Tax risks Lump-sum expenses

Facts

A. GmbH is active in the field of insurance brokerage. In the tax periods 2012 to 2015 to be assessed by the Federal Supreme Court, it had its tax domicile in the Canton of Zug. The A. GmbH employed various employees in the field, including the sole shareholder A.A and his son B.A. The company paid all field sales employees expenses in the amount of 20% of the turnover generated in each case.

In the assessment ruling of 3 November 2017 for the tax periods 2012 to 2015, the tax administration of the Canton of Zug objected, inter alia, to the amount of the flat-rate expenses. The assessment authority considered only half of the expenses to be business-related and added the other half, totalling CHF 234,000, to the profit of A. GmbH.

The objection and the appeal to the Administrative Court of the Canton of Zug were unsuccessful, on the grounds that there were no officially approved expense regulations and that the proof that the expenses were justified in business terms had failed. The objection and appeal to the Administrative Court of the Canton of Zug were unsuccessful on the grounds that there were no officially approved expense regulations and that the business justification for the expenses had not been proven.

A. GmbH then filed an appeal in public law matters with the Federal Supreme Court, requesting that the flat-rate expenses totalling CHF 234,000 not be offset.

Considerations of the Federal Court

Concept of expenses

Tax law does not have an independent definition of expenses, but is linked to employment law. Since only the "deployment costs", i.e. the costs of a specific deployment of the employee, are to be compensated under employment law, only these can be the subject of the reimbursement of expenses for tax purposes. In principle, expenses are incurred during working hours and serve to reimburse those expenses for which the employee acting in the name and on behalf of the employer pays in a first phase before being reimbursed by the employer in a second phase.

Tax treatment of flat-rate expenses at the level of the company

In order to be deductible from taxable profit, flat-rate expenses must be justified by the company's business. If there is no business justification for the expense, an addition to profit must be made for the company.

According to the Federal Supreme Court, an expense is always justified in terms of business if it can be counted in good faith among the expenses. The BGer further held that business justification is to be assumed if the expense item or investment has a direct and immediate organic connection with the production of operational services. As long as the flat-rate expenses are based on a concrete performance by the employee and are therefore not entirely gratuitous, it must be assumed that there is a fundamental business-related justification.

In its considerations regarding the business justification of the lump-sum expenses paid by the employer company, the Federal Supreme Court distinguished between two categories of personnel: company-remote employees and company-related employees.

Business justification in the case of company-remote employees

Due to the authoritative principle, the commercial law view also applies to tax law. As a result, partially translated flat-rate expenses - as long as they are based on concrete services rendered by the employee and are not entirely free of charge - represent a business-related expense for tax purposes at the level of the company.

Consequently, the Federal Supreme Court considered the offsetting to the extent of 50 percent, as carried out by the assessment authority, to be unfounded with regard to this category of personnel. The appeal was well-founded in this respect.

The Federal Supreme Court left unanswered whether the flat-rate expenses are nevertheless subject to income tax or social security contributions, as this was not the subject of the decision.

Business justification in the case of company-related employees

Shareholders and persons particularly closely associated with them are to be regarded as employees closely associated with the company. In contrast to the lower court, the BGer was of the opinion, that the internal comparison between company-remote and company-related employees only provides an initial indication as to whether the flat-rate expenses paid to the related employees represent a business-justified expense or a business-unjustified expense at the level of the company. The Federal Supreme Court did not accept the argument of A. GmbH that expenses were treated in the same way for all employees, whether company-remote or company-related.

In the present case, A. GmbH did not comply with its duty to cooperate and did not prove the amount of the flat-rate expenses allegedly paid to the related employees. Consequently, according to the Federal Supreme Court, it must be assumed that the flat-rate expenses paid to the company-related employees were not offset by any expense events. The flat-rate expense reimbursements were therefore unjustified from a business point of view or were employee benefits motivated by participation rights. The overstated expenses at the level of the company must be added to the profit for tax purposes.

Comments

In practice, for reasons of simplicity and rational processing, the question often arises as to whether expenses can generally be charged as a flat-rate rather than effectively. The present decision exemplifies the high tax risks that can exist for owner-managed companies if flat-rate expenses are poorly documented.

Often, the only remedy is expense regulations, which, however, must be approved in advance by the tax authorities. In practice, the cantonal tax authorities usually only accept such rules only accept them if the company exceeds a certain size. The tax office of the Canton of Lucerne, as well as the cantonal tax administrations of the Cantons of Solothurn and Berne, for example, only approve expense regulations when more than 10 employees are allowed to claim flat-rate expenses as so-called "executive employees". The tax administrations of the Cantons of Zug and Zurich, on the other hand, reportedly do not provide for a threshold value and, in principle, already approve expense regulations for a single employee.