In part 1 of our blog, we were looking at the key take-aways from the STFA regarding IP transactions and service transactions that are hot topics currently in focus within Swiss audits and ruling requests. In part 2, we focus on good transactions, financial transactions and TP documentation.
Goods Transactions - Transfer pricing treatment of routine entities
In many cases KPMG has seen recently, especially local distribution entities, were experiencing significant losses in Swiss multinationals, and that was primarily due to COVID-related business disruptions. For many multinationals, this leads to uncertainty in terms of how these outcomes should be treated from a Swiss transfer pricing perspective, and whether action should be taken to e.g. provide support from the group to the local routine entities.
KPMG has gained the understanding that the SFTA is increasingly faced with COVID19-related questions in their day-to-day work. The SFTA has the general view that a legal entity with a routine functional profile is expected to show an arm’s length profitability, and losses are not acceptable. However, the SFTA acknowledges extraordinary business circumstances caused by the pandemic.
Their approach is focused on a case-by-case analysis, i.e. there are no generally accepted approaches towards the treatment of COVID-related disruptions. Any approach taken by the taxpayer (centralization of losses at principal and maintenance of routine remuneration according to policy, adjustment of routine remunerations to lower quartile, adjustment of routine remuneration towards break-even result, or proportional sharing of losses with routine entities) is expected to be substantiated with plausible explanations as to why a certain approach was taken. The greater the deviation from the general transfer pricing policy is, the more elaborate an appropriate substantiation should be.
Financial Transactions
KPMG has supported various Swiss taxpayers in Swiss transfer pricing audits on the following financial transaction types:
a) The arm’s length pricing of interest rates for the provision of intercompany loans;
b) The arm’s length remuneration of parental guarantees.
KPMG understands that the SFTA has observed an increase in the use of market-based approaches to determine an arm’s length interest rate for intercompany loans as opposed to the use of the Swiss safe harbor rules. If a taxpayer chooses to apply a market-based approach, KPMG has the understanding that the SFTA places specific emphasis on a detailed analysis of the credit rating of borrowers and a sound substantiation of the applied methodologies as well as how implicit support is taken into account when pricing intercompany loans.
In terms of parental guarantees, in KPMG’s experience it is crucial that Swiss taxpayers do not have unremunerated guarantees in place. Further, a sound documentation is key to substantiate that parental guarantees are being remunerated appropriately.
Transfer Pricing Documentation
The Swiss tax law still does not have a formal TP documentation requirement in place that requires multinationals to have contemporaneous OECD-standard TP documentation (master file and a local file) in place. This leads to a lot of Swiss multinationals to believe it is not worth preparing a TP documentation for the Swiss legal entities up-front.
Nevertheless, KPMG has in recent years experienced that TP documentation is now on the standard information request lists for Swiss tax audits. Further, also in ruling procedures, the SFTA typically asks for a TP documentation. In KPMG’s understanding, the SFTA has the position that despite the tax law not prescribing a formal TP documentation, it is generally advisable to have a TP documentation in place. Without access to proper documentation, the SFTA would not be able to adopt a position during a ruling procedure. This results in long delays before a ruling request can conclusively be processed. In an audit situation, the SFTA would in extreme cases even need to proceed with an assessment without having the full picture, which could lead to adverse audit outcomes for the taxpayer.
In terms of documentation, KPMG has gained the following understanding of key items that are important for the SFTA:
- Within your TP documentation, provide the SFTA with example calculations / specific examples wherever possible to showcase the practical application of a transfer pricing method or to explain an abstract fact pattern in the specific business circumstances.
- Spend time and effort on explaining in detail why specific transfer pricing methods are chosen over others, and why e.g. the application of a profit split method would not be making sense for a given intercompany transaction, as cantonal tax authorities are making increasing efforts to promote the use of such profit allocation methods, even for standard transactions.
- Explain the use of specific allocation keys and provide examples how the use of a specific allocation key corresponds to what happens “on the ground” for a given transaction.
Conclusion
In our view, the days when Swiss authorities were content to just accept any intercompany adjustment from foreign tax authorities without a highly technical analysis of the facts, circumstances and arm’s length treatment are over.
Taxpayers in Switzerland should be treating both their operational transfer pricing as well as transfer pricing compliance in line with the expectations of the Swiss tax authorities. It is ever more important from a Swiss perspective to be well documented on all transfer pricing matters. This will ensure that transfer pricing audits run smoothly and can be closed efficiently without delays and significant costs, that transfer pricing ruling requests can be processed efficiently and that significant Swiss and counterparty tax risks can be avoided or at least mitigated.
