The Swiss tax reform (STAF) has abolished important tax privileges and introduced new incentives with the aim of maintaining Switzerland's status as an attractive business location. This creates (transfer pricing) planning opportunities and questions on operational details.
Patent box and special deduction for R&D costs
With effect from 1 January 2020, the STAF has introduced the patent box and R&D incentive regimes so that Switzerland remains an attractive location for innovative companies. Irrespective of size and industry, the patent box regime enables companies to lower their tax base if they own patents or comparable rights (e.g. licenses) and incur R&D expenses in Switzerland. Under a relatively narrow definition of patents or comparable rights that qualify for the patent box, the income arising from such patents or comparable rights is subject to a reduced tax rate. In case companies solely generate royalties by licensing patents, this income can be determined easily and directly. On the other hand, if royalties are embedded in product prices, this income must be determined indirectly. However, the tax reduction for the patent box income is tied to substance requirements of the OECD's modified nexus approach, which is directly related to the R&D activities performed in Switzerland.
In addition to the patent box regime, many cantons (optional measure on a cantonal level) have introduced a special deduction for R&D expenses of up to 50% of Swiss R&D activities. Such special deductions for R&D costs can add up to 70% of the taxable income ("relief limit").
Some practical transfer pricing implications
Adapted transfer prices / pricing systems can help taxpayers to increase the benefits from the new instruments. Over the last months questions and considerations came up primarily on the aspects outlined in the following. As always these TP considerations are linked to broader business topics:
- Transparency on IP inventory and ownership: before going into the planning of a patent box, it is important to have full visibility and transparency on the economic ownership of the IP. In many cases this transparency and clarity on IP ownership was missing as multiple entities contributed to the development of IP in the past. Similarly, information on which IP is embedded in which products was not always easily available to the tax function. Depending on the available information, modelling patent box benefits may become less accurate and with it also the basis for decision making. A proper fact finding is strongly recommended before starting with any modelling work.
- Managing the R&D cost base: increasing the Swiss R&D footprint is beneficial for the patent box through the nexus quota and for the R&D super deduction. While analyzing the current R&D cost structure might be a good starting point, tax departments should seek discussions on how the business expects the R&D function to evolve. Plans to increase the R&D footprint of a company outside Switzerland may significantly affect the potential for tax savings from a patent box. Tax functions are advised to take a dynamic view here. Decisions for a specific R&D location are typically not based on tax considerations but rather driven by other factors, such as availability of a qualified workforce, proximity to research clusters, etc. Still, tax directors should highlight to relevant stakeholders that all other factors being equal, taxes may be a differentiating factor for increasing the R&D base in a Swiss entity.
- Increasing the nexus quota for the patent box: while it is difficult to change the general R&D setup of a company to achieve tax benefits, there might be certain “quick wins” in connection with the nexus quota. A higher nexus quota is achieved when the relative share of R&D activities performed by foreign related parties decreases. In some cases the R&D cost base of foreign related parties included non-R&D costs. Unbundling such non-R&D costs from non-qualifying R&D costs, increases the nexus quota. Similar thoughts came up with regard to third party costs incurred by foreign contract R&D service providers that form part of an intercompany charge for contract R&D services.
- Determining brand remuneration for the patent box: a brand remuneration has to be deducted to determine the profit that is attributable to the patent box. While Swiss companies in general have an incentive to charge high license fee rates for trademarks to related parties, such high royalty rates have negative implications on the taxable income of the patent box as differences between royalty rates may trigger challenges.
What does the use of these instruments mean for other jurisdictions of a group?
Given the rising transparency demands globally, it can be expected that an instrument like the patent box in Switzerland will pique the interest of foreign tax authorities. Thereby, the nexus factor could draw misleading conclusions on the actual value contributions and profit allocations within the R&D setup. This is due to the fact that costs do not necessarily reflect the correct value of an R&D activity. This should be addressed appropriately in the transfer pricing documentation.
Conclusion: As we have seen, detailed questions and considerations can arise when analyzing or implementing the new measures available under STAF especially with regard to the patent box. Companies should be aware of this to avoid pitfalls while still tapping into its full potential.