Tax deductibility of vacation provisions: major implications for companies following the Federal Supreme Court’s clarification

The Federal Supreme Court's decision in detail

The tax admissibility of provisions is governed by Article 63 of the Federal Act on Direct Federal Taxation (LIFD). To be tax-deductible, the provision must (i) have been duly booked in the accounts, (ii) be justified by commercial practice and (iii) relate to events that have occurred during the computation period.

Provisions may therefore be booked to the profit and loss account, in particular for obligations for the financial year whose amounts have not yet been determined, and for other risks of imminent losses during the financial year.

With regard to the vacation provisions, the Federal Supreme Court reiterated in this decision that they cannot be considered to have been created in respect of uncertain liabilities or impending losses arising from current operations, or in respect of a risk of loss that is not yet based on actual liabilities and does not relate to current assets.

According to the case law, provisions booked to cover expenses that the company will have to bear as a result of its future activities are not permitted if there is no imminent risk during the financial year.

Indeed, employees' accumulated vacation time cannot be considered as an immediate financial risk for the employer, since an obligation to pay for unused vacation time would only exist in the event of termination of the employment contract and of the employee's incapacity to take it before leaving, or in the event of the company ceasing its business.

These provisions therefore represent reserves that form part of the taxable income and cannot be deducted from it until the company has incurred the corresponding costs, in accordance with the principle of periodicity of tax law.

The principle of periodicity prevents taxable profits from being artificially reduced by excessive provisions, in particular provisions made to cover expenses which the company will have to bear as a result of its future activities, such as vacation provisions, in the absence of a clear connection with the business year in question.

Any provision that does not meet the said conditions would not be allowed under tax law and would therefore have to be added to the company's taxable profit.

In the cantons where this new practice is followed, there may be differences between the provisions permitted for commercial purposes and those permitted for tax purposes. While the canton of Geneva has already issued its first adjustment decisions to this effect, other cantons may continue to accept these provisions entirely.

Our recommendations

In this decision, the Swiss Federal Supreme Court confirmed the principle that vacation provisions are not tax deductible. This practice, which has allowed companies to create hidden reserves, will no longer be permitted. We can therefore expect tax adjustments in future tax assessment, a risk that could be particularly significant for companies with large payrolls.

In order to mitigate the risk of tax adjustments, we strongly recommend reviewing the way in which your company books for accumulated holiday provisions and, if necessary, ensure that they are justified by immediate obligations.

Article written by Nathalie Pellanda Gaud and Simana Boianova