Tax evasion in the sale of real estate

However, the tax return of Immobilien AG (complainant) showed a real estate gain of only CHF 386'515. The difference between the assessment of the Tax Administration and the expenses claimed by the complainant is due to the fact that the Tax Administration of the Canton of Schwyz did not fully accept the claimed construction costs as value-adding expenditures.

The starting point for the assessment by the Tax Administration of the Canton of Schwyz was a general contractor agreement concluded between the Immobilien AG (the complainant) and its sister company, the Generalunternehmung AG. The content of the contract was the construction of turnkey residential buildings. The authority concluded that the contractual arrangement does not withstand the necessary third party comparison (contract with an external third party) which is why it is concluded to be tax evasion. Therefore, the costs claimed by the Generalunternehmung AG cannot be deducted completely. The assessment authority corrected the taxable property gain from the declared CHF 386'515 to a total amount of CHF 1'975'342.

After an unsuccessful objection and a rejected appeal, the Immobilien AG (complainant) filed a complaint against this offsetting in matters of public law with the Federal Supreme Court. The Federal Supreme Court had to examine whether the taxable real estate profit was correct according to the tax return of the Immobilien AG (complainant) or according to the assessment of the Canton of Schwyz.

Considerations of the Federal Court

According to Art. 12 para. 1 StHG, the amount (= profit) that exceeds the investment costs (purchase price or replacement value and expenses) in the event of a sale of the real estate is subject to the real estate gains tax. The real estate gains tax is a direct special tax which the seller has to pay on the basis of his economic capacity as a taxpayer. In principle, costs that are necessary for the construction of a building are counted as value-adding expenses that can be deducted from the real estate gain (price of the real estate and remuneration for work). In order to claim a profit reduction for property gains tax purposes by means of investment costs, the costs actually incurred by the seller must be value-adding expenses. If there is an economic relationship between the seller and the manufacturer, so that they act as a unit with regard to a certain construction project, profit shifts between the seller and the manufacturer must be examined more closely. In the present case, the Federal Supreme Court had to assess precisely such a case.

Third-party comparison and the principle of effective cost allocation

Legal transactions with affiliated companies (as in the present case) are to be handled in the same way as if the contractual partner were an external third party. What is required is a so-called "third-party comparison". The third-party comparison is infringed if the contracting authority (in this case the complainant) waives its income and transfers it directly to the affiliated company, which, however, does not provide what a third would provide in the same setting. According to the Federal Supreme Court, the best proof of correct pricing is a quotation of an independent third party.

In the present case, on the one hand, parts of the land price were shifted to the Generalunternehmung AG through an arrangement of work compensation and, on the other hand, the sale of the units of the Generalunternehmung AG assumed risks and guarantees towards the purchasers, which would undisputedly be attributable to the Immobilien AG (the complainant) in a third-party comparison. The Generalunternehmung AG was compensated by the Immobilien AG (the complainant) for this apparent assumption of these risks and guarantees. Overall, this means that the expenses indicated in the property profit tax statement did not correspond to the actual situation.

The Federal Supreme Court confirms the principle of effective cost allocation, which means that only costs which have accrued and have not arisen on the basis of artificial legal structures may be deducted from the real property gains tax. The shift of the land price to the Generalunternehmung AG and the assumption of risks and guarantees that are objectively attributable to the Immobilien AG are not to be recognised as expenses in accordance with the principle of effective cost allocation and are not to be taken into account in the calculation of the real estate profit tax of the Immobilien AG.

Conclusion

The realisation of construction projects with different companies that are legally linked to each other is common in Switzerland. The fact that an optimisation of the tax burden is persued is understandable, especially in view of the different taxes that might be affected (real estate profit and/or profit tax).

The decision shows, however, that when pricing between associated companies, especially in the real estate sector (e.g. sale of property), the tax authorities closely examine how the compensation has been calculated and which legal arrangements form the basis of any cost deferrals.

The principle of third-party comparison and effective cost allocation limits the scope for design. It is worthwhile for the implementation of construction projects by affiliated companies to create a clean and comprehensible documentation right from the start, which can stand up to third-party comparison. In the worst case scenario, a conviction for tax evasion avoid.