Withholding tax in connection with primary, corresponding and secondary adjustments
Transfer pricing adjustments by the Swiss tax authorities may take the form of a primary adjustment by the competent cantonal tax authority and/or a secondary adjustment by the Federal Tax Administration. When a primary adjustment is conducted by a foreign state, a correlative adjustment may be carried out in Switzerland in order to eliminate double taxation. These different adjustments raise a number of issues relating to withholding tax.
Questions and answers in connection with primary, corresponding and secondary adjustment
Here you will find information on various transfer pricing topics in connection with cross-border transactions. This information is intended to provide clarification on selected issues. It is general in nature and cannot be used as the sole basis for the tax assessment of a specific fact pattern.
Primary adjustments are adjustments that are made by a first tax administration to a company’s taxable profits as a result of applying the arm’s length principle to transactions involving an associated enterprise situated in a second tax jurisdiction.
In Switzerland, primary adjustments are made exclusively by the cantonal tax administrations, as they are responsible for the assessment and collection of profit tax.
Example: primary adjustment
Company A, resident in Switzerland, pays CHF 50,000 in royalties to parent company B, resident abroad, which is the owner of a trademark. Company A then deducts these CHF 50,000 from its taxable profit as business-related expense. 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 enterprises would have agreed on a price of CHF 30,000. The cantonal tax administration therefore adds CHF 20,000 to company A's taxable profit, which constitutes a primary adjustment.
Corresponding adjustments are adjustments to the associated enterprise's tax liability in a second jurisdiction which are made by that jurisdiction's tax administration as a result of a primary adjustment by the tax administration in the first jurisdiction in order to eliminate double taxation. It presumes that the primary adjustment is recognized by the second jurisdiction and, in its view, is based on a correct application of the arm’s length principle by the first tax administration. 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 administration of a foreign jurisdiction, it also falls within the competence of the cantonal tax administrations insofar as it relates to profit tax.
Example: corresponding adjustment
Company A, resident in Switzerland, pays CHF 50,000 in royalties to parent company B, resident abroad, which is the owner of a trademark. The cantonal tax administration makes a primary adjustment so that CHF 20,000 is added to the taxable profit of company A. If the foreign tax administration does not take any action, this CHF 20,000 will continue to be considered as taxable profit for company B. Thus, the corresponding adjustment for the foreign tax administration consists of reducing company B's taxable profit by CHF 20,000, in order to make it consistent with company A's taxable profit and eliminate double taxation.
Repatriation payments are repatriations of profits that have been adjusted by a tax administration between associated enterprises that are parties to a transaction. They are used to reconcile 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 Article 18 paragraph 4 of the Federal Act on the Implementation of International Tax Agreements (ITAIA), repatriation payments are not considered to be hidden profit distributions as defined in Article 4 paragraph 1 letter b of the WTA and are not subject to withholding tax, provided they are carried out in accordance with the results of a mutual agreement procedure or an internal agreement concluded on the basis of Article 16 of the ITAIA. In contrast, in the absence of a mutual agreement procedure or an internal agreement, withholding tax is levied on the payments made for repatriation purposes.
Example: repatriation payments
Company C, based in a foreign jurisdiction, is subject to a primary adjustment for an intra-group transaction with its Swiss-domiciled subsidiary D, resulting in CHF 10,000 being added to company's C's taxable profit. Following a mutual agreement procedure to eliminate double taxation, Switzerland makes a corresponding adjustment by reducing company D's tax base by the amount of the adjustment made in the foreign jurisdiction, i.e. CHF 10,000. If company D subsequently repatriates the profits, i.e. if CHF 10,000 is repatriated to company C, no withholding tax is levied on these profits.
Secondary adjustments are adjustments that arise from imposing tax on a secondary transaction. A secondary transaction is a constructive transaction resulting from the transfer of excessive remuneration, characterised as constructive dividends, constructive equity contributions or constructive loans, depending on the jurisdiction.
In Switzerland, a secondary adjustment represents the levying of withholding tax on the amount that qualifies as a hidden profit distribution in the context of transfer pricing. Secondary adjustments in Switzerland are therefore carried out exclusively by the FTA, which has sole authority for levying withholding tax.
Example: secondary adjustment
Company A, resident in Switzerland, pays CHF 50,000 in royalties to parent company B, resident abroad, which is the owner of a trademark. The FTA considers that the price of CHF 50,000 does not comply with the arm's length principle and that the price agreed between two independent enterprises would be CHF 30,000. For the FTA, a secondary adjustment involves recognising the excess remuneration of CHF 20,000 as a hidden profit distribution, which results in the levying of withholding tax.
If a primary adjustment made by a cantonal tax administration is partly or fully confirmed in a mutual agreement procedure, the question of secondary adjustment arises, i.e. the levying of withholding tax by the FTA on the amount of the primary adjustment confirmed in the mutual agreement procedure.
If the question of the levying of withholding tax is not covered in the mutual agreement, withholding tax is to be levied on the amount of the hidden profit distribution if the material and procedural criteria for collection are met.
Example: mutual agreement
Company A, registered in Switzerland, pays CHF 50,000 in royalties to parent company B, registered abroad, which is the owner of a trademark. The cantonal tax administration performs a primary adjustment of CHF 20,000 and adds this amount to company A's taxable profit. The primary adjustment leads to a mutual agreement procedure in which, under a mutual agreement, an arm's length price of CHF 40,000 is set for the royalties paid by company A to parent company B, which means that the primary adjustment of CHF 10,000 made by the cantonal tax administration is upheld. If the mutual agreement does not cover the issue of withholding tax, then withholding tax is levied as secondary adjustment on the CHF 10,000 by the FTA if it considers that the criteria for a hidden profit distribution are met.
The mutual agreement may provide for the possibility that the taxpayer makes a repatriation payment of the amount of the confirmed primary adjustment; this should generally take place within 60 days after the taxpayer’s acceptance of the mutual agreement. If the taxpayer performs this repatriation, the secondary adjustment will not be made, i.e. the FTA will not levy withholding tax on the amount of the adjustment confirmed by the mutual agreement. The payment must be documented towards the SIF, which forwards the relevant information to the FTA. However, the existence of such a reference in the mutual agreement does not oblige the taxpayer to make a repatriation payment. If no repatriation payment takes place, withholding tax is levied on the amount of the primary adjustment in accordance with the applicable DTA.
The taxpayer does not have any right to have such a reference included 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: criteria for secondary adjustment
Company A, resident in Switzerland, pays CHF 50,000 in royalties to parent company B, resident abroad, which is the owner of a trademark. The cantonal tax administration performs a primary adjustment of CHF 20,000 and adds this amount to company A's taxable profit. The primary adjustment leads to a mutual agreement procedure, the mutual agreement stipulating an arm's length price of CHF 40,000 for the royalties paid by company A to parent company B, which means that the primary adjustment of CHF 10,000 made by the cantonal tax administration is upheld. If the mutual agreement contains a special indication with regard to withholding tax and if the repatriation payment takes place in accordance with this indication, no withholding tax is levied.
The repatriation must be carried out within the time limit specified in the mutual agreement, which is in principle 60 days from the transmission of the mutual agreement to the relevant cantonal tax authority.
In exceptional, duly justified cases, the FTA may, upon request by the taxpayer, grant an extension of this time limit.
The exchange rate to be applied to determine the amount in CHF that the Swiss company should receive under a repatriation should in principle be the exchange rate in effect at the time the hidden profit distribution was granted to the foreign company.
Can repatriation be carried out by netting a reciprocal receivable between the Swiss company and the foreign affiliated company?
The FTA will only accept repatriation in the form of an actual payment. Other forms of repatriation (e.g. netting, credit note, requalification of past contributions or dividends) do not avoid the withholding tax consequences. When a repatriation has to be made in favor of the Swiss company, the foreign company cannot net a receivable that the Swiss company may have against it.
Exceptionally, the FTA will accept netting between different mutual receivables (different years or different transactions) if they are formally set out in the same mutual agreement or APA, or in a mutual agreement and APA concluded simultaneously and relating to the same matter.
Example: netting refused
Company A in Switzerland and foreign sister company B apply the profit split method to the joint development of intangible assets. The cantonal tax authority makes a primary adjustment to company A. The primary adjustment gives rise to MAP which confirms a primary adjustment of CHF 50,000. The mutual agreement contains a repatriation clause. Company B has a receivable of the same amount against company A for services rendered to company A that were not the subject of the MAP, and wishes to proceed with repatriation by waiving this receivable. Such a netting would not make it possible to avoid withholding tax on the amount of CHF 50,000.
Example: netting allowed (mutual agreement)
Company A in Switzerland and foreign sister company B apply the profit split method to the joint development of intangible assets. The cantonal tax authority makes a primary adjustment to company A for the tax years 2021 to 2023. The primary adjustment gives rise to a MAP which confirms a primary adjustment of CHF 50,000 for the 2021 financial year and CHF 40,000 for the 2023 financial year. For the 2022 financial year, however, the MAP resulted in a hidden profit distribution of CHF 5,000 to company A. This distribution reduces the amount to be repatriated to company A from CHF 90,000 to CHF 85,000.
Example: netting allowed (mutual agreement and APA)
Company A in Switzerland and foreign sister company B apply the profit split method to the joint development of intangible assets. This transaction is subject to a MAP for the years 2021 and 2022, and an APA with retroactive effect for the year 2023 (closed for accounting purposes). The mutual agreement confirms a primary adjustment of CHF 30,000 for the 2021 financial year and CHF 25,000 for the 2022 financial year. For the 2023 financial year, however, the APA reveals a hidden profit distribution of 15,000 to company A. This distribution reduces the amount to be repatriated to company B from CHF 55,000 to CHF 40,000.
Does repatriation have to be carried out in the case of a hidden profit distribution by a Swiss parent company to its foreign subsidiary in violation of the arm's length principle?
A payment made by a Swiss parent company to one or more of its fully-owned foreign subsidiaries in violation of the arm's length principle does not, in principle, constitute a hidden profit distribution subject to withholding tax under Article 4(1)(b) of the Withholding Tax Act. The FTA does not, in principle, make any secondary adjustments in such cases.
Even if such a payment is subject to a primary adjustment by the competent cantonal tax authority, which may be confirmed by a mutual agreement, there are no withholding tax consequences and no repatriation is therefore necessary, in principle.
A bilateral or multilateral Advance Pricing Agreement (APA) is an arrangement concluded between the competent authorities of two or more States, at the request of the taxpayers, that determines in advance an appropriate set of criteria for the determination of the transfer pricing for intragroup transactions over a fixed period of time. If this agreement is then correctly applied by the taxpayers, there is no hidden profit distribution and therefore no withholding tax consequences.
The question of secondary adjustment may, however, arise in cases where an APA has a retroactive effect, whether it concerns the years covered by a rollback or the years elapsed between the taxpayer's request for an APA and the signing of the APA.
If the retroactivity relates to years that have been closed for accounting purposes, a bilateral APA may provide for the insertion of a repatriation clause (such a clause is only relevant where there are consequences in terms of withholding tax, see previous question). If this repatriation is implemented by the taxpayer, the secondary adjustment will not be made, i.e. the FTA will not levy withholding tax on the hidden profit distribution by the Swiss company to a foreign company. A repatriation clause cannot be included if the APA was opened after a secondary adjustment by the FTA.
If the retroactivity relates to years that have not yet been closed for accounting purposes, the transfer prices determined under the APA are implemented directly by the taxpayer before the accounts are closed. No subsequent repatriation is then necessary.
In the context of APAs with retroactive effect, some foreign competent authorities may sometimes refuse to include the repatriation clause in the APA.
In such a case, when the retroactivity relates to years that have been closed for accounting purposes, withholding tax is levied on the amount of the hidden profit distribution, provided that the material and procedural conditions for its levying are met. The carrying out of a repatriation by the taxpayer does not therefore prevent the levying of withholding tax.
When the retroactivity relates to years that have not yet been closed for accounting purposes, the transfer prices determined within the framework of the APA are directly implemented by the taxpayer before the accounts are closed. In that case, no withholding tax is levied.
A taxpayer who is the subject of a withholding tax adjustment following an audit by the FTA may request the opening of a MAP.
If this secondary adjustment (i.e. withholding tax on a hidden profit distribution) is fully or partially confirmed by the MAP, withholding tax is due on the confirmed adjustment (the usual rules relating to the refund of withholding tax remain applicable). It is not possible to insert a repatriation clause allowing withholding tax to be avoided.
Example: mutual agreement
Company A in Switzerland pays royalties of CHF 50,000 to foreign parent company B, which owns a brand. The FTA makes a secondary adjustment of CHF 20,000, which is subject to withholding tax. The secondary adjustment gave rise to a MAP which, by mutual agreement, sets an arm's length price of CHF 40,000 for the royalties paid by company A to parent company B, partially confirming the secondary adjustment made by the FTA on an amount of CHF 10,000. The withholding tax levied by the FTA on the amount of CHF 10,000 is therefore final.
The levying of withholding tax on a repatriation to a foreign affiliated company outside a mutual agreement or domestic agreement under Article 16 of the Execution of International Tax Treaties Act, is based on domestic law. It does not result in taxation contrary to a double taxation agreement, which is why a MAP cannot be requested.
Contact
Please use the contact form for enquiries and to request a callback. If you would like us to call you back, please select the option ‘Would you like us to call you back?’ on the contact form and briefly describe your matter. Many thanks in advance.
Submit a ruling
To submit a transfer pricing ruling, please use the following email address: transferpricing(at)estv.admin.ch.
Federal Tax Administration FTA
Team Transfer Pricing
Eigerstrasse 65
3003 Berne