Tax breaks for rich foreigners under fire

The mansion of Formula One champion Michael Schumacher on Lake Geneva 2014 Getty Images

This content was published on October 19, 2014

Lump sum taxation, the made-to-measure tax regime designed to attract wealthy foreigners to Switzerland, is facing a crucial test as voters head to the polls on November 30 to decide whether or not to abolish the system for good.

Proponents of the initiative say lump sum taxation is unfair and opaque, while opponents fear Switzerland will lose in attractiveness and suffer a mass exodus of wealthy taxpayers should the system be abolished.

Those taxpayers, the so-called “tax exiles”, include big names like British rock star Phil Collins, Formula One driver Lewis Hamilton and Russian billionaire Viktor Vekselberg. All benefit from the system of lump sum taxation which sees some 5,600 foreigners without a revenue-raising activity in Switzerland taxed solely on their spending and not on their revenue or real fortune.

But succumbing to a wave of public pressure, lump sum taxation, which boosted federal, cantonal  and local coffers by some CHF700 million ($733 million) in 2012, has already been killed off in five of the country’s 26 cantons in recent years.

The system no longer exists in Zurich, Basel City, Basel Country, Schaffhausen and Appenzell Outer Rhodes.

However, St Gallen, Thurgau, Lucerne, Nidwalden and Bern, have voted to keep the system, albeit with tougher eligibility conditions.

Leftwing initiative

At the end of November, a nationwide vote will decide whether or not to deliver the knockout blow to the system of taxation that was originally created as a means of taxing wealthy English who retired to the Lake Geneva region at the end of the 19th century.

Dubbed ‘End tax breaks for millionaires (abolish lump sum taxation)’, the initiative was launched by the leftwing Alternative List groups, supported by the centre-left Social Democrats, the Greens and the trade unions.

They argue the preferential regime is arbitrary and contrary to equal rights enshrined in the Swiss constitution.

“Lump sum taxation has led to an intolerable climate in Switzerland. It is not acceptable that somebody who is middle class pays more taxes than a foreign millionaire or billionaire living a couple of kilometres away,” says Senator Christian Levrat, who is also president of the Social Democratic Party.

Mountain resorts

But the initiative faces strong opposition from the right and centrist parties.

“Taxing spending is a fiscal tool perfectly adapted for taxing people who do not have revenue in Switzerland. It is wrong to speak of unequal treatment because these people are already taxed at the source elsewhere,” says Christian Democratic Party senator Jean-René Fournier.

The lump sum system was originally devised to prevent double taxation of assets spread over multiple countries. Many rich foreigners living in Switzerland either earn their income abroad or hold some of their wealth there, and are also taxed in other countries accordingly.

The use of lump sum taxation has been favoured in recent years primarily by cantons known for their favourable climate and environmental conditions.

Vaud, with 1,396 cases in 2012 uses the regime the most, followed by Valais (1,274) and Ticino (877), Geneva (710), Graubünden (268) and Bern (211).

Cantonal autonomy

According to its opponents, the initiative represents an intolerable attack on federalism and the autonomy of cantons to determine their own tax statutes.

“Each canton should be able to decide its own tax system and adapt it according to its individual situation. Other cantons have for decades attracted foreign multinationals by offering tax breaks. Is that more ethical?”, argues Fournier.

But the left argues the system creates a kind of competition between the cantons that is akin to dumping.

Supporters of an abolition of lump sum taxation say the manner in which cantons apply the regime is opaque. They criticise that a number of beneficiaries use the system as a means of tax avoidance because they do in fact exercise lucrative activities in Switzerland.

Levrat also points to the adverse effects that the presence of so many rich foreigners has on certain mountain resorts.

“What advantage does it give Gstaad [in the Bernese Oberland region] to have all these luxury chalets that are empty for a good part of the year? The super-rich spend next to nothing and they only help to massively inflate rental prices for local residents who pay a heavy price for this unreasonable development,” he says.

Zurich experience

During the parliamentary debate, several members of the right blasted the left for attacking the wealthy.

They also stressed the importance of such taxation practices in making Switzerland economically attractive, and their concern that abolishing lump sum taxation altogether would result in a massive exodus of wealthy foreigners from the country.

“Every country has its own way of attracting people with large fortunes,” says Fournier.

“France, Portugal and Spain use this method of taxation on a much larger scale. If this initiative passes, we’ll be shooting ourselves in the foot.”

Fournier cites the example of Zurich where half of all foreigners who benefited from lump sum taxation left the canton two years after the system was abolished in 2009.

“And those who stayed pay less tax than before. So it’s the Swiss taxpayers that have to pick up the bill,” he says.

However, observers point out that half of those who stayed pay more tax than before.

Other factors

The political left reads the situation in Zurich very differently.

Tax revenues have only diminished slightly and just one in six foreigners left Switzerland over the past few years as many of them moved to other cantons.

The situation would be very different if lump sum taxation was abolished across the country, leftwing campaigners says.

“In most countries that have a similar lifestyle and infrastructure, ordinary taxation is much higher than in Switzerland,” says Levrat.

He argues that taxation is not all that counts. “These foreigners have come to Switzerland first and foremost for its peacefulness, stability, lifestyle and favourable business environment. All of which implies a minimum contribution to the common effort.”

Lump sum taxation: how does it work?

The system of lump sum taxation is based on the lifestyle and spending habits of the taxpayer in Switzerland and not on his/her actual revenue or fortune.

It applies only to foreigners who do not exercise a revenue-generating activity in Switzerland. It is also available to sports professionals and artists.

In 2012, parliament decided to tighten the conditions for eligibility for lump sum taxation to come into force next year.

The minimal level of spending taken into account in terms of cantonal taxation must now be seven times the rent or rental value of the abode and only people with an annual revenue of at least CHF400,000 ($419,000) can now benefit from this tax break with respect to federal direct taxation.

Concretely, a foreigner who purchases an apartment in Switzerland which has a monthly rental value of CHF5,000 will be taxed at the same rate as other taxpayers, on a revenue of CHF420,000 (5,000 x 12 x 7). Added to that is other spending, such as on cars or private jets. The base used for wealth tax is a minimum of ten times more than the amount declared, in this case, CHF4.2 million.

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