More than 12,000 charitable foundations are active in Switzerland. These foundations finance themselves primarily by the endowment at the time they are set up and by donations and other gifts. Many foundations, however, also realise income by trading with products and providing services. The corresponding revenue is again applied towards the purpose of the trust/foundation, thus used within the scope of the charitable purpose. A recently published practice of the Federal Tax Administration may now cost such foundations a lot of money.
Charitable foundations in value added tax law
If a charitable trust is entrepreneurial – e.g. in trading merchandise products or sustainable products – it is also subject to the value added tax as a matter of principle. It will then have to pay value added tax at the applicable rates on the income derived from its commercial activity and services. On the other hand, this foundation can also claim the value added tax charged to it as input tax.
In practice, this may lead to a situation where the entrepreneurially active foundation can purchase at lower costs than a foundation exclusively financed by donations, because the latter will invariably not qualify as an entrepreneur and therefore not be subject to the value added tax. As a consequence, it will not be entitled to claim any input tax on its expenditures (e.g. printing of leaflets; purchase of office material; or infrastructure).
The Federal Act on the Value Added Tax (MWStG) foresees that charitable institutions will only become subject to value added tax (VAT) by law if their proceeds from taxable goods and/or services exceed CHF 150,000. If this turnover is not achieved, however, the charitable trust may divest itself voluntarily of this tax exemption. It is to be borne in mind in this context that donations qualify as so-called non-payments and therefore, donations are not taxable for VAT purposes.
To give rise to value-added taxability, as per Art. 10 paragraph 1 MWStG, it is required that an entrepreneurial activity is performed. The law describes an entrepreneurial activity as a professional or commercial activity aimed at obtaining sustainable income from goods and/or services. It is not possible to glean a more concrete definition from this law. Striving for profit is not a prerequisite of entrepreneurial activity and, therefore, of value added taxability.
The Federal Council’s explanatory notes concerning the MWStG draft bill states the following with regard to the term of “entrepreneur”: On the one hand, the entrepreneur’s activity must be sustainable, i.e., aimed at generating income from goods and/or services by proceeding according to a plan over a certain period of time, and on the other hand, it must be of a professional or business-like nature. Moreover, it must be an economic activity, that is, the production of or trading with goods, or the provision of services destined for an exchange on the market, or for personal consumption. In addition, the activity must be carried out independently (self-employed), for which reason wage earners tied to an employer by an employment contract are not subject to value added tax.
The above comments make it clear that the term of entrepreneurship in value-added-tax law is broader than in general linguistic usage. And the definition of a corporation or an entrepreneur, respectively, in terms of business economics is also narrower than in the value added tax act.
Since the revision of the Swiss value added tax system also intended to achieve an alignment with the system in force in the EU to the extent possible, it is worth-while to peek across the border with regard to the term of enterprise / entrepreneur. In the EU, any activity of production or trade and any provision of services is considered a business activity which triggers value added taxability. Depending on the member state, however, different turnover thresholds apply also in the EU.
Neither in the MWStG, nor in the materials is there anything that would indicate that certain economic activities were not to be considered as entrepreneurial. Thus, as a matter of principle, even charitable foundations may be subject to the value added tax and benefit from the input tax deduction in the individual case.
Practice of the Federal Tax Administration
The right of charitable foundations to deduct prepaid value-added taxes has also been confirmed in individual cases by the Federal Tax Administration (FTA). In its publication MWSt-Praxis-Info 04, however, the FTA has stated its opinion concerning the term of entrepreneurial activity in greater detail.
The MWStG ties the entrepreneurial activity to its orientation towards the sustainable achievement of income from goods and/or services. This implies that somebody who finances itself with non-payments, exclusively (donations, subsidies) and does not receive any genuine compensation for its services, is not engaged in an entrepreneurial activity. In such case, taxability is excluded.
But in the opinion of the FTA, this also means that even in the case that income is achieved from goods and/or services but the latter are clearly of a subordinate nature, it is not possible to speak of an orientation towards achieving income from goods and/or services. According to the published practice of the FTA, an orientation towards the sustainable achievement of income is to be negated whenever more than 75% of a charitable foundation is financed by donations, subsidies, and other contributions/bequests.
In other words, a charitable foundation which finances merely 25% or less of its budget by its own entrepreneurial activity can no longer be subject to the value-added tax and, correspondingly, can no longer claim any tax pre-payment on its expenditures. It is to be expected that this will apply to the large majority of trusts/foundations in Switzerland.
Correspondingly, the majority of charitable foundations in Switzerland are likely no longer subject to value-added tax. This means that these foundations will have higher costs since they can no longer benefit from the input tax deduction.
Retroactivity of the newly published practice
In the opinion of the FTA, this practice is to be applied since the new MWStG was enacted as of 1st January 2010, even though the determination of practice was only effected in the year 2012. The FTA now expects the foundations concerned to correct their past claims for the deduction of tax prepayments or, in other words, that they restitute those amounts to the FTA. This may well result in a difficult situation for some of the foundations concerned. It is evidently to be expected that the corresponding financial resources have already been allocated in full or at least in part to their charitable purpose. These foundations now probably find themselves with an unbudgeted expense item which, presumably, will have to be financed via newly received donations.
The current practice of the FTA is to be criticised in two respects:
On the one hand, the discussed FTA practice is to be rejected in itself. To assess taxability, the MWStG bases its assessment of taxability on entrepreneurship exclusively. Quantitative elements cannot be gleaned neither from the Act nor from the materials. Entrepreneurial quality basically exists when an independent activity aimed at obtaining sustainable income from goods or services is being pursued. Art. 18 para. 2 lit. d expressly qualifies donations as non-payments because there is no quid pro quo (by the corporation or the foundation, respectively). This explains why the FTA refuses to enter a charitable foundation exclusively financed by donations in the register of VAT-taxable parties – with good reason. Such a foundation is precisely not active in an entrepreneurial manner, since there is no good or service provided against payment. But a charitable foundation which also provides goods or services against payment in the market, in addition to receiving donations, is active in an entrepreneurial way pursuant to the MWStG. The ratio of non-payments (donations) to the payments (proceeds from entrepreneurial activity) cannot play any role in this, because all prerequisites for VAT taxability stated in the law are met.
On the other hand, and as a second criticism, the retroactive application of this practice as applied by the FTA, in the author’s opinion is questionable, to say the least. The foundations concerned have relied on the wording of the law and claimed the deduction of prepaid VAT in good faith. Had it been clear from the date the MWStG came into effect that the FTA was going to refuse these deductions, the foundations would have had to calculate differently; in other words, they could only have made available fewer resources to fulfil their charitable purpose. Against this backdrop, retroaction is objectionable under the rule of law.
The FTA is of the opinion that the definition of the 25%/75% criterion is the first expression of the administration concerning the corresponding question, meaning that it therefore is not actually a matter of retroaction. This may be rejoined by the fact that the FTA – although only in concrete individual cases – has most certainly commented on the eligibility (right) of charitable foundations to deduct VAT pre-payments, and has affirmed their right to do so. To what extent such comments are binding on the FTA would probably have to be examined by a court in each individual case. In cases where there is no express confirmation by the FTA, it will probably be substantially more difficult for the charitable foundations concerned to contest the retroactive denegation of the deduction of VAT prepayments.
Need for action by the foundations concerned
Foundations having claimed a prepaid tax deduction up to now ought to analyse the risk for the past and the strategy for the future with their tax advisor.
Also, please keep in mind that statements concerning practice and/or the corresponding FTA publications are mere expressions of the Administration’s opinions. As a matter of principle, they are not binding for the judicial authority and may be overruled by the latter. In the individual case, it may well be worthwhile to verify the opportunities of success concretely in a court of law.