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Unraveling the Hierarchy of Transfer Pricing Methods in Switzerland

EY people
EY Switzerland

Multidisciplinary professional services organization

5 minute read 27 Oct 2023

Selected practical guidance from the Swiss Federal Court on the application of the TP methods in financial services transactions

In brief

  • Is there a hierarchy on which Transfer Pricing (“TP”) methods taxpayers should follow in Switzerland?
  • Is there a most appropriate TP method to use for financial service transactions in Switzerland?
  • Are taxpayers free to choose any TP method they deem suitable?

In Switzerland, the Organization for Economic Co-operation and Development (“OECD”) Guidelines as well as some sections in Swiss Federal Direct Tax Act (“FDTA”) and decisions made by the Federal Tribunal or Court (“FC”) apply when it comes to TP issues. With reference to a practical case and court decision of the Swiss Federal Administrative Court (“SFAC”) from 4 September 2023 (BVGer A-4976/2022), in the present article key insights will be drawn on the usage of TP methods for financial services transactions and on the hierarchy of their application.

The case at hand

Company A, the Defendant, operates in the asset management sector in Switzerland. The foreign non-affiliated Companies B & C provided services to Company A, strictly linked to the latter main business, i.e. portfolio management and advisory services. In the Defendant’s perspective, Companies B & C were not related parties, even if some employees of Company A were also employed, for a specific period of time, in Companies B or C in order to perform some outsourced financial services and there were some common shareholders. The adjustment introduced by the Swiss Federal Tax Administration (“SFTA”) and the subject of this case, was to reduce or disallow some of the costs charged by Companies B and C. The key issue was that the SFTA believed Company A had paid in excess for the services purchased from B and C. For this reason, Company A was considered by SFTA to have offset its profit, leading to an audit, for the purpose of levying a withholding tax on such non-cash benefits.

Also, in the view of the SFTA, Companies B & C were regarded as affiliates of Company A. This consideration was based on the fact that all the involved Companies had some shareholders or beneficial owners in common. This led to the SFTA classifying the outsourced services as intra-group transactions and applying TP rules accordingly.

Further, the SFTA challenged Company A and computed the price that Company A would have incurred for the financial services provided by Companies B & C, by using the Cost Plus (“C+”) method and comparing the hourly salary (based on notional salary) and the hourly rate quoted by Companies B & C for the relevant services as originally paid by the taxpayer. According to the Defendant, the SFTA did not come up with the right result because it was argued that they also adopted the non-optimal TP method, as the C+ method was not applicable to the transactions under scope.

The SFAC assessed the case and addressed the arguments brought forward by Company A and by the SFTA. The SFAC agreed with the Defendant on the suitability of the Comparable Uncontrolled Price (“CUP”) method application as Companies B & C had rendered similar services at similar prices to independent third parties (an internal CUP had been applied by the taxpayer to price the transactions under scope). In doing so, the SFAC also rejected the TP method applied by the tax authority, i.e. C+ method, and highlighted a so-called hierarchy of TP methods, placing the CUP at the top.

The upcoming section underlines the TP-related key points considered by the court and some new insights into the SFAC’s evaluation of how appropriate a certain TP method may be when determining the price of a specific transaction. Moreover, it highlights which considerations taxpayers have to take into account when adopting a certain TP method.

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Main points

While the Defendant was of the opinion that Companies B and C were not related, upon closer analysis it was clear that Companies A, B and C were indeed related since they indirectly had the same shareholders and there was clear evidence of influence since certain shareholders also acted as members of the Board of Directors of the Defendant. As a result, TP principles were certainly relevant when determining the prices to set in controlled transactions.

 

In the decision at hand, the SFAC deduced that there is a clear hierarchy when it comes to the application of TP Methods, stating that the CUP method is always to be applied, if possible. Also the court, referring to the SFTA circular dated 19 March 2004, described the C+ method as unsuitable for financial transactions or management functions such as the ones in this case.

 

Furthermore, the SFAC limited taxpayers’ freedom of choosing a specific TP method, as taxpayers should refer to the hierarchy in place and thus should prioritize the CUP method over the others.

As clearly mentioned in the case, when dealing with the hierarchy of the methods for determining an appropriate third-party price, SFAC confirms that there is no hierarchy when it comes to direct taxes, while in their view there was a clear hierarchy for TP matters.

 

While such point may have been valid in the past, it is important to highlight that the 2022 OECD TP Guidelines clearly state that “no one [TP] method is suitable in every possible situation, nor is it necessary to prove that a particular method is not suitable under the circumstances.” Therefore, according to this framework, there is no predefined priority for applying one TP method over the others. This guidance has clearly evolved since the OECD Guidelines were first issued but common practice leaves now the selection of the method fully to the taxpayer.

 

Further, even though SFTA instructs taxpayers to follow the OECD Guidelines, the Guidelines do not override the Swiss national legislation, which has always to be consulted at first. The basis of Swiss TP regulation, found in Art. 58 of the FDTA and Art. 24 of the Federal Tax Harmonization Act (“FTHA”), merely lists the TP Methods introduced by the OECD as such. TP professionals know that the regulation points out that prices must comply with the arm’s length principle, achieved through any of the methods. Therefore, also according to the Swiss legislation, no method is to be prioritized over another.

 

With regards to the referenced SFTA circular dated 19 March 2004, which is still theoretically applicable, it can be questioned whether such guidance is outdated or viewed as relevant today. Since TP practice has evolved over the years, it is safe to say that the application of the C+ method for financial transactions is no longer viewed as an exception. It has become common practice to apply the C+ method in the financial services industry, albeit it has proven itself to be more suitable for some transactions, such as activities or services that are supportive in nature or which could be easily carved-out for pricing purposes, such as corporate services, certain risk & execution services, distribution support services or financial reporting. Within the Banking & Asset Management industry, in key value activities where a high level of skill is required (i.e. portfolio management, investment advisory, or client relationship management) a profit split of fee-sharing type of policy is regarded as more appropriate than the C+.

 

The case under review has revealed that TP practitioners always have to keep in mind which norms are to be prioritized over others. It has to be mentioned that as the current Swiss TP regulation follows a more open and flexible approach, additional key regulatory points may be added in order to minimize possible arising doubts and issues. Regardless, TP professionals can deduct from current laws that the taxpayers should comply with one of the methods but the choice of which one to apply remains at their discretion. The only criterion is the suitability with regard to the underlying transaction. In this regard, each intercompany transaction should be properly delineated and functionally analyzed in order to determine which is the preferred method to be applied, considering its nature and economic circumstances.

Summary

While in the past there was a clear hierarchy in the TP methods to use when dealing with financial services transactions, and the cost-plus was considered not suitable for this industry, in recent times there is no longer a clear hierarchy of TP methods to use and the C+ is widely used for a certain type of activities or services. Taxpayers are free to use the most suitable TP method for the relevant controlled transaction if it produces arm’s length results.

Acknowledgement

We kindly thank Joan Guinart, Natalie Burci and Tihomir Kamenov for their valuable contribution to this article.

About this article

EY people
EY Switzerland
Multidisciplinary professional services organization
Related topics
Tax
Tax planning
Tax compliance
Tax controversy

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EY Switzerland

    EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Limited, each of which is a separate legal entity. Ernst & Young Limited is a Swiss company with registered seats in Switzerland providing services to clients in Switzerland.