A tested and internationally well established tax planning tool, the principal structure, encounters headwinds from tax authorities in Switzerland. This structure consists of an “entrepreneur” company that pools risks and revenues while contractors or limited risk distributers perform production, distribution and other activities.
Over the last years, the Swiss tax authority’s practice of principal companies has been evolving constantly. In order to harmonize the new practice, the Swiss federal tax administration has now ‘unofficially’ published guidelines which clarify the practice and requirements applicable to principal company. In short, the new guidelines include the following requirements:
- The affiliated distributors need to be exclusive and, from an economic point of view, dependent on the principal. According to the new guidelines, a distributor is exclusive and dependent if at least 90% of its profits relates to the Swiss principal business
- In the event certain key functions are outsourced, the principal company benefits may be reduced
- The distributors’ gross margin (i.e. revenue./.costs of goods) may not exceed either 3% of its revenue or its higher OPEX (including interests and taxes). Should the compensation exceed either of these thresholds, an adjustment of the principal benefit is needed.
These guidelines apply with immediate effect to pending and new tax ruling requests filed with the Swiss tax authorities. Also for existing principal rulings there is a need for action. Authorities may review in each case whether new guidelines are met. In anticipation of such investigations, the following aspects of principal structures should be analyzed in detail:
- Review of activities performed by the distributors and determination whether any issue arises with respect to the requirement of exclusivity
- Review of the gross margin at the level of the distributors and preparation of supporting documentation
- Review and identification of key functions and roles which may be outsourced (are outsourced).
The Federal Tax authorities will now start reviewing existing rulings of principal companies across Switzerland on a case-by-case basis. The consequences for non-compliance with the new regulations may include adjustments in the taxation for fiscal years which have not yet been finally assessed or even the denial of the principal company taxation scheme.
Who should take action?
CFOs, CEOs or Heads of Tax of Swiss companies with a principal company taxation should review their rulings as well as their supply chain in regard to the above-mentioned new requirements. In case of doubt they should contact their tax advisors for further clarifications.