Attribution and allocation of income from electronic commerce (I)

* Domestic law
– In general
There is no specific rule or established practice regarding attribution or allocation of income derived from electronic commerce. In this context, Switzerland tends to apply the general rules applicable to non-electronic commerce.
As mentioned earlier, resident enterprises are taxed on their worldwide profits.
For corporations, Switzerland applies a classical system under which profits are
first taxed at the corporate level and second, upon distribution, as income at the shareholder level. No tax credit is granted to shareholders receiving dividends.
Under certain conditions, a resident corporation can benefit from the participation deduction (articles 69 and 70 DTL) on participation income (including capital gain). Furthermore, Switzerland applies the exemption method for the avoidance of double taxation. Profits attributable to a foreign PE are exempt from tax.
For associated corporations, there is no tax consolidation system. A Swiss subsidiary, even if it is owned or controlled by non-residents, is treated as a resident entity subject to unlimited tax liability. In other words, each corporation is treated as a separate entity which should enter into arm’s length transactions with its associated counterpart. Under a very large body of cases, the tax authorities are allowed to readjust the accounts of associated corporations for any transfer of value (prestation appréciable en argent, geldwerte Leistung) which, to the knowledge of the transferring company, departs from what would have been granted to, or required from, a third party in similar circumstances. Such a transfer is then treated as a hidden profit distribution subject to profit tax and federal withholding tax. For the purpose of defining the proper arm’s length price of a transaction between associated enterprises, the Swiss approach, although rather pragmatic, applies the traditional methods recommended by the OECD in its transfer pricing guidelines.22 Article 58 paragraph 3 DTL provides for the three traditional methods of the OECD. While this provision refers only to hydroelectric enterprises, it is generally recognized that it reflects the general rules also applicable in other fields.  In electronic commerce, it will be difficult to define the proper arm’s length price of a transaction. In particular, it will be difficult to identify precisely what the transaction is.  This is especially the case for associated enterprises because the Internet offers vast possibilities of communicating and offering services internally through intranets, which are difficult to define and trace. In addition, proper analysis of the functions of the parties involved will have to consider the specific and rapidly changing value of the intangibles, as well as the consequences of disintermediation.
While many commentators tend to advocate the use of the profit split method in this area, similarly to global trading, Switzerland prefers to use more traditional methods of transfer pricing. It is true that, at the present time, there are few comparables in the digital sector, which will render the application of the comparable uncontrolled price (CUP) method difficult. In the near future, however, comparables may appear with the growth of electronic commerce. Furthermore, the cost plus method is generally used by Switzerland in the service sector. In particular, commercial and administrative services (such as market studies, research and development, advisory activities, or marketing) performed by a Swiss company for other associated enterprises are usually taxed under a cost plus method, in the sense that 5 per cent of the total costs (taxes included), or 1/12 (i.e. 8.33 per cent) of total salaries is required as the minimum relevant tax base (so-called service company status).  In many cases, in particular for ISPs, this tax regime should be applicable in Switzerland.