Lenz & Staehelin looks at the rise of transfer pricing litigation in Switzerland
Transfer pricing litigation on the rise in Switzerland
Switzerland’s generally low corporate income tax rates and a lack of detailed transfer pricing legislation meant that for a long time (except in obvious cases) transfer pricing proceedings in Switzerland were primarily concerned with corresponding adjustments after a primary adjustment abroad. This has changed in the last couple of years. The Swiss Federal Tax Administration (SFTA) as well as the tax administrations of large cantons (such as Zurich or Geneva) have built specialised transfer pricing teams, transfer pricing has hence become a main focus of tax audits and Swiss tax authorities are more and more willing to litigate transfer pricing cases.
Primary adjustments following a tax audit
Transfer pricing conflicts often start with a tax audit. A successful defense strategy, however, begins already earlier: although Swiss tax law does not require formal transfer pricing documentation, it is best practice to prepare appropriate transfer pricing documentation in advance and possibly also seek confirmation of the arm’s-length-nature of important controlled transactions through an advance unilateral tax ruling. Proper and comprehensive documentation is not only important to defend the taxpayer against tax liabilities, but also to protect a company’s board and management from criminal tax proceedings which are more and more often pursued in conjunction with transfer pricing cases.
Before a transfer pricing case is taken to court, there is a (oftentimes lengthy) administrative procedure where the taxpayer can present its arguments and submit additional evidence. A taxpayer should already be represented during the tax audit and the administrative procedure by counsel with broad experience not just in tax law but also in administrative procedural law and criminal tax law. From our experience, it is very difficult to correct strategical and tactical mistakes that occur in the administrative proceedings once the case lands before the courts, where the main focus lies on the correct application of the law only and less on the presentation of the facts, which are of course central to a transfer pricing case.
Once the tax authorities have issued their final decision, such decision may be appealed in front of the cantonal courts or, as the case may be, federal courts and, in last instance, to the Swiss Federal Supreme Court.
Last, the exchange of information between the different tax authorities within Switzerland has improved significantly over the last decade. A taxpayer should for example be prepared that the SFTA will communicate the results of a VAT audit to the competent Swiss cantonal tax authority, which may subsequently open a corporate income tax audit.
Mutual agreement proceedings to avoid double taxation
Once a domestic law transfer pricing audit has concluded with an upward adjustment in Switzerland, a taxpayer may need to dispute this matter on an international level also, in order to avoid double taxation. This is achieved by requesting a mutual agreement procedure (MAP) based on an applicable tax treaty.
A MAP request filed by a taxpayer to the Swiss competent authority may either result in the opening of a formal MAP process with the concerned treaty state or a domestic law agreement to adjust the tax base unilaterally (so-called internal convention), if it is clear that the primary adjustment undertaken by the Swiss tax authority is not (fully) justified. Transfer pricing cases are, however, rarely resolved through such internal conventions, as they will rarely be clear enough to be fully solved unilaterally.
Swiss MAP proceedings run in parallel to and completely independently of domestic law procedures. It is hence important to continue the litigation in front of domestic authorities and courts within the applicable deadlines. It is, however, common practice to request a suspension of domestic law procedures until a MAP is concluded. This allows the taxpayer to revive domestic law procedures, in particular if it does not approve of the result of a MAP or if the competent authorities cannot satisfactorily resolve the MAP. A taxpayer will, however, be required to waive its right to domestic law procedures if it agrees to the implementation of a MAP or an internal convention.
Once a binding mutual agreement or internal convention has been reached, all Swiss tax authorities are required to implement it. If the tax period under review is already definitively assessed, the tax authorities will issue a new tax assessment or revise the original one. In case the tax assessment is not yet final, it will simply be prepared taking the agreed upon results into account. An agreement also has an effect on criminal tax proceedings, for which penalties may be mitigated or completely waived based on the MAP.
The MAP is valid for all covered taxes of the respective treaty, ie usually Swiss income and capital taxes, as well as withholding tax. Particular care, however, needs to be taken with respect to withholding tax, as the SFTA has developed a strict practice on withholding tax on certain primary and secondary transactions from Switzerland, especially in cases of abuse, which would not be part of the MAP agreement.
Increased complexity of transfer pricing disputes
In Switzerland, the importance of transfer pricing disputes has increased drastically in the last couple of years, in particular with regards to primary adjustments originating from Switzerland. In addition, the disputes are becoming more and more complex and multi-faceted, both from a procedural and material perspective. The coordination of both domestic and international transfer pricing proceedings is thus crucial.
For example, tax criminal proceedings are often linked with Swiss primary adjustments, and such sanctions can often be waived or mitigated in case of a successful MAP. This element should hence be factored in the decision to request a MAP, rather than relying on domestic proceedings only. Particular care also needs to be taken to the withholding tax perspective of a case, as strict rules apply in this respect.
Law firms with expertise in tax litigation are uniquely positioned to handle complex international transfer pricing cases and successfully navigate and coordinate both domestic and international tax proceedings.
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