Philippe Kenel

Lump-sum taxation

by

Philippe Kenel, Lawyer, Doctor of Law, Python & Peter[1]

 

1. Introduction

As a general principle, a person domiciled in Switzerland pays wealth tax and income tax. While wealth tax is only levied at communal and cantonal level, income tax is levied at both federal level and cantonal and communal level.

Foreign nationals meeting a certain number of conditions have the right to pay a tax based on their expenditure. This type of tax is often referred to as lump-sum taxation, and replaces both wealth tax and income tax.

If a taxpayer wishes to opt for this system, they must apply to the tax authorities of the canton in which they are domiciled.

 

2. Background

The lump-sum taxation system started in 1862 in the Canton of Vaud. Introduced in Geneva in 1928, it has existed at a federal level since 1934.

For many years, this form of taxation was governed by article 1 of the Concordat dated 10 December 1948 between the cantons and the Swiss Confederation relating to the prohibition of certain tax arrangements, and only existed in some cantons.

Since 14 December 1990, lump-sum taxation has been governed, as a direct federal tax, by article 14 of the Federal Act of 14 December 1990 on Direct Federal Taxation (DFTA). Simultaneously, article 6 of the Federal Act of 14 December 1990 on the Harmonisation of Direct Taxation at Cantonal and Communal level (DTHA) sets out the conditions which cantons must follow when legislating for this tax[2].

Recent years have been uncertain for those opting for lump-sum taxation. On 8 February 2009, the population of Zurich voted to abolish this form of taxation in the canton with effect from 1 January 2010. This popular vote had a three-fold effect.

Firstly, other proposals aimed at abolishing lump-sum taxation or narrowing its application were put to popular vote or parliaments in other cantons. Although cantons such as Appenzell Ausserrhoden, Basel-Landschaft, Basel-Stadt and Schaffhausen followed Zurich’s example by abolishing this tax system, other cantons considering the issue either voted to preserve the status quo or decided to make the system more onerous.

Secondly, a popular campaign called “Stop the tax privileges for millionaires (abolition of lump-sum taxation)”, the main purpose of which was to abolish lump-sum taxation throughout Switzerland, ended up being put to public vote on 30 November 2014. Justifiably mindful of the fiscal and economic impact, 59.2% of Swiss, people as well as 25 out of 26 cantons, rejected this proposal. Although this campaign seemed to destabilise the system, the clear decision by the Swiss meant that the system remained in force and was set in stone.

Finally, so as to bolster the position of those opposed to the above-mentioned popular federal initiative, parliamentarians reformed this tax system with the Federal Act dated 28 September 2012 relating to lump-sum taxation, which amended article 14 of DFTA and article 6 of DTHA. Although we will revisit the amendments imposed by the Act dated 28 September 2012 in more detail below, the main reforms can be summarised as follows: firstly, only foreign nationals (excluding couples where one party is Swiss) can opt for this system; secondly, cantons must set out in their legislation a minimum amount of expenditure, which is CHF 400,000 for the purposes of calculating the direct federal tax; thirdly, the taxpayer’s minimum expenditure must be equal to seven times (rather than five times) the rental value of the property occupied by that taxpayer; lastly, while under the previous rules the amount of lump-sum tax included both wealth and income tax, it is now up to individual cantons to decide how they will tax the taxpayer’s wealth.

It should be noted that these amendments will apply from 1 January 2016 to foreign nationals arriving in Switzerland after this date. Taxpayers who already live in Switzerland as at 31 December 2015 will remain subject to the existing provisions until 31 December 2020 (art. 205 of DFTA and art. 78e of DTHA).

 

3. Requirements to be able to elect for lump-sum taxation

A taxpayer who wishes to opt for lump-sum taxation, together with a spouse living in the same household (art. 14, para 2 DFTA and art. 6, para 2 DTHA), must fulfil the following conditions:

1. They must not be Swiss national

Only taxpayers who do not have Swiss nationality may claim this tax treatment (art. 14, para 1, sub-para (a) DFTA and art. 6, para 1, sub-para (a) DTHA). This condition means that the following cannot opt for lump-sum taxation: Swiss nationals; foreign nationals receiving such tax treatment who then acquire Swiss nationality; those with dual nationality, one Swiss and one foreign; Swiss nationals with a foreign spouse. For a Swiss national or couples where one is a Swiss national and the other is a foreign national, the rules have changed following the reforms adopted by the federal legislature on 28 September 2012. Previously, under the old rules, Swiss nationals fulfilling the other conditions set out in the legislation were able to opt for lump-sum taxation for the year in which they returned to live in Switzerland. Virtually no taxpayer made use of this provision so it was abolished. The question of mixed nationality couples is of greater practical importance. Originally, as the legislation was silent on this issue, the Federal Tax Administration (FTA) stated that when one spouse has Swiss nationality, both spouses may opt for lump-sum taxation.[3] By introducing paragraph 2 of article 14 of DFTA and article 6 of DTHA, which states that spouses living in the same household must both meet the conditions to be able to opt for expenditure-based taxation, the Federal Council made it clear that this new provision excludes this option[4].

2. They must have an unrestricted right to remain in Switzerland granted either for the first time or after an absence of ten years or longer.

This rule is set out in article 14, para 1, sub-para (b) of DFTA and article 6, para 1, sub-para (b) of DTHA and there are two elements to this condition.

Firstly the taxpayer must have an unrestricted right to remain in Switzerland. Under article 3, para 1 to 3 of DFTA and article 3, para 1 and 2 of DTHA, a person has an unrestricted right to remain in Switzerland if they reside there or are domiciled there. If that person does not have a gainful activity, they are deemed to be resident in Switzerland for tax purposes, when, without any notable absences, they live there for at least ninety days. As for the second limb, a person is domiciled in Switzerland for tax purposes when they live there with the intention of staying there permanently.

In practice, only foreign nationals domiciled in Switzerland who apply can opt for lump-sum taxation. Becoming domiciled requires the grant of a residence permit. This requirement is a straightforward formality for European nationals (those who are nationals of an EU member state or who are nationals of a member of the European Free Trade Association) who are covered by the Agreement of 21 June 1999 between the Swiss Confederation and the European Community and its member states, relating to the free movement of people. However the situation is more complicated for nationals of a non-member state. If they fulfil a certain number of conditions, in particular the requirement to be over 55 years old and to have specific personal links to Switzerland, as set out in article 28 of the Federal Act of 16 December 2005 on Foreign Nationals (FNA) and article 25 of the Ordinance of 24 October 2007 on Admission, Period of Stay and Employment (ASEO), they may apply for a residence permit relating to pensioners. If a person is unable to meet the conditions for this type of permit, they may apply for a residence permit on the basis that granting such permit would be in the “greater public interest” (art. 30, para 1, sub-para (b) of FNA and art. 32 of ASEO). As an example of “greater public interest”, in the ordinance the Federal Council cites the protection of significant cultural interests or significant cantonal interests in relation to tax (art. 32, para  1, sub-para (a) and (c) of ASEO). As will be seen below, the cantonal tax administrations apply different minimum expenditure thresholds in applying this condition.

Secondly, the legislation states that the taxpayer must fulfil the condition of having an unrestricted right to remain in Switzerland either for the first time, or following an absence of ten years or more. The aim of this requirement is to prevent a person who is domiciled in Switzerland and also exercising gainful activity from opting for lump-sum taxation upon ceasing such activity. The Federal Council has however specified in its guidance that it wants to maintain the practice whereby a foreign national meeting the conditions for lump-sum taxation may, in each tax year, elect either expenditure-based taxation or normal taxation[5]. This means that a taxpayer is free to switch from lump-sum taxation to normal taxation, and vice versa, for as long as the taxpayer fulfils all other conditions set out in the legislation under article 14 of DFTA and article 6 of DTHA. In practice cantons interpret this differently, so we recommend that interested persons seek prior agreement from the cantonal tax authorities before making a decision on this issue.

3. Absence of gainful activity in Switzerland

This requirement, which is set out in article 14, para 1, sub-para (c) of DFTA and article 6, para 1, sub-para (c) of DTHA and states that the taxpayer opting for this treatment may not exercise gainful activity in Switzerland, is the cornerstone of the system. Although this is disadvantageous for taxpayers, this is how the Swiss population justifies the different treatment of Swiss nationals who have never exercised gainful activity in Switzerland (who may not opt for lump-sum taxation) and those who can opt for this treatment.

Tax authorities consider that a person opting for this tax treatment may not exercise gainful activity of any kind in Switzerland on a salaried or self-employed basis, as a primary or secondary source of income, from which they draw income in Switzerland or from abroad[6].

In other words, the following activities are prohibited:

• Being paid a salary by a foreign company and carrying out overseas activity from Switzerland;
• Being paid a salary by a Swiss company and carrying out activity in Switzerland; and
• Carrying out gainful activity on a self-employed basis in Switzerland.

The following activities are however permitted:

• The taxpayer opting for this treatment may carry out a non-remunerated activity in Switzerland or abroad. Although for many years the cantonal tax authorities allowed a taxpayer opting for this treatment to be an unpaid director of a Swiss company, this is no longer the case;

• Such person may carry out gainful activity overseas on a salaried or self-employed basis. However two key points must be emphasised. Firstly, some cantonal tax authorities are becoming more vigilant in checking whether any element of the activity is exercised in Switzerland, or such taxpayer’s domicile in Switzerland creates a centre of economic interest in Switzerland. Secondly, the taxpayer opting for this treatment must be certain of the tax implications of carrying out such activity in the country where it is exercised; and

• A taxpayer opting for expenditure-based taxation is allowed to invest in Switzerland or abroad. Such investments may produce income by way of interest, dividends or capital gains. If the investment takes place in Switzerland, the taxpayer’s role must be limited to that of investor and must not in reality constitute gainful activity. Moreover, the value of investments and connected income will be relevant for the control calculation which is set out below.

4. Calculation of tax payable by a person opting for lump-sum taxation

1. Introduction

As the name suggests, a person taxed on the basis of expenditure does not pay tax calculated by reference to their wealth and income, but on their expenditure. The amount of expenditure must not be less than the amount fixed by DFTA for the purposes of the direct federal tax and the minimum set by each canton for local and cantonal taxes. Likewise, whether it be for the calculation of federal, cantonal or communal taxes, the amount of expenses to be used as a basis must not be less than a multiple of the rental value of the property occupied by the taxpayer or the amount they pay for accommodation. Furthermore, it is up to cantons to determine the extent to which the lump-sum taxation includes wealth tax. Once the amount of tax has been calculated in accordance with these rules, this should be compared with an amount calculated by reference to a number of elements constituting the “control calculation”, and the greater amount will be payable.

1. Calculating the taxpayer’s expenditure

The tax which replaces income tax is calculated “by reference to the taxpayer’s annual expenditure and that of their dependants, made within the calculation period in Switzerland and abroad to maintain their lifestyle” (art. 14, para 3 DFTA and art. 6, para 3 of DTHA). This definition means that the taxpayer’s global expenditure, including annual costs in Switzerland and abroad connected to their lifestyle and that of their dependants, is integrated into the calculation. The Federal Council has stipulated that these would include “costs relating to accommodation, clothing and food, taxes, education-related expenditure (including overseas school fees), entertainment expenditure, sporting activities, travel and upkeep expenditure for costly domestic animals”[7].

1. Minimum expenditure amounts

Under the old legislation, neither the DFTA nor the DTHA fixed a minimum threshold for the amount of expenditure. The Federal Council however stated in the Ordinance of 15 March 1993 relating to lump-sum taxation in relation to direct federal tax, that at federal level, for persons living in a flat or house, it must not be less than five times the amount of rent or rental value of the property, and for all other taxpayers, two times their expenditure on accommodation and food (art. 1). This rule was adopted in practice by almost all cantons. Although the large majority of cantons had applied, either in their legislation or in practice, a minimum amount of expenditure, at least for new taxpayers, such amounts were not set out in the federal legislation.

The 28 September 2012 reform completely changed this system, even if, for many cantons, this was just by codifying existing practice for new taxpayers. The new rules can be summarised as follows.

When calculating the tax at either federal or cantonal level, the amount of expenditure of taxpayers either renting or owning a property must not be less than seven times the annual rent or rental value of such property (art. 14, para 3, sub-para (b) of DFTA and art. 6, para 3, sub-para (b) of DTHA) and, for other taxpayers, three times the annual expenditure on accommodation and food (art. 14, para 3, sub-para (c) of DFTA and art. 6, para 3, sub-para (c) of DTHA). For example, if the taxpayer’s monthly rent is CHF 6,000, the minimum level of expenditure will be CHF 504,000 (6,000 x 12 x 7).

Furthermore, the legislation stipulates that even if the amount of expenditure is more than the above-mentioned minimum, it may not in any event be less than CHF 400,000 for the purposes of calculating direct federal tax (art. 14, para 3, sub-para (a) DTHA). However, it does not set an amount to be applied throughout Switzerland to calculate cantonal and local taxes, but does oblige cantons to set an amount in their own legislation (art. 6, para 3, sub-para (a) DTHA). The majority of cantons decided to follow the minimum amounts applying to direct federal tax and set the amount of expenditure for the calculation of cantonal and communal taxes at a minimum of CHF 400,000. As referred to above, foreign nationals with non-member state nationality can request a residence permit by claiming significant cantonal interests with regard to tax (art. 32, para 1, sub-para (c), ASEO). To satisfy this condition, the cantonal tax authorities set a minimum expenditure threshold which is higher than that normally used, or apply a multiplier to the amount of expenditure.

1. Wealth tax

Prior to the 28 September 2012 reform, lump-sum taxation replaced both income tax and wealth tax. Now the legislation stipulates that from 1 January 2016, it is up to cantons to set out how lump-sum taxation might also cover wealth tax (art. 6, para 5 of DTHA). Although cantons have great flexibility, the Federal Council gives two methods which have been used by the vast majority of cantons. Cantons may either increase the amount of expenditure and apply the income tax rates to this sum to calculate tax due, or calculate the amount of wealth by reference to expenditure and apply the normal wealth tax rate[8].

1. How lump-sum tax is calculated

To calculate the tax, the usual federal and cantonal income tax rate should be applied to the amount of expenditure set out under the above-mentioned rules (art. 14, para. 4 DFTA and art. 6, para 4 of DTHA). For cantons opting for the second method set out above when taxing wealth, the usual wealth tax rate should be applied to the amount.

1. The control calculation

Once the amount of lump-sum tax is calculated in accordance with the above-mentioned rules, each year the amount of tax should be compared with that (income and wealth tax) calculated by reference to certain factors set out in Article 14, para 3, sub-para (d) of DFTA and article 6, para 6 of DTHA, with the higher amount being payable. The factors relevant to the calculation of income and wealth tax that must be entered into the control calculation are as follows:

1. Property based in Switzerland and associated income. In practice, only property belonging to the taxpayer based in the canton in which they are domiciled will be taken into consideration. If the taxpayer owns a property in another canton, this will not come within the control calculation, but the taxpayer will, however, pay wealth tax and tax on the income from such property in the other canton.
2. Moveable assets situated in Switzerland and associated income. For example, this would include works of art situated in Switzerland.
3. Investments in Switzerland, including debts secured by property charge and associated income. This rule by no means prevents a Swiss bank from holding and managing a taxpayer’s wealth. The key criterion is the location of the obligor to whom the taxpayer has granted a loan. If this is in Switzerland, the amount of the loan and revenue will be included in the control calculation to calculate the wealth and income tax due. As a result, this catches bonds in any currency from a Swiss issuer and interest thereon, shares in a Swiss company and dividends, and cash deposits in any currency held by a bank located in Switzerland.
4. Copyrights, patents and similar rights commercialised in Switzerland and associated revenues.
5. Pensions, unearned income and annuities from Swiss sources.
6. Revenues for which the taxpayer seeks partial or total foreign tax relief under a double taxation treaty between Switzerland and a foreign country. A common example would be where the taxpayer is a shareholder of a foreign company and upon receipt of a dividend invokes a double taxation treaty so as to pay tax at source at a lower rate in the company’s country of residence. In this scenario, the amount of dividend income will be factored into the control calculation to calculate income tax.

 

5. Expenditure-based taxation and international treaties

1. Introduction

In general, those opting for lump-sum taxation in Switzerland under the above-mentioned rules, benefit from the application of double taxation treaties. Nevertheless, the application of a certain number of treaties with Switzerland raises some questions. This relates to both the double taxation treaty between Switzerland and France (‘forfait majoré’ – ‘increased tax basis’) and also to treaties between Switzerland and Germany, Austria, Belgium, Canada, the United States, Italy and Norway (‘forfait modifié’ – ‘modified tax basis’).

1. The increased tax basis

Under article 4, para 6, sub-para (b) of the French-Swiss treaty dated 9 September 1966 on the elimination of double taxation on income and wealth and the prevention of fraud and tax evasion, a person is not deemed a resident of a signatory state for the purposes of the treaty if they are “a natural person who is only taxable in that State on a lump-sum basis determined by reference to the rental value of their residence or residences situated in that State”.

Although this provision is clearly not aimed at persons opting for lump-sum taxation in Switzerland, according to a memorandum dated 29 February 1968 from the FTA to cantonal tax bodies, discussions have taken place between the Swiss and French tax authorities to find a mutually acceptable procedure under article 27 of the treaty. This has created what is called the “increased tax basis”. In other words, if the taxpayer opting for lump-sum taxation accepts that the amount on which they will be taxed will be increased by 30%, the French tax authorities will consider them to be domiciled for tax purposes in Switzerland under the treaty. For misguided reasons that will not be discussed here[9], the French public finance ministry unilaterally rejected this agreement on 26 December 2012 and decided that the treaty would no longer apply to those opting for lump-sum taxation in Switzerland with effect from 1 January 2013. From this date onwards, there has been much legal uncertainty despite France’s decision, since the Swiss tax authorities have continued to consider that taxpayers paying on an increased basis may be covered by the treaty and have been granting certificates of residence based on this. Although it may seem as though this issue could be resolved at a diplomatic level, it now appears that the courts will have to decide on the matter.

1. The modified tax basis

Germany[10], Austria[11], Belgium[12], Canada[13], the United States[14], Italy[15] and Norway[16] have established a system known as the “modified tax basis” in their double taxation treaties with Switzerland. This means that the above-mentioned states, for the purposes of the double taxation treaties, treat a person as being resident only if, opting for lump-sum taxation in Switzerland, they are taxed there not only on the taxable base determined under the general principles set out above, but also on all income from the source-state which is allocated to Switzerland under the relevant double taxation treaty (art. 14, para 5 DFTA and art. 6, para 7 of DTHA).

 

6. Conclusion

After a turbulent few years due to different federal and cantonal drives, the lump-sum taxation system now has clarity and is set to last. Although it prevents the person opting for it from exercising gainful activity in Switzerland, it does offer the benefit of simplicity. Even though someone opting for this treatment must complete a tax return each year, they only need declare the wealth and revenue required by the control calculation.