Switzerland: Transfer pricing opportunities flowing from tax reform incentive regimes
Switzerland: Transfer pricing opportunities
The Swiss tax reform repealed certain tax privilege regimes and introduced new incentive regimes that aim to maintain Switzerland's status as an attractive location to conduct business. In turn, this may provide transfer pricing planning opportunities.
Patent box and special deduction for R&D costs
Effective from 1 January 2020, the tax reform introduced the patent box and research and development (R&D) incentive regimes.
The patent box regime enables companies to lower their tax base if they own patents or comparable rights (licenses) and incur R&D expenses in Switzerland. Under a relatively narrow definition of patents (or comparable rights that qualify for the patent box regime), the income arising from such patents or comparable rights is subject to a reduced tax rate. In instances when companies only generate royalties by licensing patents, this income can be determined easily and directly. On the other hand, if royalties are embedded in product prices, this income must be determined indirectly.
The tax incentive for the patent box income is tied to substance requirements of the OECD's modified nexus approach, which is directly related to the R&D activities performed in Switzerland.
In addition to the patent box regime, many cantons have introduced a special deduction for R&D expenses of up to 50% of Swiss R&D activities. Such special deductions for R&D costs can add up to 70% of the taxable income.
Some practical transfer pricing implications
Adapting certain transfer prices or transfer pricing systems can help taxpayers enhance the implications of the incentives. Over the past months, questions and transfer pricing considerations came up primarily regarding the following aspects:
- Transparency on intellectual property (IP) inventory and ownership: Before going into the planning of a patent box, it is important to have full visibility and transparency on the economic ownership of the IP. In many situations, this transparency and clarity on IP ownership was missing because multiple entities contributed to the development of IP. Similarly, information on which IP is embedded in which products has not always been easily available to the tax function. Depending on the available information, modelling patent box benefits may become less accurate and with it, also, the basis for decision-making. A proper fact-finding is strongly recommended before starting with any modelling work.
- Managing the R&D cost base: Increasing the Swiss R&D footprint is beneficial for patent box purposes through the nexus quota and for the R&D “super deduction.” While analyzing the current R&D cost structure might be a good starting point, tax departments need to seek discussions on how the business expects the R&D function to evolve. Plans to increase the R&D footprint of a company outside Switzerland may significantly affect the potential for tax savings from a patent box. Tax functions need to consider taking a “dynamic view.” Decisions for a specific R&D location are typically not based on tax considerations but rather driven by other factors, such as availability of a qualified workforce, proximity to research clusters, etc. Still, tax directors would want to note for relevant stakeholders that all other factors being equal, taxes may be a differentiating factor for increasing the R&D base in a Swiss entity.
- Increasing the nexus quota for the patent box: While it is difficult to change the general R&D setup of a company to achieve tax benefits, there may be certain “quick wins” in connection with the nexus quota. A higher nexus quota is achieved when the relative share of R&D activities performed by foreign related parties decreases. In some situations, the R&D cost base of foreign related parties includes non-R&D costs. Unbundling such non-R&D costs from non-qualifying R&D costs increases the nexus quota. Similar treatment may apply with regard to third-party costs incurred by foreign contract R&D service providers that form part of an intercompany charge for contract R&D services.
- Determining brand remuneration for the patent box: A brand remuneration must be deducted to determine the profit that is attributable to the patent box. While Swiss companies have generally had an incentive to charge high license fee rates for trademarks to related parties, such high royalty rates may have negative implications on the taxable income of the patent box as differences between royalty rates may trigger challenges.
What does the use of these instruments mean where there are other jurisdictions involved?
Given the rising transparency demands globally, it can be expected that an instrument like the patent box in Switzerland will pique the interest of foreign tax authorities. Thereby, the nexus factor could draw misleading conclusions on the actual value contributions and profit allocations within the R&D setup. This is due to the fact that costs do not necessarily reflect the correct value of an R&D activity. This would need to be addressed appropriately in the transfer pricing documentation.
Read an October 2020 report prepared by the KPMG member firm in Switzerland
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