In its decision of 26 September 2016, the Supreme Court of Switzerland resolved a long-outstanding issue of Swiss tax law: the deductibility of punitive fines by companies for corporate tax purposes. The decision is broadly applicable to both fines under criminal law and administrative penalties of a criminal or punitive nature, regardless of whether imposed by Swiss or foreign authorities. Historically, the deductibility of these fines was a mostly uncertain matter and was left largely to the discretion of the cantonal tax authorities.
Following a historic multi-year US Department of Justice Program for Non-Prosecution Agreements or Non-Target letters for Swiss Banks (the “Swiss Bank Program”), the decision holds particular relevance to the banking industry. Of potentially greater significance, however, is the relevance to any other industry where corporate fines may be imposed. As the breadth of fines covered by the decision include those imposed by criminal courts, antitrust bodies, financial services authorities, environmental commissions and health authorities, the potential application to other industries is noteworthy.
Background of the AC Treuhand Case
AC Treuhand was the subject of a 2009 European Commission decision (the “2009 Decision”) by which numerous companies were fined for their participation in alleged price fixing and anti-competitive schemes within the chemical sector. For its role in aiding the cartelists by arranging and participating in meetings, gathering and circulating data and facilitating payments between them in exchange for remuneration, AC Treuhand was fined € 348’000.
In its 2009 financial statements, the company accounted for this amount, made reserves (Rückstellungen) for the payment of the fine, and then claimed it as a deduction on its corporate tax return. The Zurich Tax Authority denied the deduction on the basis that the payment was not a commercially justified expense. Upon appeal to the Zurich Tax Appeal Court, the denial of the deduction was found to be improper. This pro-deduction decision of the appellate court was subsequently confirmed on appeal to the Zurich Administrative Court, after which the Zurich Tax Authority appealed to the Supreme Court of Switzerland.
The Supreme Court ruled that fines and financial sanctions with a penal character are not deductible, as these are not costs based on business (geschäftsmässig begründeter Aufwand). However, if the sanction is only to draw back illegally received profit (unrechtmässig erlangter Gewinn), then a deduction is acceptable. The court reasoned that allowing punitive fines to be tax deductible by companies would effectively cause the community to indirectly bear the costs of such fine, thereby circumventing the penal effect of the sanction.
Federal Law on the Tax Treatment of Financial Sanctions
The decision of the Supreme Court was made before the Bundesrat published its draft of a law addressing the deductibility issue (Bundesgesetz über die steuerliche Behandlung finanzieller Sanktionen). The bill provides, inter alia, that companies should not be able to deduct financial criminal penalties and bribes for tax purposes. The court’s decision and the proposed law are nearly identical. The bill only represents a clarification of the already existing law as interpreted by the Supreme Court.
Other Implications to the Tax Sector and Swiss Industries
The applicability of the court’s decision is broad in scope. As the fine imposed on AC Treuhand was not from a Swiss legal body, it naturally follows that the decision applies to both Swiss fines and non-Swiss fines. These fines could therefore be imposed by criminal courts, antitrust bodies, financial services authorities, environmental commissions and health authorities of Switzerland, another state or a collective body of states.
Query whether the fines imposed on Swiss banks as part of the Swiss Bank Program would actually qualify as tax fines. The fines were imposed upon the banks not because of their failure to pay taxes, but because they helped their clients hide their accounts from a non-Swiss tax authority. These facts seem to parallel the “facilitator” role of AC Treuhand in the anti-competition context that gave rise to the 2009 Decision. Indeed, the Swiss Bank Program fines imposed are derived from the revenue of the banks, so a deduction for Swiss tax purposes should be appropriate.
Furthermore the amount of each fine was proportional in two ways: (1) temporally, in that the fine was linked to the point in time that the wrongdoing occurred (what seems to be a penal factor), and (2) the magnitude of the accounts on which the fine was based (what seems to be a revenue-based factor). Insofar as fines imposed are reached by settlement, this may support the basis for deductibility.
In the “Sonntagszeitung” of 18 December 2016, a new law in France was detailed. The law allows taxpayers to settle with the authorities without an admission of guilt. If one can negotiate and resolve a conflict without an admission of guilt, the penal character of the sanction may at least be questionable.
It is important to note that some Swiss Bank Program banks may have paid a small fine that was rivalled by the collective legal, accounting and administrative costs borne by the bank in respect of the Swiss Bank Program. If the competent tax authorities ultimately deem a particular Swiss Bank Program fine to be non-deductible, it is likely that a deduction for any costs related to such fine that do not otherwise have an independent business basis would similarly be disallowed.
Although the Supreme Court decision does not set forth specific, measurable factors for determining the deductibility of fines for Swiss corporate tax purposes, further guidance may be forthcoming from the cantonal courts and tax authorities. The specific framework for analyzing the deductibility of fines will vary depending on the particular type of fine imposed and is highly fact-specific. In the case of the Swiss Bank Program and its related fines, for example, relevant factors include the revenue earned by the banks involved, the lost tax revenue to the United States on its taxpayers’ undisclosed accounts, amounts paid in lieu of an admission of wrongdoing and additional amounts imposed for “aggravating” factors.
The tax treatment of fines, penalties and penal sanctions was, until recently, an unclear area of Swiss law that varied between cantons. Now that Switzerland’s highest court has ruled on the issue, and with the forthcoming enactment of the Federal Law on the Tax Treatment of Financial Sanctions, these legal uncertainties are now more certain. Fines and financial sanctions with a penal character are not deductible; profit-taking sanctions without a penalty are still deductible.
However, the distinction between fines with penal purposes and fines with profit-taking purposes is less clear and the authorities imposing such fines are unlikely to make this distinction for the taxpayer. As multipurpose fines are unlikely to be defined with granularity as to its component parts, further consideration should be given to how these types of fines should be treated for Swiss tax purposes, especially where at least some portion is appropriately classified as having a profit-taking purpose. In any event, the burden of establishing this distinction is on the taxpayer.
Not only is the decision relevant in light of the Swiss Bank Program, but it also holds significance for any other Swiss corporate taxpayer that might be subject to a criminal or administrative fine by Swiss or non-Swiss authorities. A key takeaway from the decision is that proper planning can and should be undertaken where possible prior to the imposition of a penalty (e.g., during settlement discussions or negotiation with the authorities) to influence the characterization of the fine imposed.