RPT-INSIGHT-Swiss, facing EU tax pressure, ponder how to attract firms

* EU wants Swiss to scrap tax breaks on foreign profits

* Cantons get creative over possible solutions

GENEVA, Dec 18 (Reuters) - "Happy Taxation" is a 2011 book

by Pascal Broulis, finance minister of the Swiss canton of Vaud

and celebrant of the low taxes that distinguish Switzerland. But

as times get tougher, discontent about Swiss tax breaks is

mounting.

Cash-strapped foreign governments have already chipped away

at the secrecy that allows rich individuals to store tax-free

funds in Swiss bank accounts. Now Europe's governments have

turned the spotlight on the incentives Switzerland offers

companies.

Swiss official company tax rates of around 21 percent

compare with 33 percent in France and 29 percent in Germany,

according to a 2011 survey by accountants KPMG; often companies

in Switzerland actually pay much less. Denknetz, a left-wing

Swiss think tank, estimates Switzerland's special tax regimes

deprive other countries of up to 36.5 billion francs ($39

billion) in tax revenue each year - almost double the amount

Spain's government raised in corporate tax in 2011.

Brussels has demanded that the country, which is home to

nearly 24,000 "tax privileged" companies from online retailer

eBay to Japanese automaker Nissan, scrap special tax breaks on

some company profits.

In particular, the EU is angry that Switzerland's cantons,

or states, compete with each other to attract multinationals'

business, and charge less tax on foreign-earned income than they

do on income earned in Switzerland. Brussels has said the

practice, known as "ring-fencing", is the equivalent of

providing unauthorised state aid to companies.

Last week the European Commission unveiled a plan to counter

inventive tactics increasingly used by big companies to reduce

their tax bills, and attacked countries like Switzerland whose

policies it says encourage aggressive tax avoidance.

Switzerland is not a member of the European Union but has

had a free trade agreement with the EU for the last 40 years. It

says it's not doing anything wrong, and it has so far largely

ignored the bloc's demands, which were first made in 2005.

In June, EU finance ministers threatened unilateral action

if a "satisfactory response" is not communicated by the end of

this year. The ultimate sanction would be trade tariffs, which

would choke off Swiss industry from Europe, its main trade

partner. Member states could take action by coordinating

blacklists to be implemented at national level, said Emer

Traynor, spokeswoman for the European Commission.

Harmonised EU sanctions would require "a good deal of legal

assessment and unanimous agreement in Council", she added.

"It's clear that the EU is not going to back down on this,"

said Martin Naville, the Swiss CEO of the Swiss-American Chamber

of Commerce who co-authored a study on Switzerland's appeal for

multinationals. "There has to be a solution and Switzerland will

have to give up ring-fencing."

Swiss officials point out that EU countries such as Ireland,

which offers a headline corporate tax rate of just 12.5 percent,

provide similar tax breaks. Google uses Ireland and the

Netherlands to reduce its tax bills.

"We are called a 'tax haven' by some of our European

neighbours but Switzerland is far from having the exclusivity on

legal devices that allow companies to avoid taxes," Broulis

writes in his book.

JOY OF TAX

The 47-year-old represents the Swiss Liberals party. It's

the third largest in Switzerland's parliament and stands for a

slender state, low taxes and tax competition among cantons. He

has distributed copies of the book, which is written in French,

to every 20-year-old in Switzerland's sleepy lakeside state of

Vaud. He says he wants to reach people who "have never paid

taxes but are about to pay them for the rest of their lives."

In the book, he defends the Swiss system, which lets cantons

determine two-thirds of the taxation paid by multinationals in

Switzerland (the remainder is decided at federal level). He says

it works because the system is democratic and not too

burdensome, noting that the Swiss tradition of direct democracy

means people are regularly consulted.

EBay - headquartered in the central canton of Bern - is one

beneficiary of the system. In the past four years, it has paid

an average tax rate on overseas income of between 2.5 percent

and 3.6 percent - a fraction of the headline tax rate in its

major markets - its annual reports show. "Tax rates are

important, but it's not the only reason," an eBay spokesman said

in an email about the company's choice of base. Location,

workforce, infrastructure and quality of life are also

important.

In Broulis' canton Vaud, the official rate of corporate tax

is nearly 24 percent, but firms often negotiate a better deal.

For more than a decade, Broulis has had the final say on whether

a foreign company qualifies for special tax regimes, including

offers such as up to 10 years tax-free, subject to conditions

such as job creation.

"If taxes are too high and confiscatory they become

intolerable," Broulis writes. Companies including Yahoo and

Brazilian miner Vale have settled in the canton. Vale confirmed

tax optimisation played a role in its decision, Yahoo declined

comment.

Other firms attracted by Switzerland's "ring-fence" include

some of the world's biggest commodity firms. Oil traders Vitol

and Trafigura, for instance, are based in land-locked

Switzerland. Much of their income is generated abroad, so the

tax breaks can be ample - usually less than a quarter of

earnings they make abroad is taxed. Their headline tax rate can

fall to just 11-12 percent of profits, or even less, says a tax

official.

Vitol declined to comment and Trafigura stressed its revenue

is taxed "either in Switzerland or elsewhere." Nissan said it is

"a good corporate citizen in every country in which it

operates." Thomson Reuters also benefits from Swiss tax rates.

"The specific rates of tax we pay are at the standard Swiss

rates as appropriate," a spokesman said by email.

"HOSTAGE TO MULTINATIONALS"

As pressure from the EU has mounted, some firms have started

quizzing tax advisers about their options.

"The roots of these companies are fairly transient and if

they can get better terms somewhere else, they will consider

it," said Gary Klesch, head of Geneva-based commodities trading

and production firm Klesch Group.

That has prompted head-scratching among the Swiss as to how

to satisfy the EU without scaring firms away. Foreign firms that

invest in Switzerland employ 11 percent of the Swiss workforce

and contribute to 14 percent of GDP, according to a 2012 Joint

Study by the Swiss-American Chamber of Commerce and the Boston

Consulting Group. The 23,524 tax-privileged companies resident

in Switzerland in 2009 contributed 3.8 billion francs - around

half of the total tax income from all companies in the country,

according to the finance department.

"The problem is serious. If all these firms were to move

away, Switzerland would lose in total up to five billion francs

in tax and 10,000 jobs," Eva Herzog, finance director for the

canton of Basel said in October.

Some say the cantons have become totally dependent on

multinationals. "Cantons are now admitting that if they lose

their special tax statuses they will be in complete disarray,"

said Ada Marra, a lawmaker for the left-wing SP party and member

of parliament's economic committee. "Effectively this is an

admission that several Swiss cantons are now hostages to big

companies."

There are signs that even the Swiss are fed up with firms

being offered rock-bottom rates while people feel the squeeze.

In Zug - home to commodity trader Glencore and mining company

Xstrata - some argue that expats are pricing locals out of the

market. Voters in June backed an initiative to increase

affordable housing. Glencore declined comment and Xstrata did

not respond.

NEGOTIATING TACTICS

Some lawmakers say Switzerland's foot-dragging on the tax

issue may have weakened its negotiating position with the EU,

which is the destination of more than half its exports and a

vital prop for the economy. International pressure has already

forced it to agree ways to tax foreigners' cash held in Swiss

accounts.

"We have to be smart enough to play the flexibility which we

should still have to our advantage," said Armin Marti, a tax and

legal partner at PricewaterhouseCoopers in Zurich. "We're not an

EU member state, we can still be creative and think of what we

can do on the tax base."

Officials say the Swiss Federation is unlikely to meet the

EU's year-end deadline, but they are optimistic they can have a

tax proposal on the table by next spring. The European

Commission has seen progress but says more is needed from the

Swiss, said its spokeswoman Treynor: talks will continue and it

will report on its findings in June.

Assuming the Swiss system has to change, a presentation

co-authored by Switzerland's no. 2 tax official Fabian Baumer,

recommended in November that Switzerland should pursue "various

and bold" solutions.

One would be to charge even less: cantons could lower the

standard corporate rate. It's an approach championed by Geneva,

which has suggested slashing the standard rate to 13 percent by

2018 to keep hold of commodity giants. That way the EU could no

longer accuse it of "ring fencing," because domestic and foreign

income would be taxed at the same rate.

Traders such as Vitol have welcomed the idea. But it would

leave a gaping hole in Geneva's budget which would need filling

somehow - possibly by other cantons. "In my opinion we can't

start subsidising tax competition," said Christian Wanner,

finance minister of the northern canton of Solothurn and

president of the cantonal finance ministers.

More innovative ideas could include 'licence boxes' - which

allow income resulting from intellectual property to be taxed at

lower rates - that are already in place in EU states such as

Luxembourg, Cyprus and Belgium and the Swiss canton of

Nidwalden.

However, such a solution would not cover commodity firms,

now responsible for 3-4 percent of Swiss GDP, according to

estimates from the Swiss State Secretariat for Economic Affairs.

There could be incentives that aren't just about tax. Swiss

cantons could negotiate discounts on other charges, such as

giving companies free electricity, said one finance official,

although he said he did not personally agree with the idea.

Switzerland is already fighting back. In October, it lured

Greece's biggest company Coca Cola Hellenic, which said

Switzerland's stability and ease of doing business were behind

its choice.

"Switzerland knows how to preserve its fiscal system which

is something that many EU countries haven't been able to do,"

Broulis told Reuters.

In a one-page letter sent to U.S. companies based in Belgium

in early October, the marketing association Greater Zurich Area

highlighted negative aspects of the Flemish economy such as rail

strikes, massive public debt and the recession.

"Maybe it's time to consider changing your location and

moving your regional headquarters from Belgium to Zurich," Swiss

press quoted the letter as saying. The authority, which

confirmed it sent the note, has since apologised. "We never

intended to offend Belgian feelings or denigrate Belgium as an

investment location," it said.

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