TAX NEWS - January 2010

Switzerland Tax Alert: Federal Court rules on translation gains and losses

The Swiss Federal Court recently issued its long-awaited decision on the taxation of translation gains and losses. The decision is not good news for corporate taxpayers in Switzerland with a functional currency other than the Swiss Franc, because the court ruled that translation losses are no longer deductible. Although it will be of little consolation, translation gains are likewise not taxable.

In arriving at its decision, the Federal Court considered the current accounting rules under Swiss GAAP and IFRS for accounting for translation gains and losses. Swiss GAAP does not provide any specific guidance for the translation of functional currency financial statements into presentation currency. In practice, the principle of prudence is applied and, therefore, translation losses are recognized immediately in the profit and loss account and translation gains are deferred in the balance sheet. For tax purposes, since the principle of determinacy means that generally the tax treatment follows the Swiss GAAP treatment, until the Federal Court's decision, translation losses were considered tax-deductible and the taxation of translation gains was deferred.

The Federal Court considered IFRS, which does have a specific accounting standard (IAS 21, "The Effects of Changes in Foreign Exchange Rates") that sets out the rules for accounting for the translation of financial statements from functional currency into presentation currency. Under IAS 21, when translating from the functional currency to the presentation currency, all assets and liabilities are translated at the closing rate at the balance sheet date, and income and expenses are translated at the exchange rate at the date of the transaction (or for practical reasons the average rate for the period). All resulting exchange differences are recognized in other comprehensive income, a component of equity.

The Federal Court concluded that the Swiss GAAP principle of prudence does not apply because the translation gains and losses are not real economic losses and, therefore, should not affect the profit and loss account.


What does this mean for corporate taxpayers?

The Federal Court decision is binding for federal tax and Geneva cantonal and communal tax purposes. It is anticipated that the federal tax authorities will put pressure on the cantons to adopt the new rules, at least in the computation of federal tax.

Tax provision calculations and tax accounting should be modified to take the decision into account for the current year and going forward. In respect of prior tax years that are still open, the tax provision position needs to be reviewed to ensure there are adequate tax provisions, taking into account the nondeductibility of translation losses.

It is also recommended that accounts submitted with tax returns for prior years that have been finally assessed are reviewed to ensure that translation losses and gains have been adequately disclosed. If not, there is a risk that the tax returns can be re-opened and additional tax may be due.


Review the company's functional currency

Companies applying Swiss GAAP (CO) may wish to consider whether a change of the functional currency to the Swiss Franc is possible; this might be more difficult for companies applying a specific accounting framework such as, for example, IFRS or U.S. GAAP, where the rules relating to the determination of functional currency are more stringent.


Temporary differences and deferred tax

In many cases, if all assets and liabilities are translated from the functional currency to Swiss Francs at the balance sheet date exchange rate, there are no particular issues arising from translation gains and losses for deferred tax purposes. However, if some assets are translated at historical exchange rates, there could be a temporary difference arising as a result of the difference between the asset translated at the historical rate and the asset translated at the balance sheet date exchange rate. Companies need to ensure that deferred taxes are accounted for appropriately on these differences under the respective reporting GAAP.