Lump sum taxation in Switzerland
Private persons, who are not Swiss citizen, can agree with the tax authorities of a majority of Swiss cantons to be taxed on incomes agreed with the administration as a lump sum.
The system originates from the 19th century when wealthy foreigners spent a long time in Switzerland, i. e. for health reasons. A t that time, the only actual relief for those suffering from tuberculosis was the fresh wind of the Alps. As it was difficult to obtain a tax return from these foreigners residing in Swiss sanatoriums, the practical minded Swiss tax administrations developed a system of taxation based on the local expenses incurred by these foreign residents.
Lump sum taxation is actually a taxation where the taxable income is derived from the Swiss expenses of the tax payer. The tax authorities can include in their calculation various kind of expenses, like for instance car, ships, domestic employees, etc. Nevertheless, the main tool to approximate the local expenses are the costs incurred to maintain a domicile. The taxable income should at least be equal to seven times the annual rent of the domicile. If the monthly rent is equal to CHF 10’000.—, the taxable income amounts to CHF 840’000.— (10’000x12x7). When the tax payer does not pay a rent because he owns his domicile, the rent is equal to an amount which is calculated by the tax authorities (defined as rental income). The rental income is usually lower than a rent at a market price for the same housing.
Once the income is defined, it is taxed according to the tax brackets applicable to “normal” tax payers. The final amount of the taxation will depend on the canton where the tax payer is domiciled. Although the federal tax rate is the same in the whole country, the cantonal and municipal rates vary from one place to another: some cantons are less expensive than other (and some cantons do not allow lump sum taxation like Zurich). In addition to these taxes, a tax payer under the age of retirement must pay some contribution to the Swiss social security. All other foreign incomes are exempt from taxation. Thus, the lump sum taxation is in principle an excellent deal for the tax payer as long as his real revenues are (much) lower than the income calculated according to the Swiss expenses.
Even if the principles of the lump sum taxation appear to be quite simple, there are some restrictions applicable that must be kept in mind.
A tax payer benefiting from the lump sum taxation is not allowed to work in Switzerland. Nevertheless, he can receive from abroad revenues like rents, interests or royalties. He can also be a shareholder of Swiss companies and sit on their board. Should he receive incomes from a Swiss source, these incomes add to the taxable income agreed with the Swiss tax authorities. This is the case if the tax payer is shareholder of a Swiss company and receives dividends. It is also the case if he gets rents from Swiss real estates which he owns. This restriction implies that the revenues of the tax payer must be of foreign source to avoid a larger taxation in Switzerland than the previously agreed amount.
Another restriction relates to the minimum taxable income under which tax authorities do not agree to this taxation. This amount is of CHF 400’000.— for the federal and the cantonal taxation. Nevertheless, some cantons still agree to assess their taxes on a lesser amount.
This question of the minimum taxable income leads to another problem. In order to become a tax payer in Switzerland, it is necessary to obtain a residency permit. Citizens from the EU are allowed to establish themselves freely in Switzerland without requiring an authorization. Other citizens, like Russians , Chinese or maybe Britons soon, do not enjoy an unconditional right to live in Switzerland. A residency permit must be sought from the Swiss immigration department. Such an authorization can be granted if the new immigrant brings an economical advantage to Switzerland. This is the case if he pays a lump sum tax based on at least twice the required minimum amount, i. e. of CHF 800’000.— at least.
Another restriction to this kind of taxation is the prohibition to use DTT treaties. Most of the DTT concluded by Switzerland deny the quality of resident to a resident taxed according to this scheme. Therefore, if such tax payer receives foreign incomes like dividends, royalties or rents subject to a foreign withholding tax, it is not possible to claim the benefit of a DTT in order to reduce the foreign withholding tax. If the benefit of the treaty is nevertheless claimed, these incomes are added to the incomes agreed with the Swiss administration as a lump sum. It is very important before electing for such taxation to check the wealth structure of a potential beneficiary in order to estimate whether his taxation according to this scheme will be beneficial or detrimental to his financial interests.
Estate taxes have been abolished in most of the Swiss cantons (and do not exist on the federal level). Nevertheless, in certain cantons, tax payers benefitting lump sum taxation are still submitted to a cantonal estate tax. The choice of the canton where a tax payer will reside will then have different outcomes in case of transmission by death. Besides, if the heirs do not live in Switzerland, it must be also checked what is the tax situation for the heirs in their countries. Although the estate could be tax free in Switzerland, it is far from sure that the heirs will also be exempted of any further taxes.
A residency permit in Switzerland and an agreement with the tax authorities regarding lump sum taxation are not a fully bullet proof tax shelter if the tax payer does not actually reside in Switzerland. The Swiss immigration administration will not check the days spent in Switzerland and the tax administration will continue cashing taxes wherever the tax payer actually lives. If he actually lives in another country, hiding himself from the local tax authorities, he can be caught and obliged to pay further taxes in the country where he really lives. To pay taxes in Switzerland will not be an excuse not to be taxed in this other country. The cases published by courts show this mistake sometimes made by foreigners enjoying this scheme.
Lump sum taxation is actually a powerful tool in order to reduce one’s taxation, but it must be used after a thorough examination of all the personal parameters of the future resident in Switzerland.