Tax domicile of legal entities – not always so clear
It is not always clear, where the primary tax domicile of a legal entity is. This question, however, can have great significance in the light of the considerable differences in taxation levels between cantons or jurisdictions.
Tax domicile of legal entities – not always so clear
In Switzerland, legal entities are subject to unlimited taxation in the canton in which they have their legal seat or place of effective management (primary tax domicile). These two alternative nexuses can lead to situations in which it is not clear which canton or jurisdiction can claim the right to unlimited taxation of a legal entity – a question which can have great significance in the light of the considerable differences in taxation levels between cantons or jurisdictions.
I. Unlimited right to tax
Under Switzerland's national as well as international tax law, a legal entity is subject to unlimited taxation in Switzerland, if its legal seat (place of incorporation) or its place of effective management is in Switzerland (personal nexus).
a) Inter-cantonal tax law
According to Swiss law, where a legal entity's seat and its place of effective management are in different cantons, and therefore more than one canton claims a right to unlimited taxation, the resulting conflict has to be resolved pursuant to the rules concerning the constitutional prohibition of the inter-cantonal double taxation.
In its decision 2C_627/2017 of 1 February 2019, the Swiss Supreme Court for the first time ruled that in such cases a legal entity's primary tax domicile and accordingly also the place of unlimited taxation, will always and exclusively be the place of effective management.
b) International tax law
Under international tax law, residency conflicts have to be resolved based on the applicable double taxation treaty. In Switzerland's double taxation treaties, the conflict is usually resolved in favor of the place of effective management, if two jurisdictions claim an unlimited taxation right.
2. Place of effective management under Swiss inter-cantonal tax law
According to the jurisprudence of the Swiss Supreme Court, a legal entity's place of effective management is where its economic and effective interests are focused. The decisive question is therefore, where the usual business – in line with the entity's business purpose, is run. If the business is run from more than one place, it is crucial where the entity's management is carried out predominantly. The term «effective management» refers to the place where key management decisions which are necessary for the conduct of the entity's business are made in substance. «Effective management» needs to be distinguished from mere administrative tasks on the one hand and from activities carried out by the most senior persons on the other, as long as these are limited to controlling the effective management and making fundamental decisions only. The place where the board of directors' meetings are held is of minor importance only. Equally, the places, where general assemblies are held or the shareholders reside is not decisive. Nevertheless, the residency of the person who is in charge of the effective management can play an important role, if the effective management is essentially performed by one person in various places, without the legal entity having a fixed place of business or its own staff. Such constellations have to be considered carefully, even if the managing person's place of residence should only ever be decisive, if no other place of effective management, at which the necessary tasks are regularly carried out, can be proven.
3. Burden of proof
As a general rule, the tax authority claiming a right to taxation has to prove the facts for such taxation right. Therefore, the tax authority claiming a right to unlimited taxation has to demonstrate and prove that a legal entity meets the requirements for unlimited taxation.
To prove a legal entity's legal seat, the respective entry in the commercial register is sufficient.
If the cantonal tax authorities claim their right to unlimited taxation based on a legal entity's place of effective management, however, they have to demonstrate the circumstances based on which they conclude that a legal entity's seat is of a formal nature only and not the place where the effective management is carried out.
4. Limited right to tax
If the cantonal tax authorities do not succeed in demonstrating that an entity's place of effective management is in their canton, it can still claim a right to limited taxation based on an economic link, such as a permanent establishment or a fixed place of business.
Depending on the factors to be allocated to such a permanent establishment or fixed place of business, the canton of the secondary tax domicile with its limited right to tax may nevertheless get to tax a predominant part of the profit and capital of a tax payer.
II. Remarks on procedural law
To appeal against a case of inter-cantonal double taxation at the Supreme Court, it is not necessary for the entity to obtain decisions from the highest cantonal courts of both cantons claiming a right to tax – one such decision from the highest cantonal court is sufficient to appeal against the tax assessments of both cantons.
However, a legal entity has to ensure that it does not forfeit its right to appeal against a final cantonal tax assessment. If a legal entity, knowing of the conflicting tax claim of another canton, submits to a tax assessment without reservations, it may forfeit its right to appeal against this tax assessment. In particular, this is the case if it files a tax return in such canton without reservation, pays tax bills without reservation and does not appeal or take any legal remedies against the tax assessment.
Further, an entity forfeits its right to appeal if it acts in bad faith, i.e. if it knows about a conflicting tax claim of another canton and still does not mention this in the tax return. Such behavior may lead to effective double taxation.
With tax rates being lowered as a result of the corporate tax reform adopted last year and tax revenue expected to decline in the wake of the economic downturn caused by the Covid-pandemic, it may be expected that cantonal tax administrations will try to find ways to intensify their efforts to claim a right to (un)limited taxation in the future.
Planning management capacities and reviewing operational activities can help to avoid unpleasant tax repercussions.
If you have questions regarding your tax domicile, our tax team will be happy to support you.