Overview of Switzerland’s Federal Act on Tax Reform and AHV Financing (TRAF)

On May 19, 2019, Swiss voters approved the Federal Act on Tax Reform and AHV Financing (TRAF), which came into effect on January 1, 2020. This reform introduces an internationally accepted tax system, ensuring Switzerland remains an attractive and competitive business location while safeguarding appropriate tax revenues.

Key Changes Under the TRAF

1. Abolishment of Existing Tax Regimes
   The reform eliminates preferential tax regimes at the cantonal level for holding, domiciliary, and mixed companies. Additionally, the federal practices for principal companies and Swiss Finance Branches are also discontinued.

2. Patent Box Regime
   A new patent box regime, in line with OECD standards, is introduced. Income derived from domestic and foreign patents and similar rights is taxed separately with a maximum reduction of 90%.

3. Additional Deduction for Research and Development (R&D)
   An optional additional deduction for domestic R&D expenses is introduced at the cantonal level, aiming to enhance Switzerland’s appeal as an R&D location, with a maximum deduction of 50%.

4. Notional Interest Deduction on Equity
   High-tax cantons have the option to introduce a notional interest deduction on surplus equity. This option is intended to align with the cantonal governments’ plans to reduce cantonal tax rates.

5. Disclosure of Hidden Reserves and Transitional Regulations
   When transitioning from preferential tax regimes to ordinary taxation, a two-rate model is applied. Profits related to built-in gains from preferential regimes are subject to a reduced tax rate. Cantons can set this reduced rate at their discretion. This model provides a competitive income tax burden during the five-year transition period. The “old law step-up” option allows for a tax-neutral disclosure of hidden reserves if companies voluntarily relinquish preferential regimes before the new legislation takes effect.

6. Relief Limitation
   Patent box, R&D super deductions, notional interest deductions, and possible amortizations from the old law step-up are subject to a relief limitation of 70%.

7. Increase in Dividend Taxation
   For federal tax purposes, 70% of income from qualifying participations (with at least 10% investment) is taxable at the shareholder level. Cantonal and communal tax purposes will see at least 50% of such income taxed. Previously, the tax rates were lower, ranging from 50% to 60%, depending on the nature of the income and the canton.

8. Adjustment of Capital Tax
   To compensate for the loss of tax advantages from preferential regimes, cantons may lower capital tax rates on equity related to patents, qualifying participations, and intra-group loans.

9. Reduction of Cantonal Income Tax Rates
   While TRAF does not directly address the reduction of cantonal income tax rates, this is necessary to maintain attractiveness for companies affected by the reform. The increase in the cantonal share of federal income tax from 17% to 21.2% allows cantons to lower their tax rates. For instance, Canton Schwyz is expected to offer a competitive combined tax rate of approximately 11.85% on pre-tax income.

10. Adjustment of the Capital Contribution Principle
    Companies listed on a Swiss stock exchange can only distribute capital contribution reserves without Swiss dividend withholding tax if an equivalent amount of reserves subject to Swiss withholding tax is also distributed (50/50 rule).

11. Extension of Lump-Sum Tax Credit System
    Swiss permanent establishments of foreign companies are now entitled to claim foreign tax credits on income from third countries through a lump-sum tax credit.

12. Social Compensation through AHV
    The tax reform is anticipated to create a CHF 2 billion shortfall, which will be offset by various AHV contributions.