Transfer prices published by SFTA

Primary adjustments are adjustments to the taxable profit of a company that are made by a first tax authority based on the application of the arm's length principle to transactions involving an associated company situated in another country.

In Switzerland, primary adjustments are made exclusively by the Cantonal Tax Administrations, as these are responsible for the assessment and collection of profit tax.

Example: Primary correction

A Company A domiciled in Switzerland pays license fees of CHF 50’000 to a parent Company B domiciled abroad, which is the owner of a trademark. Company A then deducts CHF 50’000 from its taxable profit as a business expenditure. The Cantonal Tax Administration is of the opinion that the price of CHF 50’000 does not comply with the arm's length principle and that two independent companies would agree on a price of CHF 30’000. The Cantonal Tax Administration therefore adds back CHF 20’000 to the taxable profit of Company A, which constitutes a primary adjustment.

Corresponding adjustments are adjustments to the tax liability of the associated company in a second state that are made by the tax authority of that state on the basis of a primary adjustment by the tax authority in the first state in order to eliminate double taxation. It presumes that the primary adjustment is recognized by the second state and, in its view, is based on a correct application of the arm's length principle by the first state. In practice, the corresponding adjustment occurs most frequently in mutual agreement procedures.

If a corresponding adjustment is made in Switzerland on the basis of a primary adjustment by the tax authorities of a foreign state, it also falls within the competence of the Cantonal Tax Administrations insofar as it relates to profit tax.

Example: Corresponding adjustment

A Company A domiciled in Switzerland pays license fees of CHF 50’000 to a parent Company B domiciled abroad, which is the owner of a trademark. The Cantonal Tax Administration makes a primary adjustment so that CHF 20’000 is added back to the taxable profit of Company A. If the foreign tax authority does not take any action, this CHF 20’000 will continue to be regarded as taxable profit of Company B. The counter-adjustment for the foreign tax authority therefore consists of reducing the taxable profit of Company B by CHF 20’000 to bring it in line with the taxable profit of Company A and to eliminate the double taxation.

Profit repatriations are repatriations of profits between affiliated companies that are involved in a transaction that has been adjusted by a tax authority. They serve to bring in line the commercial balance sheet with the tax balance sheet resulting from the adjustment. These are not mandatory under either treaty law nor domestic law.

In application of Art. 18 para. 4 StADG, profit repatriations are not deemed to be a benefit in kind under Art. 4 para. 1 let. b VStG and are not subject to withholding tax if they are carried out in accordance and as a result of a mutual agreement procedure or based on an internal agreement on the basis of Art. 16 StADG. In contrast, in the absence of a mutual agreement procedure or an internal agreement, withholding tax is levied on payments made for the purpose of repatriation.

Example: Profit repatriation

A Company C domiciled in a foreign country is subject to a primary adjustment for an intragroup transaction with its subsidiary D domiciled in Switzerland, which leads to the addition of CHF 10’000 to the taxable profit of Company C. Following a mutual agreement procedure to eliminate double taxation, Switzerland makes a corresponding adjustment by reducing the tax base of Company D by the amount of the adjustment made in the foreign state, i.e. CHF 10’000. If Company D subsequently repatriates the profits, i.e. repatriates the CHF 10’000 to Company C, no withholding tax is levied on these profits.

Secondary adjustments are adjustments resulting from the taxation of a constructive transaction. A secondary transaction is a fictitious transaction to shift the excess profits that are reclassified as constructive dividends, constructive equity contributions or constructive loans, depending on the country.

In Switzerland, the secondary adjustment corresponds to the levying of withholding tax on the amount that qualifies as a benefit in kind in a withholding tax context. Therefore, secondary adjustments in Switzerland, are therefore carried out exclusively by the SFTA, which has sole responsibility for levying withholding tax.

Example: Secondary correction

A Company A domiciled in Switzerland pays license fees of CHF 50’000 to a parent Company B domiciled abroad, which is the owner of a trademark. The SFTA concludes that the price of CHF 50’000 does not comply with the arm's length principle and that the price that would be agreed between two independent companies would be CHF 30’000. The secondary adjustment for the SFTA is to qualify the surplus of CHF 20’000 as a benefit in kind that leads to the levying of withholding tax.

If a primary adjustment made by a Cantonal Tax Administration is confirmed in whole or in part in the mutual agreement procedure, the question of the secondary adjustment arises, i.e. the levying of withholding tax by the SFTA on the amount of the primary adjustment confirmed in the mutual agreement procedure.

If the question of the collection of withholding tax is not regulated within the framework of a mutual agreement procedure, withholding tax must be levied on the amount of the benefit in kind if the material and procedural requirements for collection are met.

Example: Mutual agreement

A Company A domiciled in Switzerland pays license fees of CHF 50’000 to a parent Company B domiciled abroad, which is the owner of a trademark. The Cantonal Tax Administration performs a primary adjustment of CHF 20’000 and adds this amount back to Company A's taxable profit. The primary adjustment leads to a mutual agreement procedure in which an arm's length price of CHF 40’000 is assumed for the license fees paid by Company A to parent Company B by means of a mutual agreement, so that the primary adjustment of CHF 10’000 performed by the Cantonal Tax Administration is retained. If the mutual agreement does not address the issue of the secondary adjustment, the withholding tax on the amount of CHF 10’000 will be levied by the SFTA if it is of the opinion that the conditions for a benefit in kind are met.

The mutual agreement may provide for the possibility that the taxpayer carries out a profit repatriation of the funds in the amount of the confirmed primary adjustment, generally within 60 days upon the conclusion of the mutual agreement. If the taxpayer carries out this profit repatriation, the secondary adjustment will not be made, i.e. the SFTA will not levy withholding tax on the amount of the adjustment confirmed by the mutual agreement procedure. The payment must be documented towards SIF, who forwards the corresponding information to the SFTA. However, the existence of such a reference in the mutual agreement does not oblige the taxpayer to make a profit repatriation. If no profit repatriation takes place, the withholding tax is levied on the amount of the primary adjustment in accordance with the applicable DTA.

The taxpayer is not entitled to the inclusion of such a reference in the mutual agreement - this depends on the circumstances of the individual case. In particular, the levying of withholding tax is not waived in obvious cases of profit shifting.

Example: Requirements for secondary correction

A Company A domiciled in Switzerland pays license fees of CHF 50’000 to a parent Company B domiciled abroad, which is the owner of a trademark. The Cantonal Tax Administration makes a primary adjustment of CHF 20’000 and adds this amount back to Company A's taxable profit. The primary adjustment leads to a mutual agreement procedure, which sets an arm's length price of CHF 40’000 for the license fees paid by Company A to parent Company B in a mutual agreement, so that the primary adjustment of CHF 10’000 made by the Cantonal Tax Administration is retained. If the mutual agreement contains a specific reference to withholding tax and profits are repatriated in accordance with this reference, withholding tax is not levied.

Certain administrative directives issued by the SFTA are applicable to the area of financing transactions. These are namely the circular letters published annually by the SFTA on the interest rates recognized for tax purposes for advances or loans in Swiss francs and foreign currencies and the SFTA circular letter no. 6 of 6 June 1997 on hidden equity in corporations and cooperatives. These administrative directives constitute "safe harbour" regulations that are not binding for foreign tax authorities.

Chapter X of the OECD Transfer Pricing Guidelines contains specific guidelines for the application of the arm's length principle to intragroup financing transactions, in particular treasury activities, including intragroup loans.

The SFTA circular letters on interest rates recognized for tax purposes for advances or loans in Swiss francs and foreign currencies contain interest rates for different categories of transactions and are intended to simplify the application of the arm's length principle. If the taxpayer decides to apply them, the taxpayer does not have to prove that the interest rate applied to a transaction complies with the arm's length principle and no transfer pricing analysis is required, provided that the transaction in question falls within the scope of the circular letter and the interest rate applied is in line with the rates in the circular letter.

On the contrary, non-compliance with these interest rates creates a rebuttable presumption that the arm's length principle is not complied with. Against this background, the taxpayer has the opportunity to prove that the transaction complies with the arm's length principle and is expected to demonstrate through a transfer pricing analysis that the applicable interest rate corresponds to the market interest rate and thus to the arm's length principle.

Whether an interest rate that deviates from the interest rates provided for in the SFTA circular letters is compatible with the arm's length principle can be demonstrated by means of a transfer pricing study. In practice, such a study is expected to include at least the following elements:

• A detailed description of the main features of the relevant transaction that could affect the interest rate. This description is necessary to identify the key factors for comparability and to delineate the transaction. These factors include the term of the loan, the currency, the issue date, the borrower's credit rating and the existence of guarantees and/or collaterals.
• An analysis of the borrower's credit rating.
• A search for comparable transactions, considering the most important comparability factors.

The choice of currency is assessed on a case-by-case basis. The circumstances at the time of the transaction must be taken into account. The choice of a foreign currency must not be based solely on tax considerations.

Taking out a loan in a foreign currency may be justified in the following cases in particular:

•  The foreign currency is the functional currency of the company.
• The foreign currency enables the company to obtain more favourable conditions. However, the costs of hedging the exchange rate risk should be considered.
• The foreign currency is the currency of the main income resulting from the utilization of an asset financed by the loan.

In the context of a transfer pricing analysis, it is important to distinguish between the rating of a borrower (issuer credit rating) and the rating of a financial transaction (issue credit rating).

The main difference is that the rating of a transaction, which is based on the borrower's rating, takes into account the specifics of the transaction and its impact on the credit risk assumed by the lender. The rating of a transaction can therefore be higher than that of the borrower. For example, a loan agreement may provide for a guarantee or a senior/privileged repayment that reduces the credit risk and thus improves the rating. In other cases, however, the borrower's rating may be better than that of a transaction. This is particularly the case if a loan is subordinated, and the loan is only repaid after other loans have been reimbursed.

It is recommended to use the rating of a financial transaction (and not the rating of a borrower) to determine an arm’s length interest rate.

If a rating from an independent rating agency is available for a borrower, then this rating must be used.

If no such rating is available, an estimate of the rating must be made. There are various approaches to this:

• Use of methods defined and used by rating agencies;
• Use of financial software with which the rating can be estimated mainly using statistical models.

It is recommended to apply one of the methods used by rating agencies. However, the use of financial software is not excluded, provided that the reliability of the results can be proven.

A borrower's rating is a tool for determining its future solvency. It is therefore important to consider the impact of future transactions on the borrower's balance sheet, income statement and treasury function.

However, it is appropriate to base the rating on historical financial data if this can be regarded as sufficiently representative of future financial data.

Each rating agency uses its own standard. There are reliable comparison tables for the various standards that can be used to convert a rating into one standard or another. The ratings of potential comparable transactions are usually listed in one of the standards provided by the rating agencies.

It is therefore recommended that the standard of one of the rating agencies be used for a rating. However, it is not ruled out to use other standards if it can be proven that a reliable comparison or conversion table exists. However, the use of such other standards should give the possibility to search for comparative values without compromising the reliability of the results.

Banks are subject to special regulations to ensure their capital strength against certain risks and to protect customers from the bank's insolvency risk. They require an internal process for the reliable assessment of credit applications from companies. This includes a rating system. Based on this, the banks determine the conditions under which they finance independent companies.

Internal ratings of taxpayers in the banking sector can be accepted as comparative values if the same methodology has been applied to determine the interest rate.

The implicit support (group support) has an impact on the creditworthiness of a company and therefore on its credit rating. It must therefore be taken into account when estimating a borrower's rating, as this rating determines to a certain extent the interest rate at which the borrower receives the loan.

Implicit support must be assessed on a case-by-case basis. It does not necessarily benefit all Group companies to the same extent. If it turns out that a borrower is receiving implicit support, its rating must be adjusted accordingly.

A company must be rated as if it was not part of a group (i.e. on a standalone basis). However, any implicit support must be taken into account.

In exceptional cases, the Group Credit Rating may be used for the rating of a borrower. However, it must be demonstrated that this is the most reliable indicator considering all facts and circumstances. In particular, the indicators for the creditworthiness of the company must not differ from those of the group (e.g. in the case of structures in which the group is held by a number of intermediate holding companies).

It is unlikely that there is only one interest rate on the market for a particular transaction. It is therefore common practice to determine a range of arm's length interest rates. If the interest rate applied is within the interquartile range, the interest rate is usually accepted for tax purposes. The taxpayer must determine which specific interest rate he would like to apply and justify his choice. In this context, it must be examined whether the interest rate chosen corresponds to the interest rate that an independent borrower (taking into account the conditions of the transaction) would have received from an unrelated third party and which he would be prepared to accept under other realistic options, based on the assumption that the borrower wishes to optimize his weighted average cost of capital (WACC).

With regard to financial transactions, the OECD describes which specific methods are used to determine an interest rate:

• The Comparable Uncontrolled Price Method (CUP method): According to the OECD, the CUP method is easier to apply for financial transactions than for other types of transactions, which is due to the large number of markets and the availability of information for this type of transactions. Accordingly, the application of the CUP method is commonly used and often preferred. The application of the CUP method requires the determination of internal or external comparables.
  

Depending on the circumstances, the use of other methods is not excluded. The OECD mentions the following methods in this regard:

• Cost of funds.
•  The use of credit default swaps: Credit default swaps are financial instruments that are comparable to insurance contracts for the assumption of credit risk in return for a risk premium. The results can be unreliable because of the limited degree of liquidity on the markets for this type of instruments, which, as stated by the OECD, leads to high volatility. Thus, the spread applied to these financial instruments may partially reflect the liquidity problem observed in the markets for these instruments. In this case, it is not representative of market conditions. The use of credit default swaps is not recommended.

This is not an actual transaction, as the parties do not conclude a contract. The comparability criterion is therefore not met. Furthermore, it is not clear from a bank opinion whether an independent borrower would accept the same conditions or whether there are other, more favourable alternatives.

Against this background, a bank opinion can only serve for exceptional cases as a starting point, but is not sufficient to prove compliance with the arm's length principle. The use of this method is therefore not recommended.

The application of the CUP method requires the determination of internal or external comparables. The SFTA accepts bonds issued on the market and private financial transactions whose details are available in databases as comparative transactions.

To determine internal or external comparable transactions, the selection criteria that have an influence on the interest rate must be defined based on the most important comparability factors. The main criteria are:

•  Rating
• Effective (remaining) term
• Currency
• Issue date of the transaction.

If comparable transactions have been identified, it must be determined: i) which comparables are to be used and ii) whether an adjustment is required to determine an arm’s length interest rate. Two types of comparables are possible:

• The interest rate applied to comparable transactions: The interest rate is determined at the time the respective transaction is concluded. It corresponds to the yield expected by the markets at that time for this type of transaction under the assumption of a sale at nominal value. However, this interest rate does not reflect the market conditions at a later date. It is therefore not recommended to use the interest rate of comparable transactions that were not executed close to the time of the transaction under analysis.
• The yields calculated for comparable transactions: It is recommended to use yields calculated at a point in time close to that of the transaction under analysis. These yields reflect the current market conditions, regardless of when the comparable transactions were issued/executed.

Due to the volatility of the markets, these yields should be calculated over a certain time period and an average should be used to increase the reliability of the results.

It is not easy to find comparables in Swiss francs. Therefore, comparables in other currencies can also be used. In view of the proximity and economic interdependence between Switzerland and the EU, the use of comparables in Euros is recommended.

In this case, a reliable adjustment of the results is necessary to improve the comparability. In practice, in most cases it is appropriate to make an adjustment corresponding to the difference between a swap interest rate in Swiss francs and a swap interest rate in Euros for the same term.

Parties who have concluded a loan agreement can include a clause in the agreement that allows them to repay the loan under certain conditions partly or in full before its maturity date.

The effects of early repayment clauses on the arm's length interest rate must be considered. It is therefore necessary to determine which party benefits from the clause and whether there is an actual benefit. Various factors, such as the economic environment, must be taken into consideration. For example, if the markets anticipate a significant rise in interest rates, it is likely that the lender will activate the repayment clause and benefit from it. Consequently, in such a context, it is likely that the lender will be more inclined to accept a lower interest rate to the extent that the risk associated with the loan is minimized by the said clause. Conversely, and under the same circumstances, a borrower would be more reluctant to negotiate such a clause. Finally, repayment clauses for short-term variable interest rate loans appear unrealistic in terms that the risk associated with interest rate volatility is lower. A clause to protect against this risk therefore does not seem appropriate.

Despite the abolition of LIBOR, banks continue to grant loans with variable interest rates. The application of a variable interest rate therefore complies with the arm's length principle, provided that the interest rate applied also complies with the arm's length principle.

It is important to use a reference rate that is equivalent to those used in practice by banking institutions as a substitute for LIBOR. These rates are determined according to new market standards set by stock exchange institutions or central banks that administer them. For the Swiss franc, it is SARON (Swiss Average Rate Overnight). LIBOR can have different maturities (e.g. one day, one week, three months), while the alternative interest rate chosen is an overnight rate. For this reason, there are methods to derive a longer-term interest rate from this daily rate and these should be taken into account. For intercompany loans in Swiss francs, the "Last Recent" option and the use of the SARON Compound Rate was selected.

The reference rate must be in line with the new market standards set by stock exchange institutions or central banks that are in charge of the administration. In particular, the following must therefore be considered:

• The new reference rates set for each currency;
• The term of the LIBOR rate originally intended for the calculation of the variable interest rate;
• The calculation method for determining longer-term reference rates from the updated daily reference interest rates (e.g. SARON);
• Spreads calculated by the International Swaps and Derivatives Association (ISDA) according to a specific method and supported by the banking sector. These margins are intended to ensure that the new reference rates are equivalent to LIBOR rates in terms of risk.

Any change to the terms and/or conditions of an intercompany loan must comply with the arm's length principle. In this context, it should be analysed whether:

the loan terms (e.g. term, risk premium, application of a fixed interest rate) that were revised under the pretext of replacing LIBOR were changed in accordance with the arm's length principle; [Example 2]

the possible termination of a contract as a result of the replacement of LIBOR corresponds to the original contractual terms and is economically justified; [Example 3]

 the interest rates applicable from 1 January 2022 have been calculated correctly. Under this assumption, an adjustment of the risk premium is a priori not justified. [Example 4]

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