The article explores the reality of hedge fund managers moving operations to Switzerland, the major drivers and inhibiting factors for such moves as well as the most commonly used structures from the perspective of two service providers advising fund managers on their Swiss relocation.
From April 2010 the UK income tax rate for earnings of more than £150,000 will be raised to 50%. The impact of this tax increase is aggravated by the tightening of the resident non-domiciled rules in previous years which no longer permit UK resident but non-domiciled hedge fund managers to leave a portion of their income offshore. The UK like many other European countries is suffering from budgetary restraints imposed by massive sovereign borrowings during the financial crisis. The prediction of fund managers and economists alike therefore is that taxes throughout the EU including the UK will continue to rise in the medium to long term.
Furthermore, there is significant concern amongst fund managers with respect to the proposed EU regulation of the alternative investment industry. Even though the latest compromise proposals and re-drafts of the AIFM directive have shown a more measured approach than the initial Commission draft, hedge fund managers based in the EU can expect a much more rigid and restrictive regulatory environment which will have a significant impact on their operations and profitability.
Importance of soft factors
Soft factors continue to play an important, if not decisive role in fund managers’ decision making process whether or not to move operations to Switzerland. A not insignificant percentage of London based fund professionals (and often their spouses) is not willing to swap the hectic English metropolis for a more peaceful life in Zurich, Geneva or the even more rural Zug and Schwyz. Despite its central location in the heart of Europe, its beautiful landscapes and the proximity of great skiing, it needs to be acknowledged that life in Switzerland is not for everybody. Having talked to many UK based fund managers who are considering a move, we have learned that these soft factors are not to be underestimated.
Best of both worlds: dual set-up
Even though there have been a few prominent examples of fund managers having left London for good, it is our observation that the majority of fund managers that have moved or are in the process of moving to Switzerland prefer a dual set-up, i.e. they maintain a London presence and open a new second office in Switzerland. This structure has a number of important advantages:
• London continues to be a financial center and an important place to meet with investors, service providers and other counterparties. Fund managers do not want their move to interfere with their existing relationships. The dual set-up enables fund managers to maintain their existing London network while enjoying the Swiss tax benefits and being in close proximity to continental Europe’s largest institutional investor base.
• A dual set-up offers attractive tax planning solutions. Having a presence in London as well as in Switzerland opens up a wide range of tax structuring options. Typically, dual set-ups involve the establishment of a Swiss corporation or a branch of the London office in Switzerland. Based on a functional analysis, total income is allocated between the London office, the Swiss corporation/branch and possibly other offshore entities. This can be used to optimise overall taxation and reduce taxation of the implicated Swiss resident entity and individuals.
• Fund principals will often find it difficult to move their entire London team to Switzerland. Due to the above mentioned soft factors, a number of team members will likely not want to relocate. A dual set-up will allow fund principals and a part of the team to move while accommodating those who prefer to stay in London.
• A dual set-up creates structural options to respond to future developments in tax and regulatory matters in and outside the EU. It is far from clear where regulation and taxation of fund managers in Europe is heading. Having one leg in the EU/UK and another in Switzerland will allow fund managers to be flexible in their reaction to such changes by shifting certain roles and activities within their organisation to another jurisdiction.
There are a number of myths surrounding Swiss taxation:
• Contrary to public belief, taxpayers in Switzerland are not able to negotiate their tax rates with the authorities. In reality, the Federal and Cantonal tax authorities are bound by and cannot deviate from the tax rates determined by the legislator.
• The often cited Swiss lump sum taxation regime for individuals is generally not available to hedge fund managers. As Swiss tax law considers the activity of a fund manager as “gainful”, the legal conditions to qualify for lump sum taxation are usually not met.
The key advantages of the Swiss tax system are (1) a transparent and competitive tax environment with some cantons offering very low corporate and individual income tax rates, and (2) an excellent ruling practice where a taxpayer can approach both the Federal and the cantonal tax authorities with a complex structure to agree on the tax consequences in a binding ruling.
The average corporate income tax rate in Switzerland is approximately 21%. However, the canton of Schwyz has recently amended its tax law to reduce the effective corporate income tax rate in the municipalities of Wollerau or Pfäffikon to approximately 11.8%. A further reduction of the corporate income tax rate applies to so-called mixed companies, i.e. companies generating at least 80% of their revenue and having at least 80% of their expenses outside Switzerland. If these conditions can be met, the corporate income tax rate can be reduced to between 9% and 12%.
For individuals cantonal tax rates range from approximately 20% to 45%. Due to a recently introduced tax reform an individual may benefit from a special tax relief on dividend income. In many cantons, the overall tax burden on dividend income may be reduced by 40% to 75% for shareholders holding at least 5% or 10% in the capital of a Swiss company. Pursuant to a recent decision of the Swiss Supreme Court this tax privilege also applies to dividends from foreign companies.
Conclusion and outlook
Due to its favourable tax regime, sound infrastructure and large investor base, Switzerland will continue to attract fund managers from the UK and other EU countries. The predominant relocation structure seems to be the so-called dual set-up where the manager maintains its London presence and opens a new office in Switzerland. This structure has a number of significant technical and practical advantages and allows for interesting tax structuring options.
Markus A. Federle is a co-founder and Managing Director of the The Fairsky Group. He advises fund managers on the relocation of their operations to Switzerland. Roger Dall’O is a certified Swiss tax expert and Partner at Tax Partner AG, a Zurich based tax advisory firm. He specialises in advising hedge fund clients on their Swiss tax set-up.