Implications of European Union Law on Swiss (direct) taxation - a “TOUR D’HORIZON”

Dr. J. Kläser, MLaw1

1. Some personal thoughts

The author of this contribution came to Maastricht to study at the university’s faculty of law in 2009. One of his first memories of that time is a lecture on international tax law held by Professor Rainer Prokisch. Professor Prokisch entered the room and, rather surprisingly, he had not immediately in mind to lecture on this day’s class topic, which – as far as the author can remember – was about “treaty shopping”. Instead, Professor Prokisch was eager first to get to know his new students, their various personalities, and their cultural as well as educational backgrounds. Professor Prokisch’s intention was obviously to start building a personal relationship with each of his new students before diving into the deep waters of tax law.

Professor Prokisch is curious about humans and students in particular. For Professor Prokisch, it has always been of particular importance to establish a personal and convenient atmosphere in which students can learn and grow. Aside from these extraordinary social capacities, Professor Prokisch is a living encyclopedia in tax law and his opinion on tax law matters; moreover, he has been recognised by scholars and practitioners worldwide for decades.

The author of this contribution for the honour of Professor Prokisch is grateful that he had the opportunity to be his student during his Master of Laws studies which enabled the author to extend his horizon in tax law and also to grow personally.

The author’s subsequent contribution seeks to provide a high-level overview of the various implications of European Union (EU) law on Swiss taxation.2 Several fields of expertise related to tax law are covered by this contribution in which Professor Rainer Prokisch has held an expert role during the last decades, such as EU law, public international law, constitutional law and administrative law.

2. General introduction

The sovereignty of states is anchored, amongst other things, by their competence to levy taxes on their own. Although, from a high-level point of view, the Swiss Confederation’s national tax sovereignty may appear to be more set-in-stone than is the case for EU Member States today, there are nevertheless numerous implications of the EU’s normative legal system on the Swiss Confederation. Finally, as a result of Switzerland’s failed accession to the European Economic Area (EEA) in 1992, the Swiss Confederation has been subject to an “integration without membership”.3

3. EU Law and Swiss taxation

3.1 Acquis bilatéral

3.1.1 Introduction

The acquis bilatéral between Switzerland and the EU and its member states is relatively comprehensive and consists of more than 100 agreements, of which some have been amended or replaced by protocols since those agreements were signed. This acquis bilatéral also covers tax matters, outlined prima facie hereinafter.

Concerning questions of validity, applicability, precedence and interpretation of the agreements between Switzerland and the EU, the principles of international law of the Vienna Convention on the Law of Treaties must always be taken into account.

In the summer of 2021, the latest attempt on negotiations on an institutional framework agreement between Switzerland and the EU, that should have led to some sort of legal umbrella function for governing the bilateral relation, failed. In essence, such an agreement would have fundamentally changed EU-Swiss relations. In relation to market access agreements, it would have introduced the dynamic adoption of developments in EU law in the Swiss legal order. It would also have established a dispute settlement mechanism enabling both parties to refer disputes to an arbitration panel. The Court of Justice of the European Union (CJEU) would have been involved in all matters pertaining to the interpretation of EU law. At present, such framework agreement has no majority in Switzerland and would very likely be rejected amongst Swiss citizens having the final say on its adoption.4

3.1.2 Free Trade Agreement

The Free Trade Agreement (FTA)5 of 1972 liberalises trade with industrial products. The agreement also stipulates a ban on subsidies (Art. 23 (1) (iii) FTA). However, the scope of this subsidy provision appears to be rather limited. The wording is very similar to the state aid provision in the Treaty on the Functioning of the European Union (TFEU)6, but the scope of the FTA is obviously not comparable. According to Art. 2 FTA, the scope refers to originating products. The European Commission nevertheless sought to invoke the FTA to persuade Switzerland to abandon its cantonal company status tax regimes.

As we know today, the European Commission’s reasoning was odd since the concerned companies were not allowed to perform any business activity in Switzerland or only a subordinate one, and their activity was generally restricted to the provision of services, including financing activities, administration of participations, and licensing, and to trading activities on foreign territories. Regardless, the EU’s political powerplay was successful, and the Swiss Confederation has abolished its preferential cantonal company tax regime.

Following from the foregoing, it is true to state that the European Commission’s state aid control de facto has an indirect effect on Swiss tax matters, although this occurs obviously without a binding legal basis.7 De jure, though, the impetus of the FTA on Swiss direct taxation is only a theoretical one.

3.1.3 Free Movement of Persons Agreement

3.1.3.1 Introduction

Perhaps the most crucial agreement of the acquis bilatéral is the Free Movement of Persons Agreement (FMPA)8 , which guarantees Swiss and EU citizens the right of entry, residence, access to work as an employed and self-employed person and the right to stay in the other contracting party’s territory. It has opened up the contracting parties’ labour markets.9

Unlike under the TFEU provisions, the right to free movement laid down in the FMPA is exclusively connected with economic conditions, i.e., in particular gainful employment. The FMPA imposes restrictions on the contracting parties’ (i.e., EU member states and the Swiss Confederation) domestic tax system. According to Art. 9 para. 2 Annex I FMPA, persons falling within the personal scope of the agreement are to be granted the same tax privileges as domestic persons.

3.1.3.2 Free Movement of Workers (Art. 9 Annex I FMPA)

The FMPA initially regulates the free movement of workers between the contracting parties. Accordingly, the acquis communautaire, according to Art. 45 TFEU is laid down in Art. 9 Annex I FMPA. Equal treatment in terms of employment and working conditions shall be guaranteed for foreign employees who fall within the scope of the FMPA.

From a Swiss tax law perspective, the free movement of workers and the equal treatment requirement under Art. 9 Annex I FMPA are primarily targeting the special Swiss source tax system for income from employment, which includes an exception to the ordinary tax system of self-declaration for income from employment.10

3.1.3.3 Non-Discrimination (Art. 2 FMPA)

The general non-discrimination clause set forth in Art. 2 FMPA shall be triggered provided neither the free movement of workers (Art. 9 para. 1 Annex I FMPA), the freedom of establishment for self-employed persons (Art. 15 Annex I FMPA) nor the freedom to provide services (Art. 19 Annex I FMPA) can be relied on. As a result, it can be held that the general non-discrimination clause is of very limited importance for Swiss tax matters. The ultima ratio clause appears to be of a rather theoretic nature. A non-employed person, for example, or a retired person could refer to this default provision within the FMPA.

3.1.3.4 Freedom of Establishment for Self-Employed Persons (Art. 15 Annex I FMPA)

Freedom of establishment for self-employed persons is stipulated in Art. 15 Annex I FMPA. Self-employed persons shall receive treatment in the host country with respect to access to and exercise of their self-employment activity that is no less favourable than would have been granted to its own nationals. Legal persons are precluded from this provision (Art. 12 para. 1 Annex I FMPA).

3.1.3.5 Freedom of Services (Art. 19 Annex I FMPA)

The freedom to provide services as laid down in Art. 19 Annex I FMPA applies to both individuals (i.e., cross-border services) and legal persons (i.e., secondment of employees). The freedom to provide services is limited to a temporary stay of up to 90 days.11 The freedom to provide services provision has obviously no particular significance in direct matters within the relationship between the Swiss Confederation and the EU. Due to the temporary limitation of the freedom to provide services under the FMPA, no discrimination in tax matters should occur.12

3.1.4 Exchange of Information Agreement

Switzerland and the EU have signed an agreement regarding the automatic exchange of bank information in tax matters on 27 May 2015.13 Accordingly, the OECD’s global standard on the Automatic Exchange of Information has been included in the new agreement. In formal legal terms, the signed agreement is a protocol of amendment to replace the taxation of savings agreement between Switzerland and the EU that had been in force since 2005.14^,15 However, it still includes the existing withholding tax exemption for cross-border payments of dividends, interest, and royalties between related entities that is comparable to the Parent-Subsidiary Directive.16

3.2 Selected Court Cases

3.2.1 Court of Justice of the European Union

3.2.1.1 Grimme17

Grimme, a German national and resident of Switzerland, was the director of a branch established in Germany. The company had its registered office located in Switzerland. Grimme asked the Deutsche Angestellten‑Krankenkasse to assess the status of his activity in the German branch from the perspective of social security law. The Deutsche Angestellten-Krankenkasse was of the opinion that, with regard to his activity in the German branch, Grimme was obliged to join the German statutory pension insurance scheme. With regard to the effects of the FMPA on the membership of Grimme as an applicant in the main proceedings of the German statutory pension insurance scheme, the CJEU had to assess (i) whether the FMPA guarantees a right to freedom of establishment not just to individuals but also to legal persons formed in accordance with the law of a Member State or of Swiss law and having their registered office, central administration, or principal place of business within the territory of a contracting party. Furthermore, the CJEU had to establish (ii) whether the applicant in the main proceedings can recall any rights from the provisions of the FMPA on the freedom to provide services and, finally, (iii) the CJEU had to examine whether compulsory membership of the German statuary pension scheme prejudices the equal treatment of the applicant in the main proceedings in his capacity as an employee.

As already stated above18, the CJEU held that it could not be argued that legal persons are granted the same right of establishment as individuals under the FMPA. In terms of the freedom to provide services provision under the FMPA, the CJEU stated that the applicant could not derive any rights from that provision since, in the case at hand, the actual work necessarily exceeded the 90 days threshold of actual work in a calendar year. Lastly, the CJEU judged that it follows from the facts that Grimme is a German national and carries out his activity as an employee for the German branch. Therefore, the present case cannot be a matter of discrimination by the authorities of a contracting party against a national of another contracting party.

Though the CJEU ruling in the Grimme case does not relate to a tax dispute, it is of importance to understand the CJEU’s interpretation of the acquis bilatéral and its steady progress. In the Grimme case, the CJEU apparently still assumed a rather limited scope of application of the FMPA. A national of a contracting party (e.g. from Germany) residing in another contracting party (e.g. Switzerland) who is treated unequally by his home state in relation to hisplace of residence could not invoke the protection of the FMPA at this point in time.

3.2.1.2 Ettwein19

The German Ettwein couple both held the German nationality, pursued an independent professional activity and earned all their income in Germany. On 1 August 2007, they moved their residence to Switzerland and continued to pursue their professional activity in Germany and to earn almost all their income in Germany. In the following, the Finanzamt Konstanz refused the application of the preferential German splitting regime for spouses, arguing that due to the couple’s personal and family situation, it was not applicable because their residence was neither in Germany nor in one of the EU Member States, nor in a state which is a party to the EEA Agreement. Thus, the spouses were placed under a separate taxation regime.

The CJEU was asked whether the refusal by the German tax authorities to grant Mr. and Mrs. Ettwein the benefit of the splitting regime on the sole ground that they resided in Switzerland was compatible with the provisions of the FMPA. The CJEU judged that the FMPA must be interpreted as precluding German tax legislation that refuses the benefit of joint taxation by the ‘splitting’ method on the sole ground that their residence is situated in the territory of the Swiss Confederation. The FMPA had been considered applicable since Mr. and Mrs. Ettwein were nationals of a contracting party to the FMPA and resident in the territory of another contracting party, namely the Swiss Confederation, and they pursued a self-employed activity in the territory of the other contracting party, i.e., Germany.

By their judgement, the CJEU has obviously moderately adjusted its initial position as laid down in the Grimme judgment. Now the prohibition of discrimination under the FMPA may also be interpreted inversely. Unsurprisingly, the FMPA applies mutatis mutandis to self-employed cross-border commuters since Art. 15 para. 2 Annex I FMPA stipulates precisely this.

3.2.1.3 Bukovansky20

Bukovansky, holding both the Czecht and German nationality, lived in Germany from 1969 until July 2008. From January 1999 to February 2006, he worked in Switzerland, where he was employed by a number of companies belonging to the Novartis Group. At that time, he was subject to income tax in his state of residence, namely Germany. In 2006, Bukovansky was transferred by his Swiss employer, as part of a transfer agreement, to a subsidiary of the Novartis group established in Germany. In 2008, Bukovansky, while continuing to work for a German subsidiary of the Novartis group, transferred his place of residence to Switzerland. In his 2008 income tax declaration, he assumed that, for the period during which he had been resident in Switzerland, namely from August to December 2008, he was, pursuant to Art. 15 lit. a para. 1 of the German-Swiss Double Tax Agreement, subject to tax in Switzerland as a ‘reverse’ frontier worker. The German competent tax administration, however, took the view that the income in question had to be subject to taxation in Germany for the entire tax year 2008.

The referring court asked the CJEU, in essence, whether the principles of non-discrimination and equal treatment, set out in Art. 2 Annex I FMPA, must be interpreted as precluding a bilateral agreement on double taxation, such as the German-Swiss Agreement, under which the right to tax employment income of a German taxpayer who does not have the Swiss nationality is vested in the state where the income originates (Germany), although he has transferred his residence from Germany to Switzerland whilst retaining his place of employment in Germany, whereas the right to tax employment income of a Swiss national who is in an analogous situation is vested in the new state of residence (Switzerland).

The CJEU held that in comparison with taxable persons residing in Germany, Bukovansky suffered no tax disadvantage and there would be no reason to conclude that there is discrimination resulting from unequal treatment contrary the FMPA as laid down in Art. 2 of the FMPA. Furthermore, the FMPA must be interpreted as not precluding a bilateral agreement on double taxation, such as the German-Swiss Agreement, under which the power to tax the employment income of a German taxpayer who does not have the Swiss nationality is vested in Germany as the state where the income originates, although he has transferred his residence from Germany to Switzerland, even though the power to tax the employment income of a Swiss national who is in an analogous situation is vested in the new state of residence, in this case, the Swiss Confederation.

Although the reserved position of the CJEU concerning tax allocation rules under a double tax convention is consistent, inter alia in light of its judgements in Gilly21 and Renneberg22, it can still be regarded critical whether such protective measures, as those ones that are covered under the Swiss-German double taxation agreement for German nationals, are not at offence of the FMPA. Furthermore, we learnt from the Ettwein-Case t hat the prohibition of discrimination under the FMPA can also be interpreted inversely.23

3.2.2 Swiss Federal Supreme Court

3.2.2.1 Taxation at Source Case I, BGE 136 II 241

In its well-known Geneva taxation at source judgement, the Swiss Federal Supreme Court ruled down the rules for persons not resident in Switzerland (so-called non-residents).24 Precisely, the case concerned a cross-border commuter who was resident in France with Swiss citizenship. Due to his economic affiliation, the Swiss national was subject to limited taxation in Switzerland, i.e. taxation at source on the income of employment from Swiss sources. The appellant had claimed various deductions in the respective years, some of which were granted to him by the administration and some of which were denied, which in his opinion represented a violation of the FMPA. 

The Federal Supreme Court judged that the complaint was justified in view of the FMPA. Accordingly, taxpayers who qualify as quasi-residents can apply for tax deductions not taken into account in the source taxation tariffs.25 The judgment ultimately led to a legislative revision of the Swiss source taxation regime in terms of income from employment in the meantime (see more details hereinafter).

3.2.2.2 Taxation at Source Case II, BGE 140 II 167

The Swiss federal judges had to assess whether an unequal treatment was compatible with the FMPA in the case of a foreign employee who qualified for the source taxation regime for taxpayers with personal affiliation (i.e. residence in Switzerland). In more concrete terms, the foreign employee transferred his tax domicile from one canton to another canton, which resulted in a pro rata temporis apportionment between the two concerned cantons.

The appellant argued that this special rule led to a less favourable treatment than for ordinary taxed residents as it is applicable for Swiss citizens and persons with a specific Swiss long-term residency permit. Whilst the Swiss Federal Supreme Court in Lausanne considered the source taxation procedure in principle permissible for administrative reasons, a discrimination that is incompatible with the FMPA was still recognised, insofar as the special source taxation provisions result in higher taxation. The federal judgment got transposed into domestic tax laws by means of the legislative revision of the Swiss source taxation regime (see more details hereinafter).   

4. Recent amendments of the Swiss Taxation at Source Regime26

To achieve FMPA compatibility, new rules have entered into force in 2021 for the taxation at source of employment income for individuals that are non-residents of Switzerland, or residents of Switzerland but who have no Swiss citizenship, (long-term residency) C permit, or resident spouses with a Swiss citizenship or C permit.27^,28

For Swiss residents subject to taxation at source, a mandatory subsequent ordinary assessment is carried out if they have a gross income from employment of at least CHF 120,000 or other taxable income of at least CHF 3,000 in a tax year. Such mandatory subsequent ordinary assessment also takes place if their taxable assets for wealth tax purposes at the end of the tax year or tax period amount to at least CHF 150,000. It should be noted that the subsequent ordinary assessment applies until the end of the taxpayer’s tax liability. It is not optional.29

For persons without personal affiliation, the so-called “quasi-residence” concept has been implemented in Swiss tax law. Anyone without a tax residence or domicile in Switzerland who generates a large part of his income may fulfil the requirements for so-called “quasi-residency”. These taxpayers can now demand voluntarily for a subsequent ordinary assessment. The decisive threshold should amount to at least 90% of the taxpayer’s worldwide gross income, which must be taxable in Switzerland as the country of employment.30

In all cases of a subsequent ordinary tax assessment, the effective date principle applies. This means that the canton in which the person taxed at source is domiciled or resident at the end of the tax period is competent to carry out the respective tax assessment.31

5. Final Word

Although, the Swiss Confederation has its own competence in terms of direct taxation matters vis-à-vis the EU and its member states, the Swiss Confederation exercises its powers, whereby it carefully considers the acquis bilatéral. Vice versa, the EU Member States should also pay attention to the acquis bilatéral in tax matters having a Swiss nexus.

At least in tax matters amongst both contracting parties, namely the EU and the Swiss Confederation,  pressure for supranational judicial integration appears to be rather not so indicated. As has been outlined in the foregoing, both contracting parties seem to be aware of the acquis bilatéral and its guarantees in EU-Swiss tax matters. Therefore, the potential for conflicts, at least in tax matters, should be considered rather moderate. Notwithstanding, the EU seems unwilling to accept the Swiss “agreement-based Sonderweg” any longer within a midterm perspective since it could also be attractive for certain member states. It goes without saying that it would be most likely not in the interest of the EU if individual member states leave the club again. Therefore, either the Swiss Confederation will make further concessions that go to the detriment of its own sovereignty, or a scenario may arrive where EU-Swiss cooperation is slowed down and becomes administratively probably too burdensome. Of course, the latter would be, from an economic perspective, not in the interest of the Swiss Confederation. At the end, Switzerland must strike a solid balance between its own state sovereignty and EU integration without membership.