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Thomas Nabholz
1. Background
In Switzerland at present, the cantons have the power to levy inheritance and gift tax. Except in the cantons of Appenzell Innerrhoden, Neuchâtel and Vaud, direct descendants are exempt from inheritance and gift tax, while spouses and registered partners are exempt from inheritance tax in all cantons. The treatment of civil unions differs amongst the cantons. On the one hand, the applicable tax rates range from 0% (i.e. exempt from tax) to more than 40%, and on the other, definitions of the term “de facto partner” or “cohabiting partner” differ substantially. In cantons where no special rule for unregistered civil unions is applied, inheritance and/or gift tax is usually levied at the maximum tax rate, which can be as high as almost 50%. This tax rate also applies to inheritances and gifts to other unrelated persons.
According to the text of the initiative, all inheritances and gifts would in future be subject to a tax of 20%, regardless of the degree of relationship. Exceptions are foreseen for:
- A one-off tax-free allowance of CHF 2 million on the total value of the estate and lifetime gifts;
- Gifts / estates left to spouses or registered partners;
- Gifts of a maximum of CHF 20,000 per year and recipient;
- Donations to tax-exempt legal entities (e.g. charitable foundations);
- Special relief will also apply for transfers of companies and agricultural enterprises.
One third of the funds earned by the Confederation from the national inheritance tax would remain with the cantons and the remaining two thirds would be paid to the Federal Old Age Insurance. According to reports in the media, total income from this new tax is estimated at approximately CHF 3 billion.
If the initiative should be successful, a public ballot will be held. For the initiative to be successful, both a majority of the electorate and a majority of the cantons are required. If approved, the new provisions will have retroactive effect in that gifts made between 1 January 2012 and the date on which the new provisions enter into force would under certain conditions be subject to the new gift tax of 20%.
2. Initiative’s chances of success
Although the political debate about the initiative has already started, it is currently impossible to predict the outcome of a popular vote.
Given the tax-free amount for estates of CHF 2 million proposed by the initiators, a majority of the Swiss population is unlikely to ever be affected by the new inheritance tax. Some experts therefore believe that a majority of the voters are likely to be in favour of the initiators’ idea. However, other ballots in the past have made it clear that the Swiss public is unwilling to accept additional redistribution measures (e.g. tax fairness initiative [2010], health insurance initiative [2003], capital gains tax [2001]).
Also, the acceptance of the initiative would mean that direct descendants as well as parents and siblings will be liable for inheritance tax of 20% on inheritances that exceed the tax-free allowance. These parties currently pay substantially lower inheritance taxes in almost all cantons. On the other hand, unrelated parties will also be taxed at 20%, and these persons currently are subject to more than 20% tax in most cantons. Direct descendants, parents and siblings would therefore be taxed at a higher rate than at present, while unrelated parties would benefit from a lower rate.
According to the initiators, who estimate a tax yield of approximately CHF 3 billion, the share of the cantons in the new tax would amount to around CHF 1 billion, which is more or less equal to the amount that the cantons already earn on inheritance and gift taxes. The text of the initiative does not explain the key that would be used to distribute these funds between the individual cantons, but the wording seems to indicate that the initiators want the cantons to collect the tax and to forward two thirds of the proceeds to the Federal Old Age Insurance whilst their share of one third remains with the respective canton. With such a distribution most cantons are likely to collect more than they do today. However, it should be assumed that some cantons will lose out if these new rules should be introduced.
3. Succession planning in view of proposed inheritance tax
According to the initiators, the existence of family companies, SMEs and agricultural enterprises should not be jeopardized by the tax. To achieve this, the intention is to apply special rules for companies that are passed on to the next generation. The initiators will leave it to the legislator to work out the details of this plan, but suggest that, for example, relief can be granted in the form of an additional tax-free allowance of CHF 8 million when companies are valued for estate purposes and a reduced tax rate of 10% can apply, provided that the business will be continued and the heirs will own a substantial share of the business. In practice, however, such an approach will likely lead to many questions.
3.1 Continuation of business
In many cases the heirs are not (yet) willing or not (yet) able to continue to operate an inherited business themselves, or the testator himself only played a passive role as shareholder before his death. It remains to be seen whether the legislator will also allow the tax-privileged inheritance of a company if the heirs will not take on an active role in the company. It is also not clear when exactly the heirs will be deemed to own a substantial share of a business, and in particular whether the shares of several heirs (e.g. several children) could be added together to reach this share.
In particular if the heirs will be unable or do not want to continue the business, a sale should be planned very carefully from a tax point of view and as early as possible.
3.2 Definition of a business
It is also not clear how a business would be defined. The legislator would be required to adopt a generally valid definition of a business should the initiative be successful.
3.3 Valuation of company
A next question relates to how the value of an inherited company will be determined. It is generally not possible to objectively define a fair market value for a company, because the value of a company is usually determined in a transaction governed by the rules of supply and demand. Tax administrations usually apply the practitioner method to calculate the value of the shares in a company for the purposes of wealth tax. This method may be sensible for wealth tax purposes, but is likely to fail in the case of the new inheritance tax as applied to SMEs in particular: As the practitioner method is based on past figures, the profits of previous years are included in the value of the company on the assumption that it is possible to earn the same profits in the future. However, the chances for success of SMEs are typically tied to the company owner. When the owner retires from the company, the profit and thus the objective value of the company drops, at least over the short to medium term. This reduction in value should be considered for the purposes of inheritance tax.
4. Planning options
The retroactive application of the national inheritance tax to gifts made after 1 January 2012 proposed by the initiative does not leave much leeway for planning. Although individual solutions can surely be found, they would have to be implemented before the end of this year.
However, depending on the actual tax relief that will be granted for the transfer of companies, there will presumably be considerable leeway for planning in the future if the initiative should be adopted by the Swiss electorate.
