Following up from the recently published Swiss Court Decision part 1, there is a new court decision involving transfer pricing in Switzerland and Guernsey, and the relevance of justifying not only the right substance, but also arm’s length remuneration for high-value or routine services.
This longwinded decision not only involves transfer pricing, but also tax subtraction (soustraction d’impôt) and other penalties. In the following paragraphs we highlight the key take-aways from this proceeding solely from a Transfer Pricing perspective.
ACo is a Swiss entity performing asset management activities and incorporated in Geneva. Further, ACo is a direct shareholder in CLtd, entity incorporated in Guernsey acting as fund manager and operating since 1999.
CLtd was the fund manager for several funds and from 1999 until 2005 had no employees. The first office sublease agreement was signed by CLtd in 2007 and as of 2008 CLtd employed only 4 people. CLtd charged management and performance fees to the funds.
Since 1999 CLtd outsourced investment advisory activities to third parties. From 2001, CLtd also delegated investment advisory activities to its related party ACo. The third-party advisors were compensated with 0.75% of the management fees plus between 40% and 70% of the performance fee. On the other hand, ACo was only remunerated with a portion of the management fee (i.e. no performance fee shared with ACo).
Based on the facts provided, ACo was also providing order placement services for certain funds managed by CLtd as well as marketing and distribution activities (i.e. CLtd benefited from ACo’s reputation and client contacts. ACo’s redirected visitors to CLtd’s site).
In July 2010. the Geneva Tax Authorities (GTA) opened a procedure against ACo covering the period 2001 to 2007 for tax evasion and tax recovery, under the argument that ACo had not been properly remunerated in previous years for the services rendered to CLtd (investment advisory, order placement and marketing and distribution).
In 2013 the GTA notified the following tax assessment decisions:
- ACo had not been sufficiently remunerated for the investment advisory services since no performance fee had been allocated (70% of performance fees should have been received).
- ACo also should have been compensated for the order placement services (up to a maximum of 0.09% on the net asset value of the funds).
- ACo should have also been rewarded for its marketing and distribution efforts with around 55% of the management fee received by CLtd (later reduced only to 40%).
In consequence, the GTA issued 3 tax adjustments notices plus penalties. Subsequently, ACo submitted an appeal on such adjustments and decisions.
In October 2017, the Administrative Court of Geneva confirmed that:
- ACo should indeed be compensated with 45% of the performance fees (against the original 70% recommended by the GTA).
- Penalties were in place but cancelled the tax recoveries linked to the activities of order placement and marketing and distribution
Following this resolution, both ACo and the GTA appealed against the decision of the Administrative Court of Geneva.
As a result, in October 2018 the Court of Justice ruled:
- The remuneration for the investment advisory should encompass 70% of the performance fee, as initially suggested by the GTA.
- The reestablishment of the tax adjustment related to the order placement services.
- Cancellation of tax adjustment related to the marketing and distribution activities.
- Confirmation of suggested penalties.
Subsequent appeals followed by ACo and the GTA, and finally the Federal Supreme Court ruled in December 2019 that:
- The tax adjustment related to the performance fee should be at the level of 70%.
- The reestablishment of tax adjustment related to the order placement services for some of the funds (cancelled for all funds of funds).
- The reestablishment of tax adjustment related to the marketing and distribution activities.
This court decision clearly shows that:
- Offshore structures, especially if equipped with little substance, are increasingly challenged by the Tax Authorities and are certainly difficult to sustain in the post-BEPS world,
- It is more relevant than ever to ensure that all intragroup services are properly remunerated.
- The use of internal comparables is one of the key pillars to ensure a sound transfer price setting when dealing with intragroup flows.
- Legacy intragroup structures involving offshore locations with low substance translate into material tax and reputational risks.
- Taxpayers will be exposed to more scrutiny by the Swiss Tax Authorities and the Swiss courts, and
- The Swiss Tax Authorities rely on a pragmatic, substance-based and results-oriented approach when dealing with similar issues.
As mentioned in our previous note, it is therefore critical that the remuneration of entities in offshore jurisdictions be anchored in objective facts and consistent with the substance of the arrangements as reflected in salaries and in communications to external stakeholders.
Swiss-based financial groups should review carefully the following elements that are likely to come under focus in all Cantons following this decision:
- Presence and substance in low tax jurisdictions;
- Deviation from internal comparables when setting intragroup prices;
- Delegation of decision-making to a related party that does not possess the relevant knowledge/resources;
- Client referral without an arm’s length remuneration; and
- Outsourcing of investment/portfolio management activities to lean entities.
Please feel free to reach out to Ralf Eckert, Luis Sanchez or Thomas Steinbach to discuss individually how EY could assist you in running an assessment to identify, assess, manage, document or mitigate such risks.