SWITZERLAND Trends and Developments Contributed by: René Matteotti, Monika Bieri, Daniel Schönenberger and Manuel Ulrich, Tax Partner AG
The court further clarified that domestic law does not establish a hierarchy among these methods. The deci - sive criterion is the method that is best suited in the particular case to determine an arm’s length price. Given the long-term supply relationship, the exclusive supply to shareholders, and the limited functional and risk profile of the hydropower plant, the court consid - ered the cost-plus method to be appropriate. Determination of the cost base A central issue concerned which cost components must be included in the cost base. The Federal Supreme Court adopted a comprehensive full-cost approach. The cost base must include:
parameters defined by the Supreme Court (full cost base including taxes and a 5% notional equity return, combined with a 5% profit mark-up), the lower court concluded that the arm’s length principle had not been violated. The taxpayer’s position was ultimately upheld. Departure from the OECD Transfer Pricing Guidelines and Reaction of the Swiss Federal Tax Administration Although the Federal Supreme Court characterised its approach as a cost-plus method, it departs in material respects from the OECD framework. First, it replaces a comparability-based, range-oriented analysis with normatively fixed parameters (5% notional equity return; 5% profit mark-up), without deriving these figures from a robust benchmarking or comparability study. Secondly, it expands the cost base to include income and capital taxes as well as a notional return on equity. Both elements are in tension with OECD transfer pric - ing principles, under which non-operating expenses – particularly income taxes – are generally excluded from the cost base of a cost-plus analysis, and capi - tal structure considerations are addressed through a functional and risk-based profitability assessment rather than through the integration of equity returns into the cost base. It is also methodologically prob - lematic that the court relied on contractually agreed controlled prices as a normative reference, even though those very transactions are subject to the arm’s length test. Overall, the judgment narrows the methodological discretion recognised under the OECD framework and transforms what is essentially an empirical, comparability-driven method into a nor - matively standardised valuation model. In a timely statement, the Swiss Federal Tax Admin - istration correctly clarified that the Supreme Court’s methodology is confined to the specific domestic con - text of Article 58 (3) DBG and cannot be extended to cross-border cases. In the international context, OECD-conform practice continues to apply, accord - ing to which non-operating costs – including income and capital taxes – are not to be included in the cost base. The judgment does not constrain the Swiss competent authority – namely, the State Secretariat
• operating costs; • financing costs; • income and capital taxes; and • a notional return on equity.
The court accepted a notional equity interest rate of 5% and justified this by reference to the requirement of financing neutrality. Comparability between differ - ently financed enterprises requires that both debt and equity capital be adequately taken into account. By doing so, the court adopted an expressly normative concept of full costs that goes beyond the classical, function-based understanding of the cost-plus meth - od under OECD doctrine. Determination of the profit mark-up With regard to the mark-up, the Federal Supreme Court held that for a routine activity with a limited risk profile, a mark-up in the mid-single-digit range is appropriate. It confirmed that a 5% profit mark-up on a net basis falls within an arm’s length range. At the same time, the court emphasised that the arm’s length test does not aim at identifying a mathemati - cally precise point value. In the absence of reliable comparables, a hypothetical range must be applied. Only recognisable and material deviations are relevant for tax purposes. Remittal and outcome The Federal Supreme Court annulled the contested decision and remitted the case to the Administrative Court of Graubünden for reassessment. Applying the
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