Federal Act on Tax Reform and AHV Financing

Federal Act on Tax Reform and AHV Financing (TRAF) (formerly known as Tax Proposal 2017): enactment date

The Swiss tax reform accepted by the people at the public referendum on 19 May 2019 (TRAF) is a comprehensive reform package including changes to the federal Tax Harmonisation Act, requiring changes to be made to cantonal tax laws, as well as changes to non-tax laws. TRAF will have an impact on the taxation of both corporate bodies and individuals subject to tax in Switzerland. The main aim of the reform is to abolish the current privileged corporate tax regimes applicable at cantonal level and replace them with internationally accepted measures including the introduction of a patent box regime and reduced ordinary tax rates and other measures. It is anticipated that TRAF will become effective at the beginning of 2020.

The purpose of this ‘In brief’ is to outline enactment date considerations relating to the corporate tax elements of TRAF, referring to relevant guidance under IFRS, by focusing on the interplay of federal and cantonal tax laws.

Enactment date concept

IAS 12 ‘Income taxes’ requires current and deferred tax balances be measured based on tax rates and laws that have been enacted or substantively enacted by the end of the reporting period. Substantive enactment is achieved when any future steps in the enactment process will not change the future outcome. This could be achieved before the full legislative process is complete. The standard requires an analysis of local legislative processes to determine the date on which a tax law is considered enacted or substantively enacted.

General enactment process in Switzerland

In Switzerland, the usual process for the enactment of new laws at federal level is as follows: Parliament first discusses the new legislation. After parliament has approved a new law, Swiss citizens can initiate a referendum. A referendum is successful if 50,000 signatures supporting a popular vote are collected within 100 days. If a referendum is not initiated, or not successful, the (substantive) enactment date is typically the date when the 100 days have lapsed. If a referendum is successful and the subsequent popular vote approves the law, the (substantive) enactment date is typically the date of the vote. If the popular vote declines the law, it is up to the legislator to initiate a new attempt to change the existing legislation or remain with the status quo. 

Some federal laws are directly applicable to individuals and corporate bodies. However, in some areas a new federal law merely sets boundaries for cantonal legislation. Before such law can be applied, specific legislation within these federal boundaries is generally required on the cantonal level. In such cases, the local processes in each canton need to be considered to determine the date of enactment (substantive enactment). The legislative process at cantonal level is similar to the federal process; however, the number of signatures and the time to collect them for a referendum vary from canton to canton. Furthermore, some cantons require a specific majority in the cantonal parliament for important changes to specific laws – if that quorum is not reached, a mandatory referendum vote is needed. The (substantive) enactment date is typically also the end of the referendum period or the date of the cantonal popular vote.

TRAF: interplay of federal and cantonal tax laws

TRAF will predominantly reform the cantonal taxation of corporate bodies subject to taxation in Switzerland. Switzerland has 26 cantons, each with different tax laws that are harmonised to a certain extent via the federal Tax Harmonisation Act.

While the Tax Harmonisation Act sets the boundaries for cantonal tax laws, each canton has significant discretion when it comes to determining its own rules within the context of TRAF, including the amount of relief regarding qualifying income for the patent box, the decision on whether to introduce an additional R&D deduction and other areas. However, cantons cannot decide not to change their legislation. If cantons fail to successfully conclude their ordinary cantonal legislative implementation process for TRAF prior to the end of 2019, under the explicit transitional rules in the Tax Harmonisation Act the cantonal government must decide on the cantonal implementation parameters for the various relief measures, which will become effective (temporarily) until the/a new cantonal implementation proposal has successfully passed the cantonal legislative process − including a successful cantonal referendum vote, if any[1]. As far as cantonal tax rates are concerned, while it is expected that a significant number of cantons will materially change their tariff, the cantons are completely free and no harmonisation is prescribed by the Tax Harmonisation Act. 

However, there are some elements in TRAF that can be applied directly, without the need for specific cantonal legislation. Should cantonal law be in direct conflict with those elements of the Tax Harmonisation Act, the federal law takes precedence after 31 December 2019. In our view, the main elements of TRAF relevant for accounting can be categorised as follows: 

Mandatory elements: 

• Discontinuation of the special cantonal privileges[2]

Mandatory elements, which include a voluntary aspect that needs to be decided on at the cantonal level: 

• The introduction of a patent box regime is mandatory. Within the framework the amount of tax reduction is limited to 90%; however, cantons can choose lower reductions. 
• TRAF limits overall relief to a maximum of 70%. In other words, minimum taxable income is at least 30%. However, cantons can choose lower relief limitation thresholds.
• The introduction of the separate rate approach is mandatory; however, the separate rate can be determined by each canton.

Voluntary elements with full discretion at cantonal level: 

• Cantonal reductions in income tax rate
• R&D super deduction
• NID for high tax jurisdictions

As a result of this interplay between the Tax Harmonisation Act and the respective cantonal tax laws, TRAF will result in changes to different tax laws at various legislative levels on different dates. For most cantons, the sequence is as follows: First, the federal Tax Harmonisation Act will be amended, followed by subsequent adjustments to cantonal laws. Cantonal implementation will follow the respective cantonal legislative processes, which differ to some extent from canton to canton and follow canton-specific timing.

Each canton has options and leeway when it comes to deciding whether and/or to what extent each element of the Tax Harmonisation Act is to be implemented in cantonal tax law. Therefore, for most cantons there is considerable uncertainty as to what will be enacted in cantonal tax law, even after the Tax Harmonisation Act has been passed at federal level. The impact will only become certain as and when each cantonal legislative process has been substantively completed or the cantonal government has decided on the (temporarily) applicable parameters to fill the discretion foreseen for the cantons in the norms of the federal Tax Harmonisation Act, which in this scenario will become applicable directly. The effective date for the reform at federal level is anticipated to be 1 January 2020. 

Since the potential impact of TRAF is substantial for many cantons, most cantons have started the legislative process for the cantonal tax law – even before the federal parliament approved the new law (28 September 2018), before the referendum period at federal level ended (17 January 2019), and/or before the popular vote (19 May 2019) takes place. It is expected that in many cantons the legislative process will be substantively completed in 2019 as well, with the Tax Harmonisation Act and the revision of the cantonal laws becoming effective on 1 January 2020. In some cantons, the legislative process is already substantively completed depending on the outcome of the popular vote on 19 May.

[1] Art 72z, para 2 StHG/LHID/LAID (proposed).
[2] For the sake of completeness it should be noted that as of the date the new TRAF rules apply, certain practice-based regimes − including the Swiss Principal Company Regime and the Swiss Finance Branch Regime − currently applied for direct federal tax purposes are also expected to be abolished. However, given that these regimes are only based on practice interpretations by the Federal Tax Authority and their abolishment is not triggered by a respective change in the underlying legal norms (in other words the modalities and timing of these changes are unknown at this stage), no final conclusion is currently possible on how the abolishment of these regimes should be treated from an enactment perspective.

Enactment date considerations under IFRS

One enactment approach 

Upon enactment of the Tax Harmonisation Act at federal level, entities should assume that changes to cantonal law will occur and should assess the potential tax consequences. However, at such time the legislative process on cantonal level will in most cantons not yet be (substantively) complete. Moreover, the outcome of the cantonal process will probably not be sufficiently clear to make a reasonable estimate of taxable profits, applicable tax rates and tax bases. In this case, as is the case for all uncertain tax positions, good-quality disclosure of the judgments taken by management and any potential exposures should be made.

Our view of the IAS 12 accounting requirements is that for most entities, the appropriate unit of account is the reform overall, as demonstrated by the (substantive) enactment of the changes to cantonal law. Thus (substantive) enactment generally occurs when a canton has determined its specific position, either by way of amending the cantonal tax law or by the cantonal government issuing provisional rules. In either case there will be a set of cantonal rules determining cantonal tax law, as the changes to the federal Tax Harmonisation Act alone are unlikely to lead to sufficient certainty about the effects of the reform changes on a particular entity. 

The date on which the federal Tax Harmonisation Act is (substantively) enacted would not generally be the enactment date for IFRS financial reporting purposes, as generally the cantonal process is expected to still be ongoing. However, the potential consequences of the changes to cantonal legislation should, if material, be disclosed in the notes to the financial statements based on best estimates. Such disclosure should be reviewed and updated at each reporting date, based on continued re-assessments of the potential tax impact considering the most likely elements of the respective cantonal law.

However, the question arises as to how to deal with a situation where a canton has not decided on changes to the cantonal tax law by the time financial statements for the period including 31 December 2019 are finalised, and the cantonal government has not issued provisional implementation parameters for the canton. 

In our view, in such a scenario preparers should consider that the mandatory elements can be applied directly. Entities should look at the underlying legal framework, assess whether there are taxes expected to be paid as a result of those reliefs being withdrawn, and account for those based on the requirements laid down in IFRIC 23. Any subsequent changes in the cantonal tax law would be accounted for when they are substantively enacted.

Alternative approach: two enactment dates

An alternative approach would be to take a more rigid view of the legislative framework and consider two separate enactment events for the federal Tax Harmonisation Act and each cantonal law. The enactment of the Tax Harmonisation Act is the basis for changes on cantonal level, and therefore it is known that certain reliefs will fall away but will be replaced by something that is not decided upon or substantively enacted. In these circumstances, entities should look at the underlying legal framework and assess whether there are taxes expected to be paid as a result of those reliefs being withdrawn. Any subsequent changes in cantonal tax law would be accounted for when they are substantively enacted. 

However, this approach could lead to significant volatility due to multiple changes in tax rates and provisions – for example, full provision for income taxes when the federal Tax Harmonisation Act is enacted and it is known that certain reliefs will be withdrawn, which is then reduced or removed as any new cantonal reliefs are enacted on a canton by canton basis at a later stage. In general, increased volatility in provisions in these circumstances would likely make the financial statements more difficult to understand. Hence, in our view, for most entities, before cantonal laws are substantively enacted, disclosure is the appropriate response as articulated above, and not this alternative approach.

Conclusion

In our view, in most cases it is more reasonable and supportable by IAS 12 ‘Income taxes’ for (substantive) enactment to occur once the cantonal law is (substantively) enacted. In addition, the ‘one enactment’ approach avoids the volatility of deferred tax balances that might arise from two enactment events, which increases the usefulness of the financial statements to the reader. Once the Tax Harmonisation Act is (substantively) enacted, good quality disclosure is in most cases the appropriate response.

As a result, the enactment of the Tax Harmonisation Act at federal level will not lead to any immediate change in the accounting for income tax. Existing deferred tax assets or deferred tax liabilities arising from temporary differences will still be measured at the existing tax rate until the cantonal legislative process is (substantively) complete (i.e. upon the [substantive] enactment of new tax laws or provisional rules at cantonal level). 

Since enactment will be considered to be when the cantonal tax law(s) are (substantively) enacted, the actual date of (substantive) enactment may vary from canton to canton depending on the (substantive) enactment of each individual canton’s legislative process.

At a glance: 

The Swiss tax reform (‘Federal Act on Tax Reform and AHV Financing’ or ‘TRAF’, formerly known as ‘Tax Proposal 2017’) is a comprehensive reform package that will require amendments to both federal and cantonal tax laws. This ‘In brief’ discusses determination of the enactment date under IFRS.