A year after the post-tax reform began, companies have only begun to discover the use of the new incentive systems for innovation. Initial practical experience shows great potential advantages for companies operating in Switzerland.
Swiss tax reform
One year ago, on January 1, 2020, the federal law on tax reform and the legal provisions for implementation at cantonal level came into force. This date marked the end of a 14-year marathon debate aimed at aligning Swiss tax law with international rules. The result is the most significant change to the Swiss tax system in over 50 years.
The key element, which the EU and the OECD demanded with increasing pressure, was the lifting of the special status for cantonal tax purposes of holding companies, domiciliary companies and "mixed" companies. The core of the reform was to create OECD-compliant incentives to keep Switzerland in the top group of the most attractive business locations from a tax point of view. With the introduction of a super deduction for research and development costs (R & D) and tax relief for patent income – the so-called "patent box" – two attractive tax incentives for innovations were created as part of the tax reform Toolkit. Both special regulations are available at cantonal tax level, but not for federal income tax.
A federal law on tax reform formed the framework that the cantons had to fill in by changing their own cantonal tax laws. Due to the different composition of their taxpayers, the cantonal governments pursued different strategies in their tax policy: many opted for a significant reduction in the general corporate tax rate, while others, in particular Zurich, Bern and Aargau, were dependent on more targeted relief through exploitation, as the new special regulations maximum. As a result, the tax incentives for innovations in these latter cantons have the greatest impact. It should be noted that the new regulations are associated with a relief restriction. This provision ensures that taxes are paid on at least 30% (or more, depending on the canton) of income before special deductions (R&D super deduction, patent box deduction, notional interest deduction, amortization of top-ups).
Table 1: Corporate income tax rates (CIT) and effects of tax incentives for innovation
|Ordinary CIT rate
|R&D super deduction
|Patent box CIT rate
After the first year of the post-tax reform era, there are significant differences between industries in applying the new rules. While pharmaceutical, chemical and engineering companies were quick to seize the opportunity, the reaction in other sectors like financial services has been lukewarm – wrongly.
R&D super deduction
For cantonal income taxes, an additional deduction of up to 50% can be claimed for certain expenses in connection with a taxpayer's own R&D activities and for expenses for outsourced R&D services.
Qualifying R&D activities for the super deduction
As a first step, a taxpayer needs to identify his qualified R&D activities. Practice shows that companies, and especially their academic staff, often set the bar too high when it comes to characterizing their activities as "R&D". It has therefore proven helpful that tax specialists analyze the situation together with the company's scientific department.
The definition of R&D for super deduction purposes remains rather vague. The tax laws refer to the definition in the federal law on the promotion of research and innovation, which, however, offers little orientation. Therefore, greater importance is attached to the OECD-Frascati Manual and the Oslo Manual. In principle, all five Frascati criteria (see Figure 1) must be met for any type of innovation in order for the activity to be classified as R&D.
Figure 1: Definition of R & E.
according to the OECD Frascati manual
• R&D encompasses creative and systematic work carried out in order to increase knowledge – including knowledge about people, culture and society – and to develop new applications of the knowledge available.
• Novel, i.e. H. Creation of new knowledge;
Significant developments are taking place in the automation of business processes and in the use of the possibilities of artificial intelligence (AI) for new products. This seems to apply to all industries where innovation is often about new applications that cover the use of research results from different scientific disciplines like computer science, physics, geography, behavioral research etc.
The Frascati manual requires R&D to create new insights for the company, and at best, those insights have not yet been used in the specific industry. The latter requirement, however, cannot be weighted too heavily. In addition, the Swiss tax administrations attach great importance to the criterion of uncertainty about the success of a project. Failed projects are therefore a good indicator of innovative activities. Of course, the evaluation of innovation projects through mechanical application of the Frascati criteria rarely leads to clear and reliable results. All circumstances of the entire innovation case must be taken into account.
In general, if a company is strategically committed to innovation in a particular area and backs that strategy with significant investments, the chances of applying the R&D super deduction should be good.
Super deductible R&D expenses
For own R&D activities, the super deduction is calculated on the basis of the corresponding personnel costs plus an increase of 35%, taking into account the material costs for R&D. After taking a holistic view of R&D activities instead of evaluating individual projects, practice has shown that the use of personnel costs for fixed teams instead of project-related personnel costs is an acceptable approach. In addition to personnel costs for the actual researchers, the costs for personnel with direct management and administrative functions for the research and development teams can also be included.
Of course, innovation teams often do not devote themselves exclusively to R&D activities, but also carry out routine functions, for example. Likewise, the share of R&D management in overall management tasks is generally decreasing at higher management levels. Accordingly, certain cantons tend to exclude board costs from the super deduction. In practice, all of these circumstances can be dealt with pragmatically in that certain staff costs are not allowed at a flat rate.
Contract R&D services
In the case of outsourced (contractual) R&D, Swiss tax law generally transfers the right to the R&D super deduction to the client. The recipient can claim the super deduction for 80% of the invoiced costs.
In cases in which a company provides R&D services for a client who is not based in a canton where the R&D super deduction is available, it can claim the super deduction itself. This applies in particular to R&D services that are provided in Switzerland for the benefit of a foreign recipient.
In principle, R&D services between group companies can be charged at full cost and with a reasonable mark-up. This generally leads to a much higher qualifying effort at the level of the client than if he had carried out the R&D himself and could only claim the personnel costs. In the (tax) planning of R&D functions within a corporate group, this is an aspect that must be carefully considered.
Many countries have tax incentives in the form of lower taxation on income from intellectual property rights, which are shown in a separate segment – commonly referred to as a patent, license or IP box. The Swiss variant corresponds to the minimum standard specified in the BEPS Action 5 report of the OECD by using the modified nexus approach and defining qualified IP rights somewhat more narrowly than the report.
Within the patent box, the net income from the exploitation of patents and similar intellectual property rights (IP) is worked out. A company can generate such revenue by licensing and selling patents, or by selling goods and services based on patents. The patent box profit, multiplied by the nexus ratio and the tax relief factor (varies depending on the canton), results in the tax-exempt income.
Qualifying IP Rights
The following IP rights qualify for the Swiss patent box:
- Swiss patents;
- European patents with the designation Switzerland;
- Patents for inventions in other jurisdictions, utility models; and
- Comparable IP rights such as additional protection certificates and statutory data protection for pharmaceutical products and pesticides.
Although not expressly mentioned in the law, income generated on the basis of exclusive licenses for the use of patents on Swiss territory also qualifies for the box.
The law is only based on the registration of a patent at home or abroad and offers a clear and very easy-to-use criterion for qualifying the rights. Patent applications, expired / revoked patents, trademarks, designs, copyrights and trade secrets are not qualified. An important topic in this context is software. According to Swiss IP law, software can be protected by copyrights, but not by patents, unless it is part of a patented product (computer-implemented invention). As a result, software is only qualified for the box if it is part of a patented invention or has itself been patented abroad.
Figure 2: Factors for calculating the patent box deduction from taxable income
(Click to enlarge)
1) Depending on the selected scope of the patent box: pre-tax income of the company, the product family or the product.
Calculation of the patent box deduction from taxable income
When using the patent box, a company must first select the scope of one or more boxes. This choice is determined, among other things, by the level of development of the various products and the capabilities of the Enterprise Resource Planning system with regard to data granularity.
When using the indirect method of calculating patent box profit, the idea is to eliminate any box profit revenue that is not directly related to a patent. Experience shows that the distinction between qualified and non-qualified income needs to be discussed with the tax authorities. For example, in financial services certain parts of the investment result can be generated on the basis of a patented solution and should therefore not be taken out of the packaging like the financial result in other industries. In some cases where the indirect method is difficult to apply, qualified profit can also be determined by a "synthetic" direct calculation: Based on a transfer pricing study, the company can determine the amount of license fees that third parties would agree to the use of comparable patents .
When IP rights are assigned to the patent box for the first time, the expenses for the development of such an IP, for which a tax deduction has been claimed in the last 10 years, will be recovered for systematic tax reasons. The Swiss cantons pursue different approaches, which in most cases make it possible to lower the tax costs for entry into the patent box in advance. However, this requires careful planning of the entry. Recapturing and continuously calculating the nexus ratio requires a relatively time-consuming tracking and tracing of R&D expenditure. Automation is the key in this area to make the application of the patent box efficient.
For companies involved in innovation, the R&D super deduction and patent box may offer the opportunity for significant tax savings. These tools provide a reason to reassess innovation and patent strategies from a tax perspective. Companies are well advised to analyze how they can best benefit from the Swiss innovation toolkit. You should also use the opportunity and standard practice in Switzerland to negotiate and receive a preliminary decision from the relevant tax authorities. When it comes to implementation, the Swiss tax authorities are usually cooperative and open to pragmatic solutions.
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Thomas Nabholz is a partner at Meyerlustenberger Lachenal, where he
Thomas advises corporate clients from various industries
Before joining the company in October 2019, Thomas was Co-Head of Switzerland
Julian Kläser is a senior associate and tax expert at Meyerlustenberger Lachenal.
Julian's work focuses on Swiss national and international tax
Julian has a PhD in tax law and publishes regularly
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