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I.Fiscal Sovereignty and Constitutional Principles
1. FEDERALISM AND FISCAL SOVEREIGNTY
a)Distribution of Fiscal Sovereignty
As a consequence of Swiss federalism,1 Switzerland’s tax system incorporates three levels of taxation: taxes are imposed by the federation, the cantons and the municipalities.2
According to Article 3 of the Federal Constitution of the Swiss Confederation (Constitution),3 the cantons retain law-making power except in areas where the Constitution expressly delegates this power to the federation. Therefore, the federation is only allowed to levy those taxes which the Constitution exclusively grants its competence over. These are the following:
-Federal direct tax (Article 128 Constitution)
-Value added tax (Article 130 Constitution)
-Stamp duty on securities, receipts for insurance premiums and certain other commercial deeds (Article 132 I Constitution)
-Withholding tax on income from moveable capital assets, lottery winnings and insurance benefits (Article 132 II Constitution)
-Taxes on commodities such as beer, tobacco and mineral oil etc. (Article 131 Constitution), customs duties (Article 133 Constitution), and traffic taxes (Articles 85 and 86 II Constitution)
-Taxes on gambling houses (Article 106 III Constitution)
Conversely, the cantons are essentially free to levy any taxes, except those which are exclusively reserved to the federation.4 The cantonal constitutions further delegate and organise the division of tasks and powers between each canton and its communes. Although the cantons have original taxing powers and are even permitted to create new taxes, they do not have unfettered discretion over the design of their tax system. They are limited by the Tax Harmonisation Act5 which obliges them to levy certain types of taxes. Further, they are generally restricted by the fact that the Constitution and all federal laws take precedence over any conflicting cantonal and municipal law.
b)Federal Tax Harmonisation Act
For a long time, fiscal federalism resulted in the existence of 26 (often very) different cantonal tax laws. This situation hindered personal and economic mobility within Switzerland.6 Taxpayers who were liable to be taxed in two or more cantons were subjected to different assessment principles and procedures in each canton, for example, in the case that a taxpayer lived in one canton and owned real estate property in another canton. Furthermore, an exit tax could be imposed if an individual or a legal entity relocated from one canton to another canton.
In order to remove these obstacles, on 12 June 1977, the Swiss people accepted a new federal competence in a referendum to harmonise cantonal and federal direct tax law. Subsequently, the Tax Harmonisation Act entered into force on 1 January 1993, and after a transition period of 8 years has actually applied from 1 January 2001.
The Tax Harmonisation Act significantly improved tax coordination in Switzerland, introducing tax harmonisation with regard to direct taxes between the federation and the cantons (vertical tax harmonisation) as well as between the cantons themselves (horizontal tax harmonisation). It is a legal framework that contains rules on the tax subject, the tax object, the tax base, the tax period and the tax procedure. Some of these rules go into minute details, whilst others leave a certain scope of action and some room for interpretation to the cantons. The Tax Harmonisation Act, however, does not harmonise tax rates and tax allowances. In this regard the cantons remain fully sovereign. Hence, tax competition between the cantons and also between the communes is not hindered by the Tax Harmonisation Act.7
2. MAIN (CONSTITUTIONAL) PRINCIPLES
The principle of legality (Article 5 Constitution) is of fundamental importance in Swiss tax law. Article 127 I Constitution ensures its application to tax matters and states that “the main structural features of any tax, in particular those liable to pay tax, the object of the tax and its assessment, are regulated by the law”.
Swiss courts as well as academic literature demand strict adherence to the principle of legality. The principle requires that tax laws are be put to an optional referendum. Furthermore, the law must be appropriately detailed in order to comply with the constitutional requirement of legality.
The principle of universality is enshrined in Article 127 II Constitution. It demands that each member of a community should contribute to the community’s financial burdens and denotes that all taxpayers or groups of taxpayers should be subject to the same taxes and taxation rules. However, although the principle of universality aims to prevent the application of any privileges or discrimination, Swiss tax law does contain certain privileges which are considered justified due to their fulfilment of other constitutional principles and goals. In particular, certain tax incentives granted to foreign wealthy taxpayers, such as the lump-sum taxation, 8 or to foreign companies are considered justified by the goal to foster the Swiss economy.
c)Principle of Uniformity and Ability-To-Pay Principle
The principle of uniformity and the ability-to-pay principle share similar content, requiring that each taxpayer must contribute to the fiscal burdens of the state according to his or her economic, financial and personal resources (Article 127 II Constitution).
The Constitution demands both horizontal and vertical equality of treatment of individuals. Horizontal equality requires that taxpayers living in the same economic and personal circumstances and deriving the same amount of taxable income should be subjected to equal taxation. Vertical equality, on the other hand, requires that taxpayers living in different economic and personal situations and/or deriving a different amount of taxable income should be subjected to different levels of taxation. Vertical equality particularly refers to the design of the tax scale and to the question on whether progressive, proportional or degressive tax rates should be chosen.9
d)Prohibition of Inter-Cantonal Double Taxation
Since 1874, the Constitution explicitly prohibits inter-cantonal double taxation. Today, the prohibition is enshrined in Article 127 III Constitution. Inter-cantonal double taxation arises if a taxpayer is simultaneously subjected to the same or similar taxes on the same tax object by two cantons, for example, if the taxpayer is considered to be a tax resident of two cantons. No law on the prevention of inter-cantonal double taxation has ever been enacted. Instead, the Federal Supreme Court developed a dense network of rules covering the allocation of taxing rights between the cantons. Some of these rules have in the meantime been enacted by the Tax Harmonisation Act, but still most of the inter-cantonal allocation rules is based on case law.
The basic rules are the following: any income from real estate, permanent establishments and fixed places of businesses may only be taxed by the canton wherein the property is situated. The same rules apply for the taxation of net wealth. All other income or net wealth, including income from employment or income from moveable property, may only be taxed by the canton where the taxpayer has his or her main tax residence (usually the taxpayer’s centre of living).
The constitutional prohibition on inter-cantonal double taxation also embodies a kind of non-discrimination rule: A taxable person who is only liable to have part of his or her income taxed in a certain canton may not be treated less favourably than a taxpayer whose whole income is taxable in that canton.
The Constitution expressly requires that “state institutions and private persons shall act in good faith” (Article 5 III Constitution). Additionally, Article 9 Constitution states that “every person has the right to be treated by state authorities in good faith and in a non-arbitrary manner”. Whereas Article 5 III Constitution demands honest and trustworthy behaviour from every person, Article 9 Constitution explicitly focuses on the relationship between the individual and the state. Every person has a legally enforceable right to be treated in accordance with the principle of good faith by legislative bodies as well as by those who apply the law.10
In tax law, the principle of good faith is of high relevance. In particular, it is considered to be the legal basis for the prohibition of an abuse of rights and the Swiss doctrine of preventing tax avoidance. According to the constant jurisprudence of the Federal Supreme Court, the criteria for defining tax avoidance are the following:
-the transaction structure or legal set-up chosen by the taxpayer is inappropriate or unusual, and completely inappropriate to the economic facts; and
-the taxpayer’s primary goal for utilising the chosen legal form was to achieve substantial tax savings; and
-the taxpayer will in fact achieve substantial tax savings if the legal form chosen is accepted by the tax administration.
If the criteria for tax avoidance are met, the real facts are disregarded and replaced by those facts that would have been considered as the usual and appropriate approach. For example, if the taxpayer tries to convert taxable dividend income into tax-free capital gain by using a completely inappropriate transaction structure, no tax free capital gain, but taxable dividend income will be recognised.
In practice, moreover, the principle of protecting a legitimate expectation that is also based on the principle of good faith is important in the context of the Swiss tax ruling practice.11
1See for more explanations on Swiss federalism the Chapter on Constitutional Law, pp. 135.
2See for the following and for more details on the whole chapter: MADELEINE SIMONEK, Tax Coordination between Cantons in Switzerland - Role of the Courts, in Michael Lang/Pasquale Pistone/Josef Schuch/Claus Staringer (eds.), Horizontal tax coordination, Amsterdam 2012 (cit. SIMONEK, Tax Coordination), pp. 221.
3Federal Constitution of the Swiss Confederation of 18 April 1999, SR 101; see for an English version of the Constitution www.admin.ch (https://perma.cc/M8UJ-S369).
4According to Article 134 Constitution, value added tax, stamp duty, withholding tax as well as special consumption taxes are exclusively reserved to the federation. In contrast, income taxes are levied on the federal and cantonal levels and depending on the cantonal order on the communal level as well.
5Federal Act on the Harmonisation of Direct Taxes at Cantonal and Communal Levels of 14 December 1990, SR 642.14.
6See for the following and for more details on the whole chapter: SIMONEK, Tax Coordinations, pp. 236.
7See p. 260.
8See pp. 254.
9See p. 266 for a leading court decision with regard to degressive income tax rates.
10See for the following and for more details MADELEINE SIMONEK, The principle of good faith in Swiss domestic and international tax law, in Cécile Brokelind (ed.), Principles of Law: Function, status and impact in EU tax law, Amsterdam 2014, pp. 319.
11See for more details on the Swiss tax ruling practice pp. 267.