Change in practice on interest rates for loans
A foreign group company granted an unsecured loan of CHF 0.5 billion to a Swiss permanent establishment of another foreign group company at an interest rate of 2.5% and a current account credit line of CHF 0.5 billion at an interest rate of 3.0%. As part of the assessment of the direct federal tax and Zurich state and municipal taxes, the Zurich Cantonal Tax Office did not consider these interest rates to be at arm's length and accepted only 1.08%. Although the Administrative Court of the Canton of Zurich also considered the interest rates not to be at arm's length, it only made an adjustment in the amount of the difference to the maximum interest rates in accordance with the FTA's annual interest circular (1.5% and 2.0% in the relevant tax periods).
In essence, the Federal Supreme Court clarifies that taxpayers who deviate from the safe harbour interest rates no longer enjoy the protection of the FTA Circular if they cannot provide evidence that the interest rate is market-compliant. In such cases, the tax authorities are entitled to determine a market-compliant interest rate, which may even be lower than the maximum permitted safe harbour interest rates. This decision increases the tax risk for loans between related parties if the agreed interest rates differ from the safe harbour rates of the FTA.
In Switzerland, the arm's length principle applies to loans between related parties. The FTA publishes annual circulars with safe harbour interest rates, which are generally considered by the tax authorities to be arm's length and therefore economically justified without further evidence being required from the taxpayer. The published interest rates thus serve to facilitate the application of the arm's length principle to loans between companies and their related parties.
As a result of the harmonisation of tax legislation, these safe harbour rules apply not only to direct federal tax and withholding tax, but also to cantonal and municipal taxes. This ensures a uniform application of the arm's length principle for interest payments between related parties throughout Switzerland.
If a taxpayer adheres to the safe harbour interest rates, the tax authorities will assume that no payment in kind has been made. However, if a taxpayer deviates from these rates, the taxpayer must demonstrate that the rate used is standard market practice and the arm's length principle.
If this cannot be proven, the tax authorities' previous practice was to assume a payment in kind in the amount of the difference between the interest rate applied and the safe harbour interest rate.
In this decision, the Federal Court of Justice has now confirmed that in such a case the tax authorities are no longer bound by the safe harbour interest rates when determining the monetary benefit. In this case, a market interest rate can be determined that is even lower than the maximum safe harbour interest rate. The monetary benefit is then calculated as the difference between the actual interest rate applied, and the market interest rate set by the tax authorities.
Whether this decision affects your company depends on whether loans are granted to shareholders or to other group companies and on the interest rate structure of these loans. All loans to related parties for which the agreed interest rates differ from the safe harbour interest rates should be reviewed in light of the court decision.
Loans between unrelated parties and loans between related parties where the interest rate is based on safe harbour rates are not affected.
To minimise the tax risk, documentation should be prepared each year for all affected loans to demonstrate that the different interest rate is in line with the market. To avoid the administrative burden of such documentation or to eliminate the tax risk altogether, the interest rate on the loans should be changed in accordance with the safe harbour rates. This should be considered in particular for loans where the agreed interest rate differs only slightly from the safe harbour rate and therefore presents a disproportionate high risk.
In the case of non-market rate interest, the offsetting of a cash payment may give rise to both gains and withholding tax consequences, which can be significant, particularly in an international context.
The Federal Supreme Court ruling of 17 July increases the tax risk of loans between related parties. You should act proactively now to ensure that you meet the requirements of the new case law. By carefully reviewing your financing structure and complying with the safe harbour interest rate, you can ensure that your company remains in an optimal tax position.
If you have any questions, please do not hesitate to contact us.
Article written by André Kuhn, Sara Krisch and Aleksa Koljancic
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