SWITZERLAND'S LUMP-SUM TAXATION: THE ATTRACTIVE ALTERNATIVE TAX MODEL IN SWITZERLAND

Approximately 5,000 tax payers in Switzerland take advantage of the so-called ‘lump-sum taxation’ method, which offers significant tax advantages based on a flat-rate tax system.

Switzerland levies taxes at the federal, the cantonal and municipal levels. The advantages of this fiscal model therefore depend on more than specific situation of any individual tax payer but also on the canton in which the taxpayer resides. Vaud, Geneva and Valais Cantons are particularly renowned for these tax privileges being used by high net worth individuals such as Michael Schumacher, Viktor Vekselberg and Phil Collins, among many others. Aside from the reduced taxation level, one of the system’s main advantages is that lump-sum taxpayers do not need to declare their global wealth and/or their global sources of income, which provides them with a further degree of privacy. Who qualifies for lump-sum taxation? For non-Swiss citizens to qualify for lump-sum taxation, the prospective tax payer must meet certain criteria, such as being (or becoming) a Swiss resident and not generating any employment income from sources within Switzerland. It is important to note that although establishing Swiss residency has become less problematic for EU citizens in most cases, the situation may be different for individuals from non-EU countries. How does the lump-sum taxation system work? Income Taxation Under the lump-sum taxation model, an individual is not taxed based on his personal worldwide income but rather on the basis of his living expenses (for himself and his family). This is generally assessed based on the taxpayer’s ‘housing expenses’ multiplied by a factor of 5, whereby housing expenses are defined as annual rental payments or – in cases of property ownership – the theoretical rental value of the taxpayer's home. However, it is important to note that certain minimum thresholds for taxable income may apply depending on the canton concerned. Based on the fact that the annual living expenses – i.e. the total amount spent by a taxpayer and his family during the course of a year for housing, holidays, school fees etc. – are generally very difficult to assess reliably, this method is less frequently used to define the income tax base of the taxpayer concerned. Although a lump-sum taxpayer is not permitted to generate any income from employment in Switzerland under the lump-sum taxation model, any income generated from Swiss sources (such as dividends, royalties, etc.) entails an additional income tax base minimum threshold. Swiss income tax under the lump-sum taxation model is subsequently based on the highest estimate of the conditions above, whereby ordinary tax rates apply. The tax rates applicable may differ significantly depending on the taxpayers place of residence. Wealth Taxation Furthermore, Switzerland levies a wealth tax on some cantonal and municipal levels. Two tests are used to identify the amount of assets subject to Swiss wealth taxation under the lump-sum taxation method: The ‘housing expense’ test capitalises the total housing expenses at 6% to obtain the overall value of taxable wealth with a variable percentage depending on the canton. The Swiss asset test is calculated based on the value of all the taxpayer’s assets in Switzerland itself (Swiss asset method). The highest result of these tests will be the basis for evaluating Swiss wealth taxation. Example The following example will clarify the significance of the lump-sum taxation and its impact on taxation: A taxpayer with a total annual taxable income from dividends and royalties of CHF 4 million moves to Switzerland. The taxpayer does not generate any income from employment in Switzerland and his worldwide assets are valued at CHF 25 million. The individual decides to invest CHF 6 million in his new residence in Switzerland. This home is estimated to have an annual rental value of CHF 150,000 for taxation purposes. The taxpayer’s ‘Swiss income’ from dividends and royalty payments amount to CHF 1.5 million. Total living expenses are considered to be less than Swiss income. Income taxation: 1) The housing expense test results in a total taxable income of CHF 750,000. 2) In this example, annual living expenses are not relevant since they are below the level of the taxpayer’s Swiss income. 3) The Swiss income amounts to CHF 1.5 million. Based on this example, total taxable income for lump-sum taxation would be CHF 1.5 million – the highest result of the above tests. Wealth taxation: Wealth taxation is based on 1) The housing expense test, which amounts to approx. CHF 2.5 million, or 2) The Swiss asset test, which in this example amounts to approx. CHF 5 million (net tax value of the property plus other assets). In the above example, the taxpayer's fiscal base would be CHF 1.5 million for income tax purposes and CHF 5 million for wealth tax purposes unless the canton of residency applies certain additional criteria (such as higher minimum levels) in order to qualify for lump-sum taxation status. Hence, despite a total actual annual income of CHF 4 million and total assets of CHF 25 million, the lump-sum taxation method reduces the taxpayer's income tax base by 62.5% and the wealth tax base by 84%, resulting in very advantageous taxation levels. What about gift and inheritance taxes? Lump-sum taxation does not cover the areas of either inheritance or gift taxes. While no such taxation exists on the federal fiscal level, most cantons and municipalities still levy gift and inheritance taxes (except for Schwyz canton). A number of exemptions apply depending on the canton, such as in cases where the surviving spouse and direct descendants are concerned. What is the so-called ‘modified’ lump-sum taxation model? Certain double taxation treaties are limited to taxpayers who are subject to ordinary taxation. In order to be sure that taxpayers who are taxed on the basis of the lump-sum taxation model benefit from these double taxation treaties, a modified system of lump-sum taxation has been devised, in which the taxpayer declares any treaty-favoured income in order to be eligible for the double taxation treaty benefits. Lump-sum taxation – quo vadis? An increasing number of voices have been raised concerning lump-sum taxation lately, which led to the privilege being abolished in Zurich Canton. The Swiss government is fully aware of the importance of this highly attractive tax model and discussions are on-going in order to address these concerns. Therefore, it is currently assumed that certain minimum income thresholds may be increased but that a lump-sum taxation model offering significant tax advantages in itself will continue to be upheld in most cantons.