Recent news events have focused on Swiss relations with other countries from a tax point of view, but what about internal Swiss tax rules among its many cantons?

Editor’s note: This is a feature in two parts about the internal tax system in Switzerland. The first part aims to introduce the basic structure, while the second part, which will be published shortly, will deal with so-called “lump sum taxation” and other special cases which have made the country a famous, or maybe notorious, tax haven.  

Switzerland’s tax agreements with other countries have hit the headlines lately, but what about the state of play within the Swiss borders and the differences between the country’s 26 cantons?

Switzerland is known around the world as a tax haven, but at about 30 per cent, the Alpine state is well ahead of the US (24 per cent) in terms of total tax ratio as percentage of GDP, according to the latest figures from the OECD. When UBS, the Swiss financial giant, recently listed the most expensive cities in the world, Zurich and Geneva both finished top three, only beaten by Oslo. Even if other factors such as expensive insurances explain their high ranking, to view the country as a free-for-all refuge for the rich is wide of the mark.

In Switzerland, tax is paid on three levels: federal, cantonal and municipal, and the cantons have a lot of leeway. “The cantons as sovereign states are authorized to levy any type of tax as long as they do not infringe upon the exclusive authority of the Confederation,” the Swiss Federal Tax Administration says in an official document. By contrast, the cantonal constitutions define the types of taxes the municipals are entitled to levy, and those rates are often referred to as small fractions of the cantonal rates.

“It’s important to remember that Switzerland is not one country but effectively 26 countries, as the cantons are almost autonomous,” Tim Urquhart, solicitor and founding member of LS&S GmbH, a Swiss private wealth law firm which is part of the Hawksford Group, told WealthBriefing. “That means that there is fierce competition between them on tax rates.”

Urquhart co-founded the firm, which advises wealthy UK citizens who are considering moving to Switzerland, in 2008. He has lived in the country for 16 years, his fifth country of residence on the continent, and he describes it as “probably the only really democratic country in Europe”.  

Federal taxes

Switzerland is a young nation and has only been a “centralised” federal state since 1848, which might be one reason why cantons have kept so much of their independence. Four official languages (German, French, Italian and tiny Romansh) and fairly equal sized Catholic and Protestant communities have probably not contributed towards national unity.

“Historically, cantons in Switzerland were more independent than they are now,” Dieter Kindlimann, former lawyer and now senior trust manager at Rothschild Trust in Zurich, told this publication. “Over the past decades, the federal government has become more powerful, in terms of taxation as well.”

Outside observers would probably agree that Swiss cantons are still powerful in tax terms. As in the US, Switzerland distinguishes between federal tax and state (or cantonal) tax, but whereas the US has 50 tax systems across one of the biggest countries of the world, Switzerland has 26 systems spread over an area much smaller than most American states.  The major technical difference is that where federal taxes makes up the lion’s share of the tax take in the US, it is the other way around in Switzerland. The top rate of federal income tax is 11.5 per cent and on top of that the cantonal rate can vary between approximately 25 and 45 per cent.

The other important federal tax is value added tax (or sales tax) which has only been in place since 1995 and at 8 per cent is by far the lowest in Europe. There is also a federal corporate income tax with a flat rate of 8.5 per cent.

The federal military and civil service exemption tax has to be paid by Swiss male citizens who avoid military duty or civil service and it has a political rather than fiscal purpose. The rate is 3 per cent of income and at least SFr400 (abut $503).

Cantonal taxes

“The best canton for high net worth individuals is Schwyz, because it has the lowest income tax and a low wealth tax,” Kindlimann said. “There is also no inheritance and gift tax in Schwyz. Most Swiss cantons don't have that for spouses and direct descendants, but in Schwyz there are also no inheritance and gift taxes for non-related people.”

For that reason, one anonymous source told WealthBriefing that Schwyz used to be a canton where people used to move to when they were about to die, but now you must have lived there for a minimum of ten years to avoid inheritance tax, the source said.

All cantons have wealth taxes based on net wealth, even though it is a much lower factor than income tax. Historically, wealth tax was the main source of income for the cantons. The first canton to shift the balance to income tax was Basel-Stadt in 1840 and the last was Glarus in 1970.

The highest top rate of wealth tax is found in Geneva but is only 1.03 per cent of net wealth, according to Steuerrecht 2010 (Tax Law 2010), by Professor Pascal Hinny, a distinguished Swiss tax expert. Schwyz (0.19 per cent) Nidwalden (0.14 per cent) and Obwalden (0.16 per cent) have the lowest rates, while the wealth tax in Zurich stands at 0.67 per cent.

“Another favourite of mine is neighbouring Zug, which has a good understanding of the problems and needs of wealthy people,” Kindlimann said. “It is not just that tax rates are low, but they have a long tradition of meeting special demands. Generally, the German-speaking cantons have lower taxes and the French-speaking and Italian-speaking ones have higher.” 

Zug is the first choice of Doctor Christoph Oesch from the Swiss Taxpayers’ Association, as Zurich and Lucerne can be reached within 25 minutes. The association focuses more on taxation for businesses, but Oesch said he believes that it is very important to attract rich people to the country, especially as the Swiss franc is such a strong currency.

The highest cantonal income tax is found in Geneva with a top rate of 46 per cent, according to Steuerrecht 2010, whereas the lowest ones are found in Schwyz (25.4 per cent) and Zug (23 per cent). The top rate in Zurich is 40.5 per cent.

However, Geneva and Vaud are two French-speaking cantons that are often described as competitive in offering so-called lump-sum taxation, which is based on expenses rather than income (and which WealthBriefing will return to in the second part of this feature).

Real estate taxes are levied by half of the cantons; some notable exceptions are Schwyz, Zurich and Zug. Poll taxes are levied in the following cantons: Zurich, Lucerne, Uri, Nidwalden, Solothurn, Schaffhausen, Ticino, Vaud, Valais and Geneva, but the amount is very low.

"Don’t build your life around tax"

For high net worth individuals who are looking to move to Switzerland, reducing the tax bill is undoubtedly a pull but it rarely dictates where they end up living as other factors might prove as important. If you speak French, for example, you would probably want to live in a French-speaking canton. Hugues Salomé, partner in charge of tax consulting for private clients at PwC in Lausanne and Geneva, highlights the importance of location, and the fact that wealthy people often want to live near airports or by the lakeside in Geneva or Zurich. 

“Tax is not everything,” Salomé told WealthBriefing. “I rarely come across clients who are exclusively tax-driven. It’s not the only reason why people come here and it’s not a good idea if you do not like the place."

“When clients move over here, costs are the first consideration and tax is a big part of that,” Kindlimann said. “But maybe someone in the family does not want to live in the countryside of Schwyz. If you want to live in a city, then you have to move to a more expensive canton.”

“You should build tax around your life, not your life around tax,” Urquhart said.