In this article, the authors analyse two recentand important developments with regard tointernational corporate tax in Switzerland,namely, the Federal Supreme Court’s decision onthe accounting and tax treatment of exchangedifferences and the improvements to the fiscalenvironment in respect of internal groupfinancing.

1. Federal Supreme Court onTreatment ofExchange Differences1

1.1. Facts and judicial proceedings

Company C domiciled in Geneva prepared its (statu-tory) financial statements in US dollars (the functionalcurrency). Company C primarily dealt in US dollars andhad, therefore, in line with generally accepted account-ing principles (GAAP) selected the US dollar as its func-tional currency. US dollar financial statements must beconverted into Swiss francs at the year-end. This conver-sion resulted in a foreign exchange (forex) gain of CHF4.7 million in the financial year 2001. However, in thefinancial year 2002, the company recorded a forex loss inthe amount of CHF 25 million.

In 2001, the relevant cantonal tax authorities includedthe forex gain in the taxable profits of Company C, but,in 2002, denied the deduction in respect of the forex lossfor income tax purposes. Company C appealed againstthe assessment for the year 2002. The Cantonal TaxAppeal Commission of Geneva (Commission cantonalede recours en matière administrative, previously Commis-sion cantonale de recours en matière d’impôts) acceptedthe deduction of the forex translation loss.

The cantonal tax administration appealed the case to theAdministrative Court of the Canton of Geneva (Tribunaladministratif), which partially adopted the opinion of thetax authorities. Specifically, the Court decided that forextranslation differences, as they reflect only unrealizedincome or losses, should not be considered for incometax purposes. Accordingly, the Court referred the 2001tax assessment back to the tax authorities to exclude theforex translation gain from taxable income.

Company C ultimately filed an appeal with the SwissFederal Supreme Court (Tribunal fédéral). The SupremeCourt largely accepted the position of the cantonal taxauthorities and held that positive as well as negativeforex translation differences should not be considered inthe determination of the taxable income. The 2001assessment was, therefore, returned to the tax authorities

to exclude the forex gain from taxable profit. The 2002assessment, which already excluded the forex translationloss, was confirmed.

1.2. Supreme Court’s findings

The basis for determining the taxable income underSwiss tax law is the financial statements drawn up in linewith commercial law. The income determined undercommercial law is, therefore, primarily relevant forincome tax purposes, unless tax law includes an explicitrule that would require an adjustment for tax purposes.The Supreme Court deliberated on the anticipated andongoing changes with regard to Swiss accounting rules.These changes have the objective of bringing Swissaccounting law closer to international accounting stan-dards, i.e. International Financial Reporting Standards(IFRS) or US GAAP. The Supreme Court also noted thatthe application of Swiss Accounting and Reporting Rec-ommendations, IFRS or similar accounting standards isalready common for a significant number of Swiss-based companies and even mandatory for certain entit-ies being active in specific areas – for example, in theordinance on telecommunications services.Accordingly,it is not unreasonable if the tax authorities take interna-tional accounting standards into account in arriving at asolution with regard to accounting questions.

The financial statements at the year-end must be pre-sented in Swiss francs according to the Swiss Code ofObligations (Swiss commercial law). However, there isno obligation to maintain the books in Swiss francs dur-ing the year. The financial accounts can be kept in anyother currency, generally referred to as the functionalcurrency.

Under these accounting standards, translation differ-ences are recorded in the equity section and not in theprofit and loss account. The Swiss Manual of Auditors,which was referred to by Company C, adopts a differentapproach, depending on whether forex differences arisein the ordinary course of business or are differences aris-ing from the translation of the financial statements (inthe functional currency) to the financial statements pre-

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* PhD (law) and Partner, Ernst &Young, Zurich. The author can be con-tacted at markus-frank.huber@ch.ey.com.

** MAS in Business Law andMaster in Law, andManager, Ernst &Young,Geneva. The author can be contacted at eric.duvoisin@ch.ey.com.

1. Federal Supreme Court, 2nd Chamber of Public Law, Decision No.2C_897/2008 (1 October 2009).

Federal Supreme Court onTreatment ofExchange Differences and Environment forInternal Group Financing Improved

Markus Frank Huber*and Eric Duvoisin**Switzerland

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pared in Swiss francs. Such forex translation differencesmust be separated from conventional exchange differ-ences. The latter arise from transactions undertaken inthe ordinary course of business (in an operational cur-rency that diverges from the functional currency) andmay reflect real gains or losses. In contrast, forex transla-tion differences have nothing to do with the ordinarycourse of business of the company, but, rather, arise fromthe conversion of the accounts from the functional cur-rency into Swiss francs. This is also evidenced by the factthat such forex translation gains or losses are onlyincluded in the financial statements drawn up in thestatutory currency, i.e. Swiss francs, and not in the finan-cial statements prepared in functional currency. On theother hand, exchange differences based on real transac-tions are included in both sets of financial statements.

Swiss tax law and commercial law are silent regardingdifferences arising from forex translations, whereasInternational Accounting Standard (IAS) 21 includesdetailed rules for the translation of financial statementsinto another currency. These rules require that transla-tion differences are recorded in equity and not in theprofit and loss account. The Swiss Manual of Auditorsreferred to by Company C presents a different solutionfor forex translations compared to IAS 21. However, theSwiss Manual of Auditors must, from a legal perspective,be classified as an interpretation of law, i.e. a referenceand its rules are not binding on the tax administration.Accordingly, there are no reasons that prohibit the taxadministration preferring an interpretation which isbased on IFRS.

Company C also argued that there was a similaritybetween forex translation differences and forexexchange differences, as both had an effect on the eco-nomic capacity of an enterprise. The Supreme Courtheld that net income should reflect a real increase orreduction in the values of an enterprise over a certainperiod of time. However, according to the SupremeCourt, forex translation differences do not result in aneffective change in the economic capacity of an enter-prise, but, rather, only represent a mechanical calculationfor accounting purposes. Forex translation differenceshave, therefore, no influence on the economic capacity ofan enterprise and should not be considered for incometax purposes. In contrast, exchange differences arecaused by concrete and realized economic transactionsthat result in an effective change of the financial positionof an enterprise.

It should also be noted that the Supreme Court did notshare the taxpayer’s view that the application of IAS 21would result in a violation of the prudence or imparityprinciples that are cornerstones of Swiss commercial law.

1.3. Comment

This decision is of great importance for Swiss corporatetaxpayers acting in a functional currency environmentother than Swiss francs. In this respect, there is consen-sus that income tax is levied on the basis of the netincome per the statutory accounts stated in Swiss francs,

subject to the following two main reservations: (1)adjustment of the net income per the profit and lossaccount if this is not drawn up in conformity with Swisscommercial law (the commercial correction); and (2)adjustment of the net income per the profit and lossaccount in line with the specific provisions of Swiss taxlaw (the fiscal correction). The authors are of the opinionthat the decision reflects a commercial correction. Tax-payers affected by the Supreme Court’s decision should,therefore, initiate discussions with the relevant statutoryauditors to address the treatment of translation differ-ences.

The authors also consider that the decision itself is far-reaching, as the Supreme Court entirely denied theapplication of the solution per the Swiss Auditors Man-ual, which is usually the reference basis for the interpre-tation of Swiss accounting law, in favour of those pro-vided for by a foreign international accounting standard(for example, IFRS).

Many unanswered questions remain after the SupremeCourt’s decision, including, but not limited to:

(1) Will there be a uniform application of this leadingcase by the tax administration in all of the differentcantons? As the Supreme Court’s decision was givenin respect of federal direct tax, this could theoreti-cally provide leeway to the cantons with regard tothe cantonal and/or communal income tax. Basedon informal soundings, it appears that the cantonsintend to apply the decision on a consistent basis allover Switzerland. At a meeting of 17 June 2010 withall of the federal and cantonal tax representatives,the Forum of the Group of the Tax Authorities dis-cussed the decision. One of the outcomes of thatmeeting should be a draft of a guideline. The draftguideline is supposed to cover the following twomain issues: (a) confirmation that translation differ-ences are not taxable and not deductible for incometax purposes, respectively; and (b) guidance thattranslation differences are to be taken into accountfor annual equity tax purposes. However, no circu-lars or guidelines from the federal and/or cantonaltax authorities are yet available, even in draft ver-sions based on the information available to theauthors.

(2) How are transitional questions to be dealt with? TheSupreme Court’s decision is not helpful regardingsuch questions, for example, in respect of the treat-ment of translation differences included in alreadyfiled, but not finally assessed tax returns and the taxtreatment of Swiss taxpayers benefiting from a taxruling in respect of such translation differences.

(3) What is the effect of the Supreme Court’s decision onthe preparation of audited financial statements? TheSwiss Institute of Certified Accountants and TaxConsultants has continued with the current versionof the Swiss Manual of Auditors (the 2009 version),which in brief states that unrealized translationlosses should be booked in the profit and loss

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account, whilst unrealized translation gains (or atleast most of them) should be accrued in the balancesheet. Consequently, the yet to-be-adopted reform ofthe Swiss accounting law,which more widely author-izes reference to international accounting standards,will have a key role in the future.

(4) What is the treatment of the translation differencefor (cantonal and/or communal) annual capital taxpurposes? According to an unpublished practice, theGeneva tax authorities have indicated that, for can-tonal and/or communal annual capital tax purposes,translation differences should be fully taken intoaccount. As noted in (1), the Forum of the Group ofthe Tax Authorities should follow the approach ofthe Geneva tax authority in this respect.

(5) What will be the prospective application of theSupreme Court’s decision? The decision has givenrise to some uncertainty in this respect. For instance,it is not known which solution should be applied bytax authorities should the IFRS be amended withregard to translation differences.

2. Fiscal Environment for Internal GroupFinancing

2.1. Background and details of the changes

Whilst interest payments on loans payable by a Swissborrower are generally not subject to Swiss withholdingtax, a Swiss borrower may, nevertheless, be subject towithholding tax if a legal entity borrows (by way of loanagreement or by accepting monies on current accounts)from more than 10 to 20 non-bank lenders and theaggregate amount exceeds CHF 500,000.2 Exceeding thisthreshold could mean that, in the case of loan agree-ments where they are issued simultaneously to raisefunds and the conditions are exactly the same and thenumber of non-bank lenders exceeds 10, the loan may beclassified as a bond.Accordingly, the interest paid wouldbe subject to withholding tax. A similar reclassificationas a bond may arise if the total amount exceeds CHF500,000 and the loan agreements are issued on a contin-uing basis and contain similar conditions and the num-ber of non-bank lenders exceeds 20. Again, the interestpaid would be subject to withholding. Last but not least,an entity may be classified as a “bank” within the mean-ing of the withholding tax law if the entity borrows on acontinuing basis from more than 20 non-bank lendersgenerally by way of current accounts and the totalamount borrowed exceeds CHF 500,000. In this case, allof the interest paid to non-bank lenders would be subjectto the 35% withholding tax. These rules were perceivedto be burdensome and a hindrance particularly withinthe context of internal group financing, such as cashpooling arrangements or intra-group loans.

Consequently, there were numerous proposals at a polit-ical level to abolish the rules and to institute a more prac-tical approach to group financing activities. Theapproved revision of the withholding and stamp taxordinances implies that, from 1 August 2010, most inter-

est payments on loan agreements or current accountrelationships between companies pertaining to the samegroup of companies (meaning all companies that mustbe fully consolidated according to GAAP) should nolonger be subject to withholding tax.3

2.2. Comment

The new regulation improves the fiscal environment forinternal group financing activities, of which predomi-nantly small and medium-sized Swiss group companieswith central cash management as well as foreign groupssearching for an attractive cash management sitetogether with low tax rates may benefit.

The amendment, however, includes a significant caveat.The new rules do not apply to groups in which a Swissgroup entity guarantees a bond issued by a foreign groupcompany. Accordingly, internal group financing activitywith more than 20 group entities may, de facto, be diffi-cult to achieve for such groups. The intent behind thecaveat is to avoid the situation that, in each case, the taxauthorities must trace the source of the funds (i.e. group-internal funds as opposed to funds derived from thirdparties by way of the bond guaranteed by one of theSwiss entities). If a Swiss company guarantees a bond ordebenture issued by an affiliated foreign company, suchthat the bond is not deemed to be issued by the Swissentity providing the guarantee, the funds raised may notbe diverted to a Swiss entity. Because of this, the taxauthorities regard themselves as unable to scrutinize andaudit as to whether or not some of the proceeds from aforeign-issued bond have been remitted to and used inSwitzerland. This could be deemed to be tax avoidance.

Based on the new provisions in the law, it is not clearhow, or, more precisely, for how long after the guarantee,these restrictions would apply should a Swiss groupentity have previously guaranteed a bond issued by a for-eign group company. It may, however, be assumed that assoon as the Swiss group entity no longer guarantees abond issued by a foreign group company, the restrictionshould be lifted. Overall, the new regulation should bewelcomed by all groups carrying out, or interested inundertaking, intra-group financing activities in Switzer-land.

3. Conclusions

The decision of the Swiss Supreme Court regardingforex translation differences will primarily adverselyaffect international trading groups based inSwitzerland – not only because it will increase theiroverall Swiss tax liabilities, but also because theapplication of the court decision will give rise tomajor legal uncertainty.Accordingly, the authorsadvocate a swift reaction from tax authorities to

Federal Supreme Court on Treatment of Exchange Differences and Environment for Internal Group Financing Improved

115© IBFD BULLETIN FOR INTERNATIONALTAXATION FEBRUARY 2011

2. Circulars Nos. S-02.122.1 (4.99) and S-02.122.2 (4.99) issued by the fed-eral tax administration (April 1999).

3. Art. 14a Withholding Tax Act.

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mitigate the effects of the court decision by way ofpublished practices.

With regard to the improvement of Swiss tax rules oninternal group financing, the authors trust that this lawamendment will be positively received byinternational groups seeking a location to set up afinance company or even by those groups that already

have a Swiss finance company.Whilst the new lawprovisions remove some obstacles, the caveat in thelaw, whereby a Swiss group entity guarantees a bondissued by a foreign group company, will be a costlyadministrative burden not only because it will have tobe monitored upfront by any Swiss financingstructure, but also on a regular basis throughout thelife of the Swiss financing scheme.

Markus Frank Huber and Eric Duvoisin

116 BULLETIN FOR INTERNATIONALTAXATION FEBRUARY 2011 © IBFD

Cumulative Index

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