture (OpCos) and distribution (in or from Switzerland CHF MixedCo, otherwise OpCos) of solar cells and electrical semiconductors. The company CH Experts provides the Group's OpCos with specialists who provide temporary (approx. 2 to 3 years) support for the market launch of new products, in particular for adapting to local conditions or customizing. These specialists are employed by CH Experts, but their costs are borne by the operating companies. CaptiveCo in Bermuda is an internal insurance company with 10 employees, which insures risks for the group companies. FinCo, which is also based in Bermuda, is a finance company with only one employee and is responsible for the group's internal financing activities (in particular the transfer of external capital to group companies in the form of intra-group loans). CaptiveCo and FinCo each report annual sales of around CHF 100 million and profits of around CHF 50 million.
The Ino Tech Group generates annual consolidated sales of approximately CHF 3,000 million.
A has taken up the position of Tax Director of the Ino Tech Group as of November 1, 2017. It will receive a draft of the CbCR for 2016 from its predecessor with the information that it still needs to be supplemented (in particular the still empty Table 3 - further information and explanations), finalised and submitted (Enclosure 1). A hopes that this will provide a good overview of the Group's tax structure and risks. In connection with the CbCR, various questions arise for A:
- When, by which company of the group and to whom is the CbCR to be submitted for the first time?
- How do you assess the following questions regarding the information content of the CbCR?
i. For which of the group companies must information be provided in the CbCR?
ii. On which points in the attached draft CbCR should A provide explanations?
iii. Does the CbCR give A the desired information on tax risks of the Ino Tech Group?
i. The German tax authorities would like to receive the CbCR of the Ino Tech Group already now. Can they request it directly through the local German subsidiary?
ii. After receiving the CbCR, the German tax authorities would like to make a transfer price adjustment based on the CbCR. Can they do this? If not, what can they do instead?
- IT Top AG inadvertently did not fill out the CbCR completely: What are the consequences?
Structural adjustments due to the current tax environment - Consolidation of the Group structure
After careful consideration of the CbCR, A comes to the conclusion that the current Group structure is in some cases not (or no longer) appropriate and that it entails considerable tax and reputational risks. A would therefore like to propose a consolidation of the group structure to the management of the Ino Tech Group.
The Ino Tech Group has two divisions, Solar and Semiconductor. The Solar Cells business unit includes Dutch R&D and Dutch OpCo, DE OpCo 1 with its production facility in Austria and the US joint venture. CH R&D 1, based in the canton of Nidwalden, CH R&D 2, based in the canton of Zurich, CH OpCo, DE OpCo 2 and US OpCo belong to the electrical semiconductors business unit. CH MixedCo is active in both business units. CaptiveCo, FinCo and CH Experts are also active in both business units.
FinCo reports a profit equivalent to around CHF 30 million and has one employee. CaptiveCo with its 10 employees generates the equivalent of around CHF 20 million in profit.
With regard to tax bill 17 ("SV17"), A is considering merging all Swiss companies into a single company. With the exception of CH R&D 1, all Swiss companies of the Ino Tech Group have their registered office in the Canton of Zurich. The two Swiss research companies, CH R&D 1 and CH R&D 2, could benefit in the future from the patent box of SV17 with Nexus approach. While CH R&D 2 does not award research contracts to other companies, about 40% of the R&D expenditure of CH R&D 1 is incurred abroad. The foreign R&D expenses of CH R&D 1 are research contracts awarded to Dutch R&D. The patent box regime of SV17 allows to take such expenses into account in an uplift of maximum 30%. In the current structure, only 78% (= 60% x 130%) of the IP income of CH R&D 1 can therefore be taxed privileged. If CH R&D 1 and CH R&D 2 were to merge, the research contracts awarded to Dutch R&D would only account for 20% of total R&D expenditure. In addition, the administrative costs of the two companies could be reduced by about 5%.
- A turns to you and wants to know whether he should retain the Bermuda companies or move them to Switzerland. In your reply, please take into account any tax risks arising from the CbCR.
- What are the tax and non-tax advantages and disadvantages of structuring by business units, whereby each business unit would be grouped under a sub-holding company?
- With regard to SV 17, which restructuring measures appear sensible and for what reasons?
Response to Anti-Tax Avoidance and Double Taxation / Treaty Override
US OpCo and DE OpCo 2, which manufacture and sell electrical semiconductor products in the USA and Germany respectively, receive their licenses from CH R&D 1. As compensation for the licenses, US OpCo and DE OpCo 2 pay CH R&D 1 a license fee in line with the third party comparison. US OpCo pays the equivalent of around CHF 50,000,000 annually in licence fees to CH R&D 1. US OpCo also pays interest of the equivalent of CHF 30,000,000 annually on loans from FinCo amounting to the equivalent of CHF 750,000,000. Since 1 January 2018, US OpCo has been taxing its remaining annual profit of the equivalent of CHF 30,000,000 at a rate of 21% (instead of 35% before the US tax reform).
In the course of the tax reform that came into force in the USA on January 1, 2018, the license payments to CH R&D 1 will be qualified as "Base Erosion Payments". As a result of these "base erosion payments", the US tax authorities will assess income taxes at the equivalent of CHF 11,000,000 instead of CHF 6,300,000.
In order to prevent any possible transfer price adjustments, DE OpCo 2, CH R&D and the German and Swiss tax authorities have agreed on the appropriate licence fee in a preliminary understanding procedure (APA).
CH R&D 1 is based in Stans, NW and is the only research facility in the country. The net licence income of CH R&D 1 is generated in Nidwalden in accordance with Art. 85 para. 3 StG-NW in conjunction with § 56a StV-NW (patent box). On average, about 60% of the research and development costs ("R&D costs") of CH R&D 1 are incurred in its own research facility. The remaining R&D costs are incurred by Dutch R&D within the scope of contract research.
As of January 1, 2018, the unilateral limitation on the deductibility of royalty expenses came into force in Germany, which limits the deductibility of royalty expenses from German taxable entities if the recipient of the royalty payments
- is taxed under a preferential regime that can be classified as harmful;
- does not carry out any substantial business activity; and
- Is subject to a tax on royalty income of less than 25% effective.
The effective tax rate of CH R&D 1 on net royalty income is 8.94%. The Nexus approach is currently not applicable.
CH R&D 1 also licenses some patents to Dutch OpCo and AU BS in the field of solar cells. These patents were largely developed through research contracts with Dutch R&D.
As the licence income is subject to effective taxation of less than 10% in the case of CH R&D 1, the Austrian tax authorities do not allow licence expenses of CHF 20,000,000 converted annually to be deducted in the case of AU BS.
The Dutch tax authorities, in turn, take the view that the actual research activities that led to the licensed patents are carried out by the majority of Dutch R&D, which is why CH R&D 1 is not the beneficial owner of the patents. Accordingly, the license expenses of Dutch OpCo of annually converted CHF 70,000,000 are not deductible by the Dutch tax authorities.
- If Germany, the Netherlands, USA and Austria were to insist on their unilateral measures to prevent base erosion and Switzerland were to refuse to adjust Swiss taxes, what would be the extent of economic double taxation?
- How are the unilateral measures taken by Germany, the Netherlands, the USA and Austria to prevent base erosion to be assessed in the light of the double taxation agreements between Switzerland and the respective countries, and how can the Ino Tech Group counteract any economic double taxation?
- How can the Ino Tech Group react to double taxation resulting from restructuring?