INTELLECTUAL PROPERTY TAXATION IN SWITZERLAND

INTERNATIONAL TAX

Intellectual Property Taxation in Switzerland Year 2003

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INTELLECTUAL PROPERTY TAXATION IN SWITZERLAND

Table of contents

INTELLECTUAL PROPERTY TAXATION IN SWITZERLAND...............3 Corporate taxation..........................................................................................3 Taxation at source...........................................................................................6 Profit repatriation...........................................................................................6 OUR OFFICES IN SWITZERLAND ..............................................................7

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INTELLECTUAL PROPERTY TAXATION IN SWITZERLAND

Intellectual property taxation in Switzerland

Switzerland is home to the World Intellectual Property Organization (WIPO). The country has introduced a number of interesting tax incentives for the management of intellectual property. For corporate income tax purposes, it is possible to pre-negotiate the expected costs relating to pure IP businesses and obtain a deduction of between 50% and 80% of gross royalty income in the form of a lump-sum tax deduction. Alternatively, significant relief is possible on royalty income if the Swiss business qualifies as a special-purpose branch, holding company or auxiliary company. The amount of source taxation on royalty income and the method of profit repatriation out of Switzerland are largely dependent on whether the Swiss operation is a company or a branch. A common structure is the Swiss IP branch of a Luxembourg company, which, as a result of the Luxembourg foreign branch exemption combined with low Swiss federal and cantonal tax rates on royalty income, produces an effective combined tax rate that can be significantly below 10%. A similar structure is possible within the Netherlands. However, this Dutch combination has become less popular following the 1997 changes in the Dutch application of the provisions of the Netherlands/Swiss treaty to "passive" branches, moving from an exemption system to a credit system. Consequently, the combined effective tax rate has increased. Branches that qualify as "active" branches may still benefit from a 90% branch profits exemption in the Netherlands, subject to substance requirements. Corporate taxation

Investment The initial injection of IP is tax neutral if it is bought by the Swiss entity at an arm's-length price. However, if the IP is contributed into a Swiss company against a share issue or below the market value, then an issuance stamp tax of 1% is triggered. This is not the case if the IP is contributed to a Swiss branch of a non-Swiss company. Alternatively, if the IP contribution is significant, it may be possible to obtain relief if it qualifies as an IP business.

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Swiss VAT issues must also be considered. This is usually more of an administrative or liquidity issue rather than a financial cost. Indeed, although the 7.6% Swiss VAT may be due by the Swiss acquiring entity, a corresponding deduction is possible under the reverse-charge mechanism. In order to participate in the future development of IP, Swiss entities may conclude cost-contribution, cost-sharing, or contract-development agreements. Restrictions are limited to transfer pricing issues. Though Switzerland uses the rules laid down by the OECD, the Swiss approach to transfer pricing tends to be rather pragmatic. Basis of taxation Swiss corporate income tax is generally levied on net after-tax income as reported in the financial statements. The method of depreciating IP should be inline with usual business practice. Both the declining balance method (40%) and the straight-line method (20%) are acceptable. Exceptional depreciation, provisions, and corrections are often allowed for tax purposes as long as they are substantiated as being commercially justifiable. Tax relief Pure IP businesses: Businesses involved in IP management often incur costs that are difficult to justify. To simplify matters, a Swiss business that is managed from abroad and has no commercial or technical organization in Switzerland, may distribute between 50% and 80% of its gross royalty income without any form of substantiation. This is considered as generally accepted tax practice and may be requested for Swiss federal, cantonal and communal income tax purposes. This is not, strictly speaking, a tax incentive. It is designed to minimize the number of litigious cases involving not only the question of deductibility of expenses, but also the question of whether or not the shareholders receive a constructive dividend for the tasks that they accomplish on behalf of the company. Any payments made in excess of the predetermined percentage of gross royalties must be clearly justified. From the remaining income, only administrative expenses and direct taxes may be deducted. The difference is usually taxable at ordinary tax rates for Swiss federal tax purposes. However, for cantonal and communal tax purposes, this ruling may be combined with the rules applicable to auxiliary companies (see

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below). This may imply that the net taxable foreign-source income is reduced by a further 80%. Based on this ruling, the combined Swiss corporate income tax on royalty income (before notional expenses) may be between 3% and 5%. Finance Branches: In order for Swiss finance branches to qualify for tax relief on group financing activity, 3/4 of the branches' gross profits should be derived from financing activities, and 3/4 of their assets should be invested in financing activities. However, in order to obtain this tax relief on royalties, IP rights or royalty income must represent less than 1/4 of the company's activities. If royalty income exceeds this threshold, it may be possible to have two branches to maximize tax-planning opportunities. As with pure IP businesses, the combined Swiss corporate income tax on royalty income (before notional expenses) may be between 3% and 5%. Auxiliary (administrative) companies: Auxiliary companies only have administrative activities in Switzerland and are exclusively engaged in commercial activities abroad. Although Swiss federal tax law does not provide for any particular relief for auxiliary companies, there are special rules for cantonal and communal income tax purposes. Indeed, companies that qualify for auxiliary company status are subject to tax on foreign-source royalty income at substantially reduced rates. Each canton has its own particular interpretation of the law. In Geneva, for example, 20% (or less) of foreign-source commercial income is taxed at ordinary rates. Foreign-source income includes income derived from the purchase and sale of goods and services abroad, income derived from the use of intangible property abroad (license fees, royalties, etc), and income for services rendered abroad. Hence, the combined Swiss corporate income tax on net royalty income may be between 8% and 12%. Holding Companies: Holding companies are exempt from cantonal corporate income tax. However, with the exception of relief for qualifying dividend income, they are subject to ordinary federal corporate income tax. Depending on the canton of residency, there is complete tax exemption on income from dividends, interest, royalties, capital-gains etc. However, in order to qualify as a holding company, at least 2/3 of the assets (or income) must be derived from

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long-term participations. Therefore, IP rights or royalty income must represent less than 1/3 of the company's activities. According to this ruling, the combined Swiss corporate income tax on net pre-tax royalty income is 8.73%. Taxation at source

Switzerland's treaty network is comprised of more than 65 comprehensive tax treaties. Since 1965, all of Switzerland's bilateral tax treaties were largely inspired by the OECD model tax convention. Treaty relief is available to Swissresident IP companies but not to IP branches of non-Swiss companies. Treaties provide for a reduction of tax at the source on royalties, as defined by the country of source, and any unrecoverable source tax can be credited against Swiss taxes. Switzerland has no controlled foreign corporation (CFC) legislation. However, in order for Swiss companies to qualify for treaty relief on their foreign source royalty income, it is necessary to respect Swiss domestic anti-abuse rules, which have recently been significantly relaxed. For pure IP businesses, these rules generally imply that a maximum of 50% of gross treaty-favoured income may be used to make deductible payments to non-residents of Switzerland. Profit repatriation

Profit repatriation largely depends on whether the Swiss IP entity is structured as a company or branch. Repatriation from a branch is tax neutral, whereas profit distributions (dividends) from Swiss legal entities suffer a withholding tax of 35%. This may nevertheless be reduced in-full or in-part under applicable international tax treaties. Royalties, management fees, service fees, and technical assistance fees are generally not subject to Swiss withholding tax. This is also true of interest income accruing on inter-company loans for as long as they are not recharacterized as bonds or bank deposits.

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