Pitfalls for start-ups

Nowadays, anyone with an innovative business idea with great growth potential founds a start-up. Most young entrepreneurs prioritise the development of markets, the scaling of their business model and the financing of growth in the initial phase. Tax issues are often ignored. As a result, decisive decisions are made early on that have consequences for the success of their vision, unfortunately not always positive ones.

It starts with the choice of legal form: because many company founders sell shares after successfully establishing their business, it is advisable to give the company the legal framework of a corporation - either an AG or GmbH - from the outset. This is because capital gains from the sale of shares in an AG or GmbH from private assets are generally tax-free in Switzerland. In contrast, the profit from the sale of sole proprietorships or partnerships is taxable as income from self-employment and is also subject to social security contributions.

In the initial phase, start-ups operate at a loss due to low revenue and high expenses. They can offset these against future profits for tax purposes. However, the possibility of offsetting tax losses is limited to seven years, which can be disadvantageous for start-ups with a long start-up phase.

Companies based in Switzerland become liable for VAT from an annual turnover of CHF 100,000 from not excluded supplies of good and services. Few start-ups reach this threshold right from the start, but they can voluntarily register for VAT. This is advantageous if many goods and services are purchased on which VAT is paid. In this case, the VAT paid can be claimed as input tax.

The financing round costs

Growth needs to be financed. Most start-ups are initially unable to finance themselves from their own resources and are therefore dependent on external funding. Banks and investors can step in and grant the start-up loans. The latter also often participate directly in the start-up by subscribing shares as part of a capital increase, for example. However, tax consequences must also be considered when choosing the most favourable financing option.

In certain cases, loans can be classified as bonds for tax purposes by applying the 10/20 non-bank rules. Withholding tax of 35 per cent is then owed on the interest payments. Nevertheless, investors from Switzerland can generally reclaim the withholding tax in full, but for foreign investors this only applies partially or not at all, depending on the country. It is therefore more complicated for local start-ups to obtain foreign debt capital.

One alternative is equity financing, but this does not come for free either. If new capital is created as part of the foundation or capital increase of a Swiss start-up in the form of an AG or GmbH, or if it receives subsidies from the direct owners, the issuance stamp duty of 1 per cent is generally due.

The capital created on the occasion of the foundation and further capital increases is exempt up to the first million francs. The company whose equity is increased is liable for the issuance stamp duty.

Tax consequences after the exit

Sooner or later, the sale of a successful start-up is an issue. This also raises tax questions. For instance, the tax-free capital gain on sales from private assets can be limited in certain situations, contrary to the principle.

To give an example, if start-up founders sell their shares from their private assets and the start-up has at the time of the sale distributable and non-operating funds, an indirect partial liquidation may occur for tax purposes within five years of the sale if certain conditions are met. For sellers, this results in a reclassification of tax-free capital gains as taxable investment income. A corresponding indemnity clause in the purchase agreement can protect the seller from the financial consequences of such an indirect partial liquidation.

Furthermore, there may be tax consequences for the sellers of a start-up if purchase price payments are linked to their continued employment. Such provisions in the purchase agreement are intended to ensure that the network and expertise remain with the start-up for a long time. As a result, such payments can be regarded as taxable income, which leads to high follow-up costs.