Provisions for vacation credits and taxes

The purpose of provisions is to ensure that expenses and losses that are probable or certain to occur at the balance sheet date but whose amount or date of occurrence is still uncertain are recognized in the appropriate period. In practice, there are regular discussions about which expenses are recognized as provisions and are therefore tax-deductible. A recent Federal Supreme Court ruling (9C_192/2024 of July 3, 2024) calls into question the previous tax treatment of provisions for holiday credits in many cantons. The background and implications of this ruling are explained below.

Facts

A. AG is a company domiciled in Geneva that provides auditing, tax consulting and management consulting services. For the 2021 tax period, the company reported a taxable net profit of CHF 78,123 in the canton of Geneva and a taxable net profit of CHF 153,216 in Switzerland. In the balance sheet attached to the 2021 tax return, it reported current provisions of CHF 2,044,982, of which CHF 250,000 related to provisions for employee vacation entitlements.

The cantonal tax administration of Geneva denied A. AG the tax deduction of the provisions for vacation credits on the grounds that this was a provision for future expenses, the main purpose of which was to reduce the net profit and thus lower the effective tax liability.

With an appeal in public law matters, A. AG finally applied to the Swiss Federal Supreme Court for the provision for vacation credits to be recognized for tax purposes in the 2021 tax year in accordance with the authoritative principle applicable under tax law.

Considerations

In contrast to the practice in various cantons in the German-speaking part of Switzerland, the Swiss Federal Supreme Court is of the opinion that provisions for vacation credits are not legally permissible deductions within the meaning of Art. 63 DFTL. According to the aforementioned legal provision, the formation of a provision requires that the obligation in question arose in the current financial year and can be traced back to normal commercial practice. In the present case, however, the taxable company is demanding that provisions for expenses that will supposedly be incurred in the future be recognized as deductible. According to the Swiss Federal Supreme Court, this violates the principle of accrual accounting. The principle of accrual accounting stipulates that business transactions are allocated exclusively to the accounting period to which they belong in economic terms. Only within narrow limits does the Swiss Federal Supreme Court Jurisprudence permit provisions to be charged to the income statement if these can be clearly linked to the financial year in question. However, offsetting results from different financial years by posting unjustified provisions can be considered an inappropriate manipulation of the accounts aimed at artificially reducing the taxable profit for the current year. In this case, this leads to an overvaluation of the liabilities or to the creation of hidden reserves in the 2021 financial period, even though the obligations in question would only be recognized for tax purposes in the year in which they fall due, i.e. in the future.

According to the Swiss Federal Supreme Court, the company is also unable to prove that there was a concrete risk that the vacation days not taken should actually have been paid out. In particular, it was not apparent that the company intended to cease its business activities in 2022, which would have entailed monetary compensation for the vacation entitlement. In the Swiss Federal Supreme Court's view, the assertion that employees perform more work in one year and would therefore take more vacation days in the following year also does not constitute a justification.

Finally, the Swiss Federal Supreme Court argues that even if, under certain circumstances, a provision would be permissible under commercial law within the meaning of Art. 958c CO, this does not automatically guarantee the tax deductibility of such as yet undetermined future costs. Despite the applicable authoritative principle, according to which the commercial balance sheet and the profit shown therein serve as the basis for calculating the taxable result, tax corrections are permitted if necessary. For example, the tax authorities are entitled to question and release any provisions which, as hidden reserves, are only intended to reduce profits and thus reduce the tax burden.

Conclusion

According to the Swiss Federal Supreme Court, a provision for vacation credits cannot be claimed either for direct federal tax or for cantonal and communal taxes, as this does not represent a current obligation and violates the principle of periodicity. In the present case, the appeal of A. AG was therefore rejected and the corresponding amount of CHF 250,000 was offset against the taxable profit and capital (= taxed hidden reserve).

This recent Swiss Federal Supreme Court ruling significantly weakens the principle of authoritativeness, as tax adjustments are increasingly being approved even for provisions that are justifiable under commercial law. This is currently leading to a certain amount of legal uncertainty regarding accruals for vacation credits under commercial law. The legal doctrine consistently criticizes the Swiss Federal Supreme Court for its decision and generally rejects it. According to the doctrine, the non-payment of vacation requires a provision or deferred income under commercial law, which should be recorded as a business-related and tax-effective expense.

It remains to be seen whether the ruling will be adopted in full by all cantons and how the practice of the cantons will develop in this regard. According to published practice, the creation of provisions for overtime or unused vacation remains permissible in a large number of cantons, provided that these are justified in terms of the business as a whole and stand up to third-party comparison (see in particular the practice in Lucerne).