The 50/50 practice in Switzerland.

• Author: Bakale, Anthony
• Position: Foreign income taxation

For many years, international corporations set up so-called Swiss reinvoicing companies, taking advantage of Switzerland's treaty network and its favorable taxation schemes. Due to their foreign activities (i.e., the fact that the majority of their income was foreign-sourced), they were granted tax privileges on the cantonal/communal level. No taxation privilege, however, was granted on the federal income tax level, with its rate of 8.5% on income after tax.

Such companies were regularly taxed as domiciliary or mixed companies. Domiciliary companies are generally not allowed to be active in Switzerland (i.e., no personnel or offices in Switzerland). Domiciliary companies are fully exempt from cantonal/communal income tax. As a result, the effective income tax burden is 7.8% federal income tax on pre-tax income.

Mixed companies, on the other hand, can have offices and employees in Switzerland. However, the volume of Swiss domestic transactions is limited. In other words, the income must generally be foreign-sourced. The foreign-source income of a mixed company (depending on the canton of residence) is exempt from cantonal/communal income up to a 90% level. As a result, the effective income tax burden, including federal income taxes, is 9-11% on pre-tax income.

In addition to the cantonal/communal privileges, the Swiss Federal Tax Administration (SFTA) has regularly accepted a lump-sum expense deduction on certain business activities (reinvoicing in particular). Such lump-sum expense is known as "50/50 practice." The 50/50 practice is applicable not only for federal income taxes, but also for Swiss withholding taxes on profit distribution (and in some cases for cantonal/ communal income taxes as well).

In principal, the 50/50 practice allows 50% of the gross margin to be paid as commission to affiliates or third parties without economic justification. Nevertheless, it is worthwhile mentioning that the SFTA does not consider the 50/50 practice as a tax incentive, but an administrative measure to determine the tax base. Because some terms were rather vague and usually required an advance ruling, the SFTA recently issued a circular to confirm the application of the 50/50 practice. However, it does not want these regulations to be considered safe-haven rules, although, for practical purposes, payments up to 50% of the gross margin (whether justified or not) are treated as deductible expenses. Whether a company is eligible for the 50/50 practice...