Under Swiss commercial law, provisions are liabilities, losses or expenses that are uncertain in terms of their occurrence or amount. The purpose of recognizing provisions is to allocate expenses to be paid to the periods in which they are incurred.

 

It is customary for such provisions to be established, among others, for taxes, pension commitments, risks associated with legal proceedings, or employee-related obligations etc.

 

In addition, provisions for risks of losses associated with current assets are also recognized under Swiss commercial law. Specifically, these are value adjustments for merchandise (usually 1/3 of acquisitions or production costs, known as “Warendrittel”) or accounts receivable (known as “del credere").

 

These "provisions" are actually not provisions in the sense of commercial law, but rather corrections for temporary losses in value on current assets (i.e. they are generally booked as negative assets for accounting purposes and not as liabilities). These value adjustments for temporary losses are generally deductible for tax purposes, if commercially justified.

 

A departure from the principle of accounting prevalence, i.e. the principle that the commercial accounts form the point of departure for determining the taxable factors of a company, is only possible if there is a specific legal basis. In the case of provisions, this applies in so far as commercially unjustified value adjustments on assets do not necessarily have to be corrected for commercial law purposes, but they usually do for tax purposes.

 

The Swiss Federal Supreme Court (“SFSC”) has recently issued a ruling on a case related to this topic, in the context of booking value adjustments (fluctuation reserves) on exchange-listed securities. While not setting a new precedent, it newly inflames a controversial topic: Disparate tax treatment for economically identical underlying facts.

In accordance with Swiss commercial law, a company has the choice between valuing its portfolio of listed securities at cost or at market value. In the case at hand, the company opted for the latter, resulting in an increase in valuation within a particular year, in which the associated exchange listing had increased.

 

To offset this increase in valuation, a fluctuation reserve was formed for value adjustment purposes in the same amount as the value increase of the securities in that particular year. The recognition of such a fluctuation reserve is permitted under Swiss commercial law – in line with the accounting principle of prudence.

 

However, the SFSC confirmed the tax practice applicable to date and an older court decision, ruling that the tax deductibility of fluctuation reserves is not recognized (as it can be argued these reserves are commercially unjustified provisions). It contended that the possibility under Swiss commercial law to form a fluctuation reserve (pursuant to art. 960b para. 2 CO) is not sufficient to legitimize tax deductibility of such reserve.

 

The SFSC has stated that there is no possibility to recognize fluctuation reserves on the securities portfolio from a corporate income tax perspective. Ultimately, the decision regarding whether to revalue and accept the associated tax consequences or to continue to value the securities at acquisition cost (as long as no impairment is necessary) rests with the taxpayer.

 

In the event that the decision is taken to alter the revaluation to market value, it would generally not be feasible to revert to valuation at acquisition cost in the subsequent year, and vice versa, due to the principle of consistency.

 

Furthermore, from a general, non-tax perspective, the SFSC is of the opinion that the non-recognition of fluctuation reserves from a tax perspective does not compromise the objective of enhancing transparency in accounting. Consequently, with both accounting approaches, the principle of transparency is ensured according to the SFSC.

Swiss commercial law is predicated on the “principle of prudence” and is generally regarded as being relatively conservative (allowing for a significant build-up of hidden reserves). The “accounting prevalence principle” that stipulates the commercial balance sheet and P&L, prepared in accordance with Swiss commercial law, as the initial point of departure for determining taxable profit, can be deviated from when there is a respective legal basis.

 

The recent SFSC ruling reiterates that a certain amount of accounting planning is important with regard to taxes, too. What is permissible under Swiss commercial law is not necessarily accepted under Swiss tax law.

 

This fact is exemplified by the revaluation of share portfolios, which in this case entails an additional tax burden. However, with the freedom to choose valuation methods, this tax consequence could be mitigated. From an accounting perspective under Swiss commercial law, both valuation methods result in the same outcome from a P&L perspective. However, from a tax perspective, these methods yield different outcomes. This discrepancy is not in line with the general Swiss tax practice, which foresees the same tax treatment for the same fact pattern (“substance over form”).

 

In summary, it can be said that from a tax perspective, it is more beneficial to value listed securities at their acquisition cost. This mitigates unfavorable tax consequences when the value increases (no taxation of an unrealized capital gain). Conversely, should the value of the relevant security decrease beyond its acquisition price, it would be necessary under both accounting choices, to mark down the value of the underlying security, which would yield a tax-deductible loss.