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Insight: Swiss, facing EU tax pressure, ponder how to attract firms

By Emma Farge and Caroline Copley

GENEVA (Reuters) - "Happy Taxation" is a 2011 book by Pascal Broulis, finance minister of the Swiss canton of Vaud and celebrant of the low taxes that distinguish Switzerland. But as times get tougher, discontent about Swiss tax breaks is mounting.

Cash-strapped foreign governments have already chipped away at the secrecy that allows rich individuals to store tax-free funds in Swiss bank accounts. Now Europe's governments have turned the spotlight on the incentives Switzerland offers companies.

Swiss official company tax rates of around 21 percent compare with 33 percent in France and 29 percent in Germany, according to a 2011 survey by accountants KPMG; often companies in Switzerland actually pay much less. Denknetz, a left-wing Swiss think tank, estimates Switzerland's special tax regimes deprive other countries of up to 36.5 billion francs ($39 billion) in tax revenue each year - almost double the amount Spain's government raised in corporate tax in 2011.

Brussels has demanded that the country, which is home to nearly 24,000 "tax privileged" companies from online retailer eBay to Japanese automaker Nissan, scrap special tax breaks on some company profits.

In particular, the EU is angry that Switzerland's cantons, or states, compete with each other to attract multinationals' business, and charge less tax on foreign-earned income than they do on income earned in Switzerland. Brussels has said the practice, known as "ring-fencing", is the equivalent of providing unauthorized state aid to companies.

Last week the European Commission unveiled a plan to counter inventive tactics increasingly used by big companies to reduce their tax bills, and attacked countries like Switzerland whose policies it says encourage aggressive tax avoidance.

Switzerland is not a member of the European Union but has had a free trade agreement with the EU for the last 40 years. It says it's not doing anything wrong, and it has so far largely ignored the bloc's demands, which were first made in 2005.

In June, EU finance ministers threatened unilateral action if a "satisfactory response" is not communicated by the end of this year. The ultimate sanction would be trade tariffs, which would choke off Swiss industry from Europe, its main trade partner. Member states could take action by coordinating blacklists to be implemented at national level, said Emer Traynor, spokeswoman for the European Commission.

Harmonized EU sanctions would require "a good deal of legal assessment and unanimous agreement in Council", she added.

"It's clear that the EU is not going to back down on this," said Martin Naville, the Swiss CEO of the Swiss-American Chamber of Commerce who co-authored a study on Switzerland's appeal for multinationals. "There has to be a solution and Switzerland will have to give up ring-fencing."

Swiss officials point out that EU countries such as Ireland, which offers a headline corporate tax rate of just 12.5 percent, provide similar tax breaks. Google uses Ireland and the Netherlands to reduce its tax bills.

"We are called a ‘tax haven' by some of our European neighbors but Switzerland is far from having the exclusivity on legal devices that allow companies to avoid taxes," Broulis writes in his book.

JOY OF TAX

The 47-year-old represents the Swiss Liberals party. It's the third largest in Switzerland's parliament and stands for a slender state, low taxes and tax competition among cantons. He has distributed copies of the book, which is written in French, to every 20-year-old in Switzerland's sleepy lakeside state of Vaud. He says he wants to reach people who "have never paid taxes but are about to pay them for the rest of their lives."

In the book, he defends the Swiss system, which lets cantons determine two-thirds of the taxation paid by multinationals in Switzerland (the remainder is decided at federal level). He says it works because the system is democratic and not too burdensome, noting that the Swiss tradition of direct democracy means people are regularly consulted.

EBay - headquartered in the central canton of Bern - is one beneficiary of the system. In the past four years, it has paid an average tax rate on overseas income of between 2.5 percent and 3.6 percent - a fraction of the headline tax rate in its major markets - its annual reports show. "Tax rates are important, but it's not the only reason," an eBay spokesman said in an email about the company's choice of base. Location, workforce, infrastructure and quality of life are also important.

In Broulis' canton Vaud, the official rate of corporate tax is nearly 24 percent, but firms often negotiate a better deal. For more than a decade, Broulis has had the final say on whether a foreign company qualifies for special tax regimes, including offers such as up to 10 years tax-free, subject to conditions such as job creation.

"If taxes are too high and confiscatory they become intolerable," Broulis writes. Companies including Yahoo and Brazilian miner Vale have settled in the canton. Vale confirmed tax optimization played a role in its decision, Yahoo declined comment.

Other firms attracted by Switzerland's "ring-fence" include some of the world's biggest commodity firms. Oil traders Vitol and Trafigura, for instance, are based in land-locked Switzerland. Much of their income is generated abroad, so the tax breaks can be ample - usually less than a quarter of earnings they make abroad is taxed. Their headline tax rate can fall to just 11-12 percent of profits, or even less, says a tax official.

Vitol declined to comment and Trafigura stressed its revenue is taxed "either in Switzerland or elsewhere." Nissan said it is "a good corporate citizen in every country in which it operates." Thomson Reuters also benefits from Swiss tax rates. "The specific rates of tax we pay are at the standard Swiss rates as appropriate," a spokesman said by email.

"HOSTAGE TO MULTINATIONALS"

As pressure from the EU has mounted, some firms have started quizzing tax advisers about their options.

"The roots of these companies are fairly transient and if they can get better terms somewhere else, they will consider it," said Gary Klesch, head of Geneva-based commodities trading and production firm Klesch Group.

That has prompted head-scratching among the Swiss as to how to satisfy the EU without scaring firms away. Foreign firms that invest in Switzerland employ 11 percent of the Swiss workforce and contribute to 14 percent of GDP, according to a 2012 Joint Study by the Swiss-American Chamber of Commerce and the Boston Consulting Group. The 23,524 tax-privileged companies resident in Switzerland in 2009 contributed 3.8 billion francs - around half of the total tax income from all companies in the country, according to the finance department.

"The problem is serious. If all these firms were to move away, Switzerland would lose in total up to five billion francs in tax and 10,000 jobs," Eva Herzog, finance director for the canton of Basel said in October.

Some say the cantons have become totally dependent on multinationals. "Cantons are now admitting that if they lose their special tax statuses they will be in complete disarray," said Ada Marra, a lawmaker for the left-wing SP party and member of parliament's economic committee. "Effectively this is an admission that several Swiss cantons are now hostages to big companies."

There are signs that even the Swiss are fed up with firms being offered rock-bottom rates while people feel the squeeze. In Zug - home to commodity trader Glencore and mining company Xstrata - some argue that expats are pricing locals out of the market. Voters in June backed an initiative to increase affordable housing. Glencore declined comment and Xstrata did not respond.

NEGOTIATING TACTICS

Some lawmakers say Switzerland's foot-dragging on the tax issue may have weakened its negotiating position with the EU, which is the destination of more than half its exports and a vital prop for the economy. International pressure has already forced it to agree ways to tax foreigners' cash held in Swiss accounts.

"We have to be smart enough to play the flexibility which we should still have to our advantage," said Armin Marti, a tax and legal partner at PricewaterhouseCoopers in Zurich. "We're not an EU member state, we can still be creative and think of what we can do on the tax base."

Officials say the Swiss Federation is unlikely to meet the EU's year-end deadline, but they are optimistic they can have a tax proposal on the table by next spring. The European Commission has seen progress but says more is needed from the Swiss, said its spokeswoman Treynor: talks will continue and it will report on its findings in June.

Assuming the Swiss system has to change, a presentation co-authored by Switzerland's no. 2 tax official Fabian Baumer, recommended in November that Switzerland should pursue "various and bold" solutions.

One would be to charge even less: cantons could lower the standard corporate rate. It's an approach championed by Geneva, which has suggested slashing the standard rate to 13 percent by 2018 to keep hold of commodity giants. That way the EU could no longer accuse it of "ring fencing," because domestic and foreign income would be taxed at the same rate.

Traders such as Vitol have welcomed the idea. But it would leave a gaping hole in Geneva's budget which would need filling somehow - possibly by other cantons. "In my opinion we can't start subsidizing tax competition," said Christian Wanner, finance minister of the northern canton of Solothurn and president of the cantonal finance ministers.

More innovative ideas could include 'licence boxes' - which allow income resulting from intellectual property to be taxed at lower rates - that are already in place in EU states such as Luxembourg, Cyprus and Belgium and the Swiss canton of Nidwalden.

However, such a solution would not cover commodity firms, now responsible for 3-4 percent of Swiss GDP, according to estimates from the Swiss State Secretariat for Economic Affairs.

There could be incentives that aren't just about tax. Swiss cantons could negotiate discounts on other charges, such as giving companies free electricity, said one finance official, although he said he did not personally agree with the idea.

Switzerland is already fighting back. In October, it lured Greece's biggest company Coca Cola Hellenic, which said Switzerland's stability and ease of doing business were behind its choice.

"Switzerland knows how to preserve its fiscal system which is something that many EU countries haven't been able to do," Broulis told Reuters.

In a one-page letter sent to U.S. companies based in Belgium in early October, the marketing association Greater Zurich Area highlighted negative aspects of the Flemish economy such as rail strikes, massive public debt and the recession.

"Maybe it's time to consider changing your location and moving your regional headquarters from Belgium to Zurich," Swiss press quoted the letter as saying. The authority, which confirmed it sent the note, has since apologized. "We never intended to offend Belgian feelings or denigrate Belgium as an investment location," it said.

(Caroline Copley reported from Zurich; Additional reporting by Tom Miles in Geneva, John O'Donnell in Brussels and Richard Mably and Tom Bergin in London; Edited by Sara Ledwith)

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