The impact of TRAF on SMEs
Implementation of TRAF creates a competitive tax system that meets international requirements and also contributes to safeguarding pensions from old age and survivors’ insurance (AHV). Tax privileges for companies with primarily international operations have been abolished. All companies are now subject to the same taxation rules. Parliament approved various relief measures under TRAF to keep the higher tax burden for affected companies to a moderate level. These options are available not only to companies with international connections, but also to Swiss firms. In addition, most cantons have decided to cut their ordinary corporate income tax rates from 2020.
Whether SMEs can benefit directly from the measures needs to be assessed on a case-by-case basis. The increase in partial taxation of dividend income raises the private tax burden for typical SME owners. Such income is taxed at a federal rate of 70 percent and a cantonal rate of at least 50 percent.
Cantons are not obliged to introduce all measures. Each canton is free to decide which optional measures to transfer into its cantonal tax law depending on the companies domiciled in that canton and the specific financial possibilities and needs of the canton. Below, we explore two measures in more detail.
1) Additional deduction for research and development
Research and development (R&D) enjoys a high standing in Switzerland. Many SMEs are well-positioned on this front and benefit economically from their high levels of innovation. This is why the Swiss Parliament decided in favour of offering such companies an efficient tax tool.
Expenses relating to R&D performed in Switzerland are now tax deductible to a greater extent than the costs actually incurred. This applies to both natural and juridical persons. Cantons may grant an additional deduction of 50 percent of the actual expenses incurred; they are also free to provide for lower deductions or no relief at all in their cantonal tax law. R&D expenses must be incurred in Switzerland and a distinction is made between research carried out directly by the taxpayer and research commissioned (to a third party). For direct research, the calculation is based on the personnel expenses incurred for R&D plus a markup of 35 percent for rent, power, etc. For commissioned research, 80 percent of the expense for the third party is used as a basis for calculating the tax-deductible additional expense (max. 50 percent).
The definition of R&D is provided in the Federal Act on the Promotion of Research and Innovation. The appeal of this measure for SMEs depends on whether, and at what level, the respective canton offers relief. The higher, the better. Most cantons currently provide for a maximum deduction of 50 percent. As mentioned above, expenses must be incurred in Switzerland to be eligible.
However, the law does not govern every single detail. The Swiss Tax Conference (SSK/CSI) issued an initial circular in January governing the intercantonal tax allocation of companies making use of the deductions provided under TRAF. Another circular is expected to follow soon.
2) Increase in partial taxation of dividend income
Shareholders and partners with an interest of at least 10 percent benefit from partial taxation of income from dividends. This practice is intended to soften the double tax burden (corporate income tax at the company level, income tax at the level of the individual shareholder). The partial taxation provision has been in place since 2009. At the federal level, partial taxation has been increased from 60 percent (private assets) or 50 percent (company assets) to a new uniform rate of 70 percent.
At the cantonal level, minimum partial taxation of 50 percent applies as of 1 January 2020 to dividend income from qualified participations in accordance with the requirements of Direct Taxation Harmonisation Act. Cantons are free to tax such dividend income at a higher rate. If a canton taxed dividends in 2019 at a rate of less than 50 percent, or provided for an increase compared to the previously applicable partial income procedures within the framework of an implementation act, this will lead to an increase in partial taxation in the respective canton from 2020. Many SMEs therefore issued additional distributions to their shareholders in 2019. In so doing, companies had to consider not only the economic impacts, but also social security implications.
This year, companies will again need to decide whether to pay out extra remuneration in the form of a bonus or higher dividend. Further careful analysis of the situation will be required as what worked in the past may no longer be beneficial this year.
What action is required?
Can your company benefit from the new tax deduction options?
- Examine whether your company meets the requirements to apply the patent box, additional deduction for R&D or the notional interest deduction. Remember to keep the overall relief limit in mind.
Are you expecting dividend income from a qualified participation of more than 10 percent, and do you live in a canton that previously taxed such income moderately? Is your SME domiciled in a canton which has cut the corporate tax rate significantly?
- Verify which is more beneficial to you in 2020: additional salary payments or dividend distributions. In making your decisions, take social security law and other aspects into account.
Author: Denis Boivin, Head of Tax & Law and member of the Executive Committee of BDO.