Intra-Group Transactions and Cascading Tax Consequences

In an increasingly globalized world, intra-group transactions by SMEs engaged in international trade and transfer pricing are at the heart of international tax concerns. But what happens when these strategies are challenged by tax authorities? Tax adjustments then emerge as corrective measures, often unexpected, to align intra-group transactions with actual market conditions.

In Switzerland, as elsewhere, these issues are particularly complex and can lead to disputes between tax authorities and risks of double taxation. Whether primary, correlative, or secondary, this article delves into the tax implications of these adjustments, examining both the particularities of direct tax and withholding tax as a safeguard for source-based taxation, providing an overview of the current challenges and solutions in this area.

This article is the first in a trilogy that will provide a comprehensive view of these issues. Our next two articles will address the crucial role of mutual agreement procedures in correcting the adverse effects of these adjustments and recent developments in Swiss practices to avoid such effects through repatriation.

Intra-Group Transactions: Do You Have Any?

Intra-group transactions refer to commercial operations between two companies within the same group, such as the sale of goods, the provision of services, intra-group loans, royalty payments, license fees, asset transfers, etc.

To avoid tax adjustments, these transactions must comply with the arm’s length principle, where the prices applied are similar to those practiced between independent companies and accepted as such by the various tax authorities. Otherwise, a primary adjustment initiated by a Swiss or foreign tax authority may necessitate a cumbersome process to ensure all necessary cascading adjustments are made to avoid double taxation.

Primary, Correlative, and Secondary Adjustments: Understanding Their Implications to Optimize Your International Tax Strategy

Primary Adjustment

A primary adjustment involves correcting a company's taxable profit when the tax authority determines that the transfer prices applied do not comply with the arm’s length principle. This correction modifies the transfer price, considered either too low in the case of a sale (abroad) or too high in the case of a purchase (from abroad), leading to an increase in taxable profit in Switzerland.

Correlative Adjustment

A correlative adjustment aims to avoid double taxation by ensuring that the foreign state involved makes a corresponding correction to the primary adjustment. In accordance with international tax treaties, this adjustment often restores an equitable allocation of profits between the two countries. This typically occurs through a mutual agreement procedure between the tax authorities of the two countries, with the dual objective of ensuring compliance with the arm’s length principle and minimizing the risk of double taxation through a fair and balanced allocation of profits.

Secondary Adjustment

A secondary adjustment addresses financial flows that remain a bookkeeping reality unaddressed by the primary and correlative tax adjustments. It is an additional measure applied by the tax authority to tax the difference resulting from a primary adjustment as if it were a deemed transaction, often considered by the Federal Tax Administration (FTA) as a deemed dividend distribution, subject to withholding tax. Requalifications into equity contributions or loans are less common in Switzerland.

Best Practices to Adopt: Are You Doing It?

The unpredictability of adjustments, the arduous procedures, and the persistent risk of double taxation—despite mechanisms like mutual agreement procedures—underscore the critical importance for SMEs active internationally to prevent rather than endure bureaucratic burdens and financial repercussions.

Establishing a global, clear, and arm’s length transfer pricing policy is a necessary step to anticipate and eliminate tax issues at the source. Our team of corporate tax and transfer pricing experts is available to assist you in this proactive and strategic endeavor. Together, we will develop a tailored policy approved by Swiss and foreign tax authorities to secure your intra-group transactions and avoid complex and costly tax corrections that could result in residual double taxation.