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Swiss Tax Law 'Unconstitutional' Says Court

by Ulrika Lomas, Tax-News.com, Brussels

12 June 2007


A tax law introduced by the canton of Obwalden in 2006 which cut income tax for wealthy taxpayers has been struck down by Switzerland's highest court.

The Federal Tribunal in Lausanne ruled last week that the income tax law is unconstitutional because it is regressive and not based on economic imperatives

After a referendum in 2005, Obwalden, a tiny mountainous region in the centre of Switzerland, brought in an income tax law which cut tax for those earning more than CHF300,000 per year to 1% from 2.35%. Individuals earning up to CHF70,000 pay 8% and those with income up to CHF300,000 pay up to 6%. At the same time, Obwalden also cut corporate tax to 6.6%, making it one of the lowest rates in Switzerland.

Obwalden's tax reforms also prompted other cantons to respond with tax cuts of their own: cantons Zurich, Valais, Fribourg, Uri and Schaffhausen all reduced tax rates in 2006. But according to Socialist Party deputy Josef Zisyadis, who brought the action and moved to Obwalden specifically to oppose the tax regime, the court's decision has "put a brake on the fiscal cannibalism between the cantons."

"The Federal Court's decision is extremely important, on the Swiss and European level," Zisyadis added.

The European Commission is currently attempting to make Switzerland change aspects of its corporate tax regime designed to attract holding companies to the jurisdiction. The Commission argues that the Swiss tax regime, which allows cantonal governments freedom to set their own tax rates to attract new companies and wealthy expats, breaches the 1972 trade agreement between Switzerland and the EU by distorting trade and competition.

Under Swiss law, the cantons may fully or partially exempt profits generated abroad from cantonal and municipal company tax. All Swiss cantons have made use of this provision, although in different forms.

However, in April, European Union Economic and Monetary Affairs Commissioner Joaquin Almunia, told European parliamentarians that this is politically unacceptable because companies establish operations in Switzerland with the sole intention of avoiding taxes in the EU. "The European Commission has no doubt that cantonal tax schemes qualify as subsidies because they offer an unfair tax advantage to companies in Switzerland for profits generated in the EU. Income generated in Switzerland is taxed higher," Almunia told the European Parliament.

The European Commission has told the Swiss government that if it does not cooperate on the tax issue, it will initiate proceedings against the country under the EU's state aid rules, which seek to eliminate regional or industry-targeted tax breaks in the interest of promoting a level competitive playing field across the EU. However, it is unclear whether such an action will succeed as Switzerland is not a member of the EU and arguably it has no jurisdiction over Swiss laws.

As for Obwalden, the cantonal government has said that it will attempt to draw up a constitutionally acceptable tax system and present the plans before the cantonal parliament in due course.

The Federal Department of Finance meanwhile, said that while it rejects regressive tax systems, the court's decision would not reduce cantonal tax competition, nor lead to tax harmonisation.

A comprehensive report in our Intelligence Report series giving background tax and residence information on many of the key offshore jurisdictions is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report4.asp

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