Dividends of self-employed entrepreneurs in swiss small and medium-sized enterprises: loss of social security contributions

In spring 2023, the Federal Council was assigned by the Council of States to prepare a report on the loss of social security contributions or ”AHV” contributions relating to the payment of dividends to entrepreneurs with the status of “employee- entrepreneur” in Swiss SMEs since the introduction of the ‘RIE II’ tax reforms (Corporate Tax Reform II), which came into force in 2009, and the ”RFFA” (Federal Act on Tax Reform and AHV Financing) of 2020. Simultaneously with this study, our Federal Authorities were also mandated to propose measures, where appropriate, to tackle potential cases of abuse of payment of ‘excessive’ dividends. The federal executive submitted its report on 15 October.

Fabien Nanchen Wealth Planning  - Swiss tax specialist, Edmond de Rothschild

Background 

For Swiss company directors, dividends – as opposed to salaries – are not subject to social security contributions (AHV/AI/etc.). In addition, entrepreneurs-shareholders, who own in principle more than 10% of their company's share capital in their private assets, benefit from a favorable tax regime, given that only 80% to 50% – depending on the canton of residence – of the dividend constitutes taxable income. 

According to the Member of the Council of States who initiated the postulate, these differences in treatment in terms of social security contributions and taxes may have encouraged entrepreneurs to favor the payment of dividends over salary income, sometimes to an excessive degree, mainly to the detriment of social security contributions.

The Swiss Federal Council analysis

The Swiss Federal Council recalls that in view of optimising the tax and social security contributions of the company and its shareholders, the company's directors can freely choose the various legal forms of companies and ways of remuneration available by laws. In fact, according to established case law, the Federal Court considers that it is not the competence of the authorities to review freely adequacy of salaries or dividends; they may only deviate in the  distribution chosen by the taxpayers in case of clear disproportion between (1) the work performed and the salary or between (2) the capital invested and the profits distributed.

The Federal Council observes that, despite corrective measures taken at the level of partnerships, the “RIE II” has increased the attractiveness of corporations to the disadvantage of partnerships. This trend is associated to the increase in the conversion of “RI” into corporations since 2008/2009. The somewhat significant reduction in corporate income tax rates introduced by the “RFFA” reform is certainly a factor in the current success of this legal form of entrepreneurship and the “opportunistic” decisions made by entrepreneur-shareholders.

The Federal Council also notes that the current case law of our High Court requires the cumulative conditions to be satisfied:  (1) factually, the payment of an “abnormally low” salary (in the sector of activity and under normal “market” conditions) and (2) simultaneously, a clearly excessive distribution of profits through the payment of dividends. In the absence of a uniform and objective limit above which a dividend should be considered disproportionate, our courts have repeatedly referred to the guidelines issued by the Federal Social Insurance Office (FSIO) in the last few years, which provide for an assumption  that a distributed profit may be disproportionate when it represents 10% or more of the value of the corporation in principle. It should be noted that these guidelines are not binding for citizens, authorities, or judges.

In its analysis, the Federal Council notes that certain neighbour countries have legislated on the basis that entrepreneur-shareholders are considered self-employed for tax purposes, thereby allowing social security contributions to be levied on their income, including dividends received. The competent authorities are the tax authorities in respect of control and not the authorities responsible for social security contributions, such as in Switzerland.

For the Federal Council, the advantages of corporations over partnerships have led to a decrease in the number of individually owned companies, resulting in a shift from self-employment to entrepreneurs with employee status. This has led to a shift from professional income to capital gains, resulting in tax and social security savings that the Federal Council is seeking to reduce.

Measures issued by the Federal Council 

Based on this observation, the Federal Council aims to reduce this discrepancy and considers the possibility to introduce corrective measures in Switzerland through two different options: (1) on the one hand, by (re)classifying majority shareholders in Swiss SMEs as self-employed (which the Federal Council immediately ruled out, considering the enormous effort required to adapt the existing systems for the sole purpose of combating abusive situations) and (2) on the other hand, subjecting a portion of the dividends paid to entrepreneur-shareholders—which are clearly excessive—to social security contributions.

The Federal Council clearly favors the second option, which would make it possible (1) to target and tax excessive dividends appropriately (2) strengthen legal certainty for companies and citizens, and (3) simplify administrative controls.

An in-depth analysis of these measures, aimed at resolving the practical and legal difficulties of such an approach, will be undertaken as part of the next ”AVS” reform (social contributions reform), which is expected to come into force in 2030. 

Biography

Fabien Nanchen joined Edmond de Rothschild's Wealth Planning team in Switzerland in June 2024. Based in Geneva and Lausanne, he works closely with EdR's Swiss and international Wealth Planning teams present in seven jurisdictions. With nearly 30 years' experience as a Wealth Planner and expert in personal and corporate taxation, he has worked for banks, the Vaud tax authorities and fiduciaries.