Swiss canton’s tax regime irks Brussels

Stroll down the Bahnhofstrasse, and the most immediate impression of Zug, a town of 26,000 people, is of a developing country boomtown rather than Swiss backwater.

Large anonymous office blocks line the boulevard from the bustling station. Expensive shops, luxury car dealerships and marble clad banks break up the monotony. Money is in the air.

But Zug’s wealth has not been made from diamonds or oil – although both happen to be extensively traded there – but tax.

This week, the European Commission identified the capital of the eponymous canton, and neighbouring Schwyz, as examples of “unfair” fiscal competition practised by Switzerland to the detriment of European Union members.

The complaint, brewing since autumn 2005, was based on a 1972 free trade agreement between Bern and Brussels, and stoked by Switzerland’s recent successes in attracting high profile companies – often away from EU countries. Last month, Kraft Foods of the US joined groups such as Procter & Gamble and Honeywell Bull in upping sticks.

Swiss lawyers dismiss the case as without merit, as the free trade deal does not cover taxation. Moreover, Switzerland, being outside the EU, is not bound by its rules.

But the dispute reflects a deeper disapproval in European capitals that the Swiss – arguably the EU’s most conspicuous non-members – have benefited from virtual membership of the club, without having to abide by its rules. Swiss multinationals, such as Nestlé or Novartis, have enjoyed access to a market now numbering 500m people. But their government has been able to cherry pick the rules – notably on tax.

As the granddaddy of Switzerland’s low tax cantons, Zug has been particularly exposed.

“We don’t understand why the Commission has made these accusations now,” says Peter Hegglin, the cantonal finance minister. “I’m convinced our position is fully in line with the free trade agreement.”

Like most Swiss, Mr Hegglin emphasises the role of tax competition as a cornerstone of Switzerland’s extreme form of devolution, where individual cantons and communities set their own levies, and as an instrument to ensure lean, efficient government.

“Tax competition is something that is so deeply ingrained in Switzerland internally that the government has little leeway to negotiate anything,” says Walter Kielholz, chairman of Credit Suisse.

The system has served Zug well. From its farming roots, the canton reacted to the decline of its limited industrial base since the 1950s by boosting its appeal to business.

One way was by being more liberal in granting work permits to foreigners than more restrictive Zurich, the country’s leading commercial hub.

Business friendly taxation was the other. Zug is now the hub for companies from global commodities traders, such as Glencore, to the regional headquarters of leading pharmaceuticals groups. Nord Stream, the Russian dominated consortium planning a new gas pipeline under the Baltic, is the latest of many arrivals.

Zug’s appeal lies in its proximity to Zurich, its lawyers, accountants and consultants – and its modest taxes. All companies must pay Switzerland’s nationwide 8.5 per cent federal profits tax. Some others also face cantonal and municipal levies, taking the total to 16-16.5 per cent.

But special rules apply to enterprises, whether Swiss or foreign, with activities abroad, limiting their tax to 11-12.5 per cent.

That, along with the relative certainty that the rules will not change, has made Zug attractive for holding companies or groups involved in trading or distribution.

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