Navigating transfer pricing regulations in Switzerland: key insights for 2024

Transfer pricing refers to the pricing of transactions between associated enterprises within multinational groups. It covers transactions involving goods, services, intangible assets, and financial arrangements. As multinational groups play an ever-increasing role in the global economy, transfer pricing has become one of the most significant issues in international tax law.

In Switzerland, the principle of separate entity taxation applies, meaning each company within a group is treated as a separate taxpayer, and its profits are taxed individually. Underthis principle, the prices set for transactions between associated entities must comply with the arm’s length principle (“principle de pleine concurrence”).This principle requires that inter-company transactions follow the same terms that would be agreed upon between independent entities. Failing to comply can have significant tax implications, including tax adjustments and penalties.

This newsletter provides a comprehensive look at Swiss transfer pricing regulations, including the legal framework, relevant jurisprudence, administrative circulars, and practical guidance on how to ensure compliance.

I.   Legal framework and sources

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a.      International legal basis

The arm’s length principle is enshrined in Article 9 of the OECD Model Tax Convention (“MC-OCDE”).This principle has been adopted by Switzerland through its numerous Double Taxation Agreements (“DTAs”) and is reflected in the OECD Transfer Pricing Guidelines (2022 edition). Although these guidelines are not legally binding, Swiss tax authorities frequently rely on them for guidance, and Swiss courts often refer to them in judgments, as evidenced by rulings from the Swiss Federal Court (ATF 140 II 88 and ATF 143 II185).

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b.     Swiss legal basis

Swiss domestic law does not contain specific provisions exclusively governing transfer pricing. Instead, the arm’s length principle is applied indirectly through several key articles:

·       Article 58(1) of the Federal Direct Tax Act of 14 December 1990 (“LIFD”) and Article 24(1)  of the Federal Act on the Harmonization of Direct Taxes of 14 December 1990 (“LHID”)govern the taxation of profits.

·       Article 4(1)(b)  of the Federal Withholding Tax Act 13 October 1965 (“LIA”) addresses withholding tax.

These provisions allow Swiss tax authorities to adjust profits if the prices set for inter-company transactions are found not to adhere to the arm’s length principle. In cases where remuneration is deemed excessive or insufficient between related parties, Swiss tax authorities may reclassify such transactions as hidden profit distributions or capital contributions, with serious tax consequences.

Furthermore, Swiss tax authorities rely on various administrative circulars, including:

·       Circular No. 4 (2004) – Provides guidance on the taxation of service companies and stresses the importance of adhering to OECD principles.

·       Letter-Circular No. 203 (2023) – Specifies safe harbor interest rates for loans and advances in Swiss francs.

·       Circular No. 6 (1997) – Addresses hidden equity and its implications for corporate tax.

Non-compliance with these circulars creates a rebuttable presumption that the arm’s length principle has not been respected.

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II.  The Arm’s Length Principle in practice - Key concepts and consequences of non-compliance

At its core, the arm’s length principle aims to ensure that the pricing of transactions between associated enterprises reflects the conditions that would prevail between independent entities in a comparable transaction. Swiss tax law follows the OECD’s approach, treating each company as a separate taxpayer within a multinational group.

If Swiss tax authorities determine that transfer prices deviate from this standard, they may adjust taxable profits. Adjustments commonly occur in the following areas:

·       Corporate profit tax: Excessive or insufficient remuneration between related entities can be reclassified as hidden profit distributions or hidden capital contributions under Article 58(1) LIFD and Article 24(1) LHID, leading to profit adjustments.

·       Withholding Tax: In cases where a Swiss subsidiary pays excessive remuneration to its foreign parent company, the excessive portion may be treated as a monetary benefit and subjected to withholding tax under Article4(1)(b) LIA.

For instance, the Swiss Federal Court has affirmed that Swiss tax authorities may adjust profits if they identify disguised distributions to shareholders or related parties abroad (TF 2C_177/2016).

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III.   Transfer pricing methods

To ensure compliance with the arm’s length principle, Swiss companies must adopt an appropriate transfer pricing method based on the specifics of the transaction. The OECD’s Transfer Pricing Guidelines outline various methods that Swiss authorities recognize, including:

·       Comparable uncontrolled price method: This method compares the price of a controlled transaction with that of a similar transaction between independent entities. It is most applicable when there are identical or highly similar transactions.

·       Resale price method: Typically used for distribution entities, this method starts with the price at which a product is sold to an independent party, deducting an appropriate gross margin to arrive at the arm’s length price.

·       Cost-Plus method: Commonly used for manufacturers or service providers, this method adds an appropriate profit margin to the costs incurred by the supplier of goods or services.

·       Margin method: This method compares the net profit margins obtained in controlled transactions to those achieved by independent companies incomparable transactions. It is frequently used in practice due to the availability of public data.

·       Profit split method: This method is applied when the parties to a transaction contribute unique and valuable intangible assets. Profits are split based on each party's contribution, which would reflect the allocation between independent parties.

Swiss tax authorities evaluate these methods based on the specific circumstances of each case. They may also request adjustments when discrepancies arise, such as when insufficient comparability exists between the tested transaction and independent benchmarks (Principes de l’OCDE, § 3.47).

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IV.   Documentation requirements

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Although Swiss law does not mandate specific transfer pricing documentation, companies are required to cooperate with tax authorities under Article 126 LIFD and Article 39 LIA. This obligation includes providing documentation that demonstrates adherence to the arm’s length principle when requested.

Inline with the OECD’s three-tiered documentation approach, Swiss companies are encouraged to maintain:

·       Master File: Provides an overview of the multinational group’s global business, including its transfer pricing policy.

·       Local File: Focuses on specific intra-group transactions relevant to the local entity.

·       Country-by-Country Reporting : Applies to multinational groups with consolidated revenues exceeding CHF 900 million, requiring the submission of aggregated financial data to Swiss tax authorities.

Failure to provide adequate documentation can result in penalties or tax reassessments, and Swiss authorities may make adjustments based on available information.

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V.     Procedural aspects and dispute resolution

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Swiss companies facing transfer pricing audits or disputes can seek advance certainty by obtaining rulings or entering into Advance Pricing Agreements (“APAs”).

·       Rulings: These are binding confirmations from tax authorities regarding the tax treatment of specific transactions. They ensure that planned inter-company transactions comply with the arm’s length principle. Swiss cantonal authorities handle rulings related to profit tax, while the Federal Tax Administration (AFC) deals with withholding tax rulings.

·       APAs: These bilateral or multilateral agreements, negotiated by the Swiss State Secretariat for International Financial Matters, provide preemptive clarity on transfer pricing arrangements, ensuring compliance with international tax standards across multiple jurisdictions.

In the event of a dispute over transfer pricing, Swiss companies may request a Mutual Agreement Procedure under the relevant DTA or OECD guidelines. This allows tax authorities to resolve transfer pricing disputes and avoid double taxation.

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VI.    Conclusion: ensuring compliance and avoiding risk

The arm’s length principle serves as the cornerstone of Switzerland’s transfer pricing regulations, and compliance is non-negotiable. With the increasing scrutiny of multinational transactions, proper documentation, the selection of appropriate pricing methods, and the use of rulings or APAs are essential strategies for mitigating risks.

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