8 minute read 2 May 2024
Suspension bridge over young Rhone River near Ernen, Valais, Switzerland, known as 'Goms Bridge', 2018

New Q&A on transfer pricing issued by the Swiss Federal Tax Administration

Authors
Francisco Palacios

Partner, Transfer Pricing in Financial Services | EY Switzerland

Transfer pricing practitioner, financial services industry specialist, curious, family man, triathlete.

Fabian Berr

Director, Transfer Pricing and Operating Model Effectiveness | EY Switzerland

More than 14 years of transfer pricing experience, Focus on financial and IP transactions, Master degree in Economics, regular CFA Institute member.

8 minute read 2 May 2024

Additional transfer pricing guidance offers important insights into Swiss practice and the interpretation of international rules.

In brief
  • The Swiss Federal Tax Administration has launched a new transfer pricing portal expanding on recent Swiss transfer pricing guidance.
  • The portal utilizes a Q&A format to provide guidance across four major TP topics: Cost plus method, withholding tax, cost sharing agreements, and intercompany loans.
  • In this first instalment, we share our analysis of the topics captured in the first three topics. 

The new Q&A issued by the Swiss Federal Tax Administration (FTA) marks another step by the tax authorities to provide guidance on highly relevant transfer pricing topics. Available in German and French for now, the transfer pricing Q&A (TPQ&A) is a valuable source of information on the SFTA’s transfer pricing practice. In this article – the first of several analyses – we summarize key takeaways from the first 20 questions, which are grouped by topic area and offer important insights for companies seeking to interpret international tax regulations in the Swiss setting.

Q&A 1 to 9: Cost plus method

The first topic covered by the TPQ&A is labeled "Cost plus method”. However, this does not mean the third traditional transaction method set out in Chapter II, Part II.D of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECDTPG) and section 4.1.3 of the Swiss Transfer Pricing Guidance. Instead, it refers to the transactional net margin method (TNMM), which is one of the two transactional profit methods provided for in Chapter II, Part III.B OECDTPG and section 4.2.1 of the Swiss Transfer Pricing Guidance. The reason why the SFTA, and many other jurisdictions refer to it as “cost plus” is because the TNMM measures the net profit relative to an appropriate base, which for intragroup services turns out to be cost.

The TPQ&A clarifies the importance of both the cost base and the profit mark-up. It refers to the existing circulars regarding application of the cost plus method and their explicit reliance on the OECDTPG, with specific reference to the latest version published in January 2022.

Operating costs are deemed to add value to business functioning and provision of a given service and should therefore be part of the cost base. Non-operating costs such as taxes and financing costs should in principle be excluded from the cost base since they do not typically create value for the business. However, this should not be taken for granted without having considered the specific facts and circumstances of the service provider or producer of goods. For instance, while excluding financing costs would make sense for a routine service provider, when it comes to capital-intense industry players the role of capital (and thus financing costs) might be linked with the value creation for the business and the service provided or product sold. In such cases, financing costs might typically be booked as operating costs.  In contrast, for tax purposes, the theoretical background is clear and emphasized by the SFTA. In practice, though, some cantons have generally insisted on adding tax expenses to the cost base.

Pass-through costs related to third-party services should be excluded from the cost base when the profit mark-up is applied. There is a general understanding that pass-through costs are just external costs that should be allocated without applying profit mark-up. Chapter II paragraph 2.99 of the OECDTPG defines them as “costs which are potentially excludable from the denominator of the net profit indicator”. In other words, the OECDTPG sees pass-through costs as those subject to allocation but potentially not part of the cost base to which the profit mark-up is applied. It is important to point out that the OECDTPG do not deem it sufficient to classify costs as “internal” or “external” for the sake of ascertaining the appropriateness of a profit mark-up. A comparability analysis might be helpful in such situations, but can prove difficult due to lack of information (e.g., absence of cost breakdown). Finally, the same treatment should be sought to pass-through costs in the context of the simplified determination of arm’s length charges for low value-adding intragroup services.

In this sense, the TPQ&A confirms the simplified charge mechanism for low value-adding intragroup services previously set out in section 5.3 of the Swiss Transfer Pricing Guidance and is fully in line with paragraphs 7.43 to 7.65 OECDTPG. This simplified method allows companies to directly charge a 5% profit mark-up and therefore reduce the compliance burden and provide certainty to taxpayers while facilitating the review to the tax authorities. The conditions for the intragroup services to be considered low value-adding in nature are essentially the same in both the TPQ&A and the OECDTPG (paragraph 7.45). However, the TPQ&A explicitly states that such conditions need to be cumulative; this is only implied by the OECDTPG.

The administrative relief for low value-adding services are listed in line with the OECD, which the TPQ&A refers to directly.

Q&A 10 to 16: Withholding tax

Swiss withholding tax is assessed in the context of primary, corresponding and secondary adjustments. The TPQ&As on primary adjustment fully mirror the relevant section 7.3.1 of the Swiss Tax Guidance, comprising the OECD definition and one illustrative example. It confirms that the cantonal tax authorities are competent insofar as the taxpayer is subject to income tax.  The corresponding adjustment is also covered in line with the Swiss Tax  Guidance.

The TPQ&A also covers an item not included in the Swiss Transfer Pricing Guidance: repatriation. It states its non-binding nature from treaty and domestic law perspective. The repatriation is the payment made to match the balance sheet following a primary adjustment and is covered by the OECD in section 4.77 and 4.78. Due to limited experience of most OECD members, it is recommended that repatriation occur in mutual agreement proceeding (MAP) initiated for the related primary adjustment. The TPQ&A refers to Swiss law, under which repatriations are not considered as cash benefits, and withholding tax might not be levied in the context of a MAP or internal agreement. However, outside the context of such a procedure/agreement withholding tax might be levied.

Secondary adjustment is introduced by the TPQ&A following the definition of the Swiss Transfer Pricing Guidance in section 7.3.2 on procedural aspects, which in turn follows the definition provided by the OECD by reference to paragraph 2 of article 9 of the OECD Model Tax Convention. Likewise, the TPQ&A confirms that the SFTA has competence for secondary adjustment when dealing with withholding tax. The TPQ&A expands further on the practice developed by Swiss tax authorities for secondary adjustments where a MAP is opened after a primary adjustment has been made. The TPQ&A contains an example and sets out the conditions to avoid such secondary adjustment.

The interplay between primary and secondary adjustments in the context of MAPs involves a foreign tax authority dealing with the State Secretariat of International Finance (SIF), which has the exclusive authority to negotiate the MAP, the cantonal tax authorities dealing with income tax (primary adjustment) and potentially the SFTA for withholding tax purposes (secondary adjustment). Both the Swiss Transfer Pricing Guidance and the TPQ&A devote several sections to this subject as do occasional articles published by the SFTA. This is certainly a topic where we can expect more detail in the TPQ&A soon.

Q&A 17 to 20: Cost sharing agreements

A cost sharing agreement (CSA) is a US-regulated intragroup agreement in the context of joint development of intangibles. A similar contractual arrangement is set out in Chapter VIII of the OECDTPG where it is referred to as a cost contribution arrangement (CCA). Neither the CSA nor the CCA are included in Swiss law and no reference was made to CCAs in the Swiss Transfer Pricing Guidance. 

The CSA is a contractual arrangement that results from the willingness of controlled parties to share the costs and risks associated with the development of intangibles in proportion to each party’s share of reasonably anticipated benefits (RAB) expected to result from use of these cost-shared intangibles. The US cost sharing rules provide that the outcome of a CSA is consistent with the arm’s length standard only if, among other requirements, each controlled participant’s share of intangible development costs (IDCs), which includes stock-based compensation (SBC), is proportionate to its RAB share. However, the less common CCA according to the OECDTPG follows a different concept to confirm the arm’s length nature of a CCA, whereby the value contributed by each participant to the CCA needs to be assessed, i.e., costs are not the predominant factor.

The TPQ&A focuses specifically on the inclusion of SBC costs as a result of the US Tax Court’s decision in “Altera vs. Commissioner” dated 7 June 2019. Based on the court decision, where a Swiss taxpayer was party to the CSA, it was ruled that SBC is a cost to be generally included in the CSA. The SFTA generally advises case-by-case assessment. There is specific US practice on this topic.

The TPQ&A on CSA shows how far the SFTA practice could go. From now on, TP practitioners might want to stay on the lookout for international case law involving Swiss taxpayers to ascertain the stance of the SFTA and their expected practice. 

Summary

The importance of transfer pricing is expanding worldwide, and Swiss taxpayers should ensure they stay abreast of  regulatory developments affecting intra-group dealings, especially considering that Switzerland has not enacted specific domestic legislation on transfer pricing. Moreover, based on our experience, we expect Swiss tax authorities to continue increasing the number of transfer pricing audits, covering a broad range of transfer pricing issues, including those discussed in the TPQ&A.

Acknowledgement

Many thanks to Joan Guinart and Agathe Borelle for their valuable contributions to this article.

About this article

Authors
Francisco Palacios

Partner, Transfer Pricing in Financial Services | EY Switzerland

Transfer pricing practitioner, financial services industry specialist, curious, family man, triathlete.

Fabian Berr

Director, Transfer Pricing and Operating Model Effectiveness | EY Switzerland

More than 14 years of transfer pricing experience, Focus on financial and IP transactions, Master degree in Economics, regular CFA Institute member.