Impact of TRAF on 2019 financial statements - Material deferred tax effects expected

Anna Karina Schweizer Accounting Consulting Services, PwC Switzerland Nov 07, 2019

The Swiss people accepted the Federal Act on Tax Reform and AHV Financing (TRAF) in May 2019, which fundamentally changes the Swiss corporate tax landscape. Certain existing privileges are abolished, transitional rules can be applied during a transition period, and new, internationally accepted measures are implemented. Whilst these changes only enter into force as of 1 January 2020, their effects will already affect 2019 financial statements.  

IAS 12 Income Taxes differentiates between current and deferred income taxes. The former comprise income taxes payable for the current and past periods. The latter result from differences in recognition and/or measurement of assets and liabilities between the IFRS financial statements and their respective tax bases. Deferred tax assets and liabilities represent those income taxes, which are payable or deductible in future periods. This article outlines implications of TRAF on IFRS accounts in 2019; similar considerations apply under Swiss GAAP FER [1].   

As the changed to tax laws vary from canton to canton, timing, amount and impact (tax income or expense) of the Swiss tax reform depend on various variables, such as the previous tax status of an entity, its operations or its tax domicile. The key drivers on entity level are:

  • if and from which abolished privilege an entity benefited in the past, 
  • if and which transitional method is elected, and
  • which of the new measures apply and to which extent. 

The key influencing factor on cantonal level is not just the extent of the reduction of the ordinary tax rate, but also the specific features and amount of relief given for the newly introduced measures. This entails for example how much relief is given for each measure, the level of the maximum relief limitation, and if and for how long the transitional measures can be applied. For entities, which apply inter-cantonal tax allocation, additional complexities may arise. 

The following sections outline the most material one-off effects, which are expected to affect 2019 financial statements, without detailing the specific cantonal features and their practical application. Basis for the analysis is the status of our assessment as of September 2019. The conclusions presented apply to the basic mechanisms of each measure, not taking into account cantonal variations.

Reduction of ordinary tax rate 

Almost all Cantons have already decided or are planning to reduce the cantonal ordinary income tax rate. For fiscal years starting from 2020 [2] this will result in lower current income tax with the exception of entities that were taxed based on one of the since abolished cantonal regimes. IAS 12 Income Taxes [3] requires deferred tax assets and liabilities to be measured at the amounts expected to be paid or recovered, referring to tax rates and tax laws that have been enacted or substantively enacted [4] at the balance sheet date. Whilst the reduction of tax rates only impacts current income taxes in 2020, entities need to assess already in 2019 which tax rates to apply for the calculation of deferred tax balances (refer to illustration 1). This includes an analysis of the expected timing of reversal of taxable and deductible temporary differences (scheduling).

Illustration 1: Change in tax rate

Many IFRS preparers report asset balances that are higher than their tax bases and liability balances that are lower [5] than their tax bases. This results in a net deferred tax liability. All else being equal, a reduction of the applicable tax rate consequently results in a lower deferred tax liability and hence a deferred tax income. 

If an entity benefited from one of the abolished privileges in the past, the opposite effect can arise. For example, if an entity was taxed as a mixed company in the past and this privilege was accounted for as an in-substance reduced tax rate, the (substantive) enactment of TRAF results in an increased applicable tax rate. Under the assumption of a net deferred tax liability position, an increase in the applicable tax rate results in an increase of the deferred tax liability and hence a deferred tax expense.

IFRS requires that the accounting for the tax effects of a transaction or event is consistent with the accounting for the transaction or event itself [6]. As a result, the effect of tax rate changes is only partially recognised in P&L, and partially in other comprehensive income (OCI) or equity.

Example: Impact of reduction of tax rate from 20% to 18% in connection with defined benefit obligation

An entity presents a defined benefit obligation of CHF 1’000 in its IFRS financial statements. In the statutory financial statements, which are decisive for tax purposes, the obligation is zero. If the recognition criteria for deferred tax assets are met, the respective deductible temporary difference of CHF 1’000 results, at a tax rate of 20%, in a deferred tax asset of CHF 200. The tax rate change to 18% reduces the deferred tax asset to CHF 180.

Movements in employee benefit obligations under IFRS are partially recognised in P&L (current and past service cost and interest expense) and partially in OCI (remeasurements of defined benefit obligation). Consequently, the question how to allocate the corresponding deferred tax effects between P&L and OCI arises. Whilst this should be straight-forward for the effect of the current year, the allocation of the effects of prior periods is more challenging, as this calls for an analysis of the entire change in defined benefit obligation of the past years (back-tracing). 

One way to achieve this is as follows: Since 2013, with retrospective effect as of 1 January 2012, IAS 19 Employee Benefits requires that remeasurements of employee benefit obligations be recognized in OCI. Applying an approximate calculation, the deferred tax effect of the cumulative difference between the related employee benefit expense recognised in P&L under IFRS as compared to the expense for tax purposes between 1 January 2012 and 31 December 2018 could be recognised in P&L. The deferred tax effect of the remaining difference would then be recognised in OCI.

In-substance reduced rate

As of 1 January 2020, subject to various cantonal differences, entities can use the following measures to reduce income tax payable: research and development super-deduction (R&D super-deduction), patent box and in certain cantons notional interest deduction (NID). A generally acceptable approach would be to treat the benefits as reconciling items. In certain limited circumstances, entities may conclude that factoring the impact of a given regime into the applicable rate is acceptable because the benefit represents, in substance, a reduced rate of income tax. This option should only be considered when the regime results in a stable and consistent rate impact across periods [7]. 

Entities that account for one or more measures as an in-substance reduced tax rate based on the principles set out above, measure deferred taxes at this in-substance reduced tax rate already in their financial statements 2019. This may further intensify the one-off effect stemming from the tax rate reduction.

Tax losses carried forward

A deferred tax asset is recognised for tax losses carried forward amounting to qualifying taxable temporary differences, and additionally to the extent probable future taxable profits are available within the period in which the losses carried forward can be utilized [8]. The recognition criteria outlined in IAS 12 Income taxes [9] apply (refer to illustration 2). 

Illustration 2: Recognition criteria for deferred tax assets

Example 1: Change in applicable tax rate 

Example 2: Change in probable future taxable profit

Additional considerations in connection with tax losses carried forward

The two examples demonstrate for simplified circumstances how TRAF can result in remeasurements of deferred tax assets on tax losses carried forward. The assessment may be more challenging, for example, in situations where in the past entities were taxed based on a since abolished regime. The crucial question in such scenarios is how the cantonal law and its practical implementation interact with the available transition methods.

Current-law step-up

The step-up [10], (also referred to as current-law step-up) is an existing instrument many cantons already allow based on current practice. It applies as transitional mechanism when regime companies lose their status either when the conditions are no longer met, or when they voluntarily choose to become taxed normally. 

Untaxed hidden reserves (including self-generated “goodwill”) are estimated based on the difference between fair market value (“Verkehrswert”) and net tax book value. Those hidden reserves that were created under a privileged tax regime can be stepped-up tax free in the tax balance sheet. The calculated step-up amount is limited, for tax purposes, to the tax-free quota under the privileged regime applicable in the past. An exemption applies to hidden reserves on investments and land. 

The step-up either increases the tax base of identifiable assets or is treated as a discrete intangible asset. In periods subsequent to the step-up, such intangible asset (or the changed tax bases of other assets) can be amortised, which results in a tax-deductible expense. The amortisation rate depends on cantonal rules and is limited to a maximum of ten years, five years in some cantons. Since the cantonal step-up is part of the currently acceptable practice, it will only be available until TRAF comes into force, hence until 31 December 2019.

The step-up increases the respective tax bases and will therefore have an immediate impact on the temporary differences, which form the basis for deferred tax balances. If an entity determines at the balance sheet date, that it is probable, that it will make use of a step-up, it accounts for this at the best estimate either as a deferred tax asset or as a reduction of existing deferred tax liabilities respectively. 

The impact of the step-up on financial statements can result in a significant distortion of the consolidated effective tax rate, especially for entities with relatively high hidden reserves. The resulting deferred tax income in 2019 represents the future benefit of the step-up due to the amortization being tax-deductible in future periods. However, it should be noted that the deferred tax asset does not stand for a benefit directly related to TRAF. Its origin rather lies in a constitutional transitional alleviation of the effects of a potential fiscal shock, which could otherwise result from the abolition of existing privileges. Due to the recognition requirements in IAS 12 Income taxes, this benefit is realised in one go. Whereas recognition and measurement criteria [11] of IAS 12 Income taxes apply (refer to illustration 2), the initial recognition exemption does not apply.

Dual rate approach

TRAF introduces a new transitional method for the change from privileged to ordinary taxation (also referred to as special rate approach). This instrument foresees, for a period of five years, a separate taxation of future profits representing realised (or deemed realised) amounts of hidden reserves, including internally generated goodwill, which were created under the privileged regime applicable prior to TRAF.

In contrast to the step-up, the tax bases of assets and liabilities are not changed. Consequently, this instrument does not result in a similarly significant one-off effect in financial statements 2019. However, the application of the dual rate approach will affect the applicable tax rate used for measuring deferred tax balances that reverse during the five-year period. This can create one-off effects in itself. 

Entry mechanisms patent box

The changes to the tax laws regarding the patent box, especially regarding the entry mechanisms, are in force from 1 January 2020. Thus, one-off effects are generally not expected in financial statements 2019. One exemption would be if an entity already knows at their balance sheet date in 2019, that: 

  • It expects to apply the patent box mechanism and 
  • The criteria to treat the patent box benefit as in-substance reduced tax rate are met (refer to the considerations under 1.2 above). 

In such a situation, IFRS requires that management’s assumptions used for financial reporting purposes are consistent. If an entity already considers the future patent box as an in-substance reduced rate for the purpose of measuring deferred tax balances in 2019 for those temporary differences that reverse in and after 2020, the respective entry mechanism should be considered adequately.

Disclosure in financial statements 2019

It is recommended to disclose the impact of TRAF transparently and in an entity-specific manner. Extent and level of detail of the disclosure depend on an entity’s facts and circumstances, for example, how material the impact is overall. It should be noted that when several individually material effects even out, those should be disclosed separately. 

The disclosures may be divided as follows: 

  • General information:
    • General information about the Swiss tax reform and its consequences for the entity 
    • Date at which the changes are or are expected to be (substantively) enacted and when they will become effective
  • One-off effects: 
    • Abolition of previous privileges (if applicable)
    • Transitional measures step-up / dual rate (if applicable) 
    • Impact of the reassessment of current and deferred taxes in the current period
    • Tax rate reconciliation: disaggregation of the different impacts (if material) 
  • Ongoing application: 
    • Adaptation of the new cantonal measures 
    • Impact of the maximum relief limitation 
    • Expected impacts on future periods
  • Entity-specific information: 
    • Significant judgements and estimates taken
    • Accounting policies
    • Current developments 
    • Impact on tax losses carried forward 


The changes to corporate tax law applicable from 1 January 2020 can already significantly affect financial statements 2019 due to material one-off effects. Whilst current tax is expected to be impacted only from the year 2020 onwards (refer to illustration 1 ), various deferred tax effects are recognised when the respective cantonal changes are (substantively) enacted. 

These effects can be grouped based on their origin into the following categories (see table). 

As the impact of TRAF on financial statements 2019 can vary significantly, it is all the more important to disclose the entity specific situation and any one-off effects clearly and in a transparent manner. 

Change of applicable tax rate Change of temporary differences Remeasurement of deferred tax balances
  • General change of ordinary tax rate
  • Treatment of new measures as in-substance reduced tax rate (e.g. patent box) 
  • Special rate
  • Current-law step-up
  • Patent box entry mechanism model A
  • Amount of tax losses carried forward
  • Recognition criteria deferred tax assets

[1] Refer to Expertsuisse, Q&A tax accounting impact in relation to the federal act on tax reform and AHV financing (TRAF), page 2.
[2] In those cantons, in which tax rate reductions are already effective in 2019, this effect materialises in 2019 financial statements.
[3] IAS 12 § 47.
[4]Substantive enactment occurs when any future steps in the enactment process will not change the outcome.
[5]The most frequent exception is the defined benefit obligation under IAS 19 Employee benefits. 
[6] IAS 12 para 57.
[7] Refer to Expertsuisse, Q&A tax accounting impact in relation to the federal act on tax reform and AHV financing (TRAF), page 18.
[8] IAS 12 § 34.
[9] IAS 12 § 28-29
[10] Refer to Expertsuisse, Q&A tax accounting impact in relation to the federal act on tax reform and AHV financing (TRAF), page 6.
[11] IAS 12 § 28-29.

First published in ExpertFocus 2019/11


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Anna Karina Schweizer

Accounting Consulting Services, PwC Switzerland

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Reto Inauen

Director Tax Accounting & International Tax Services, PwC Switzerland

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