30 March 2017 – The Swiss Supreme Court nullifies a practice of the Zurich tax authorities regarding real estate capital gains taxation and demands the strict observation of federal tax rules by the cantons and the municipalities.

Mr. X lived in a municipality in the Swiss canton of Zurich. In 2011, he sold his property there. He then transferred his domicile to the Swiss canton of Graubünden, where he acquired a new property that was used by him and his wife. Based on the reinvestment of the sale proceeds in self-used real property, the tax office of the Zurich municipality granted a deferral of the real estate capital gains tax (which is available if the new property serves a permanent and exclusively personal use, see art. 12 (3)(e) of the Federal tax harmonization act). At the end of 2012 (after 22 months), Mr. X and his wife had to leave Switzerland for professional reasons and moved to the United Kingdom. They kept the Graubünden property as a secondary residence.

Based on the departure in 2012, the Zurich municipality concluded that the 2011 tax deferral conditions were no longer met and therefore revoked it. Consequently, they asked for payment of the tax on the capital gain derived from the sale in 2011 (CHF 220’000 plus interest). The consecutive appeals filed by Mr. X against that decision were all dismissed by the respective Zurich courts. The Zurich Administrative Tribunal considered in its judgement that a use of the new property that lasted 22 months was too short and could not be characterized as being “permanent” in the sense required by the law in order to qualify for a tax deferral.

In its judgement of 7 March 2017, the Swiss Supreme Court (the Court) approved the appeal of Mr X (represented by Robert Desax of Walder Wyss). The Court concluded that the revocation of the tax deferral by the Zurich municipality violated Swiss federal law. The Court stated that, under federal law, a deferral must be granted if a property that served a permanent and exclusively personal use is sold if the proceeds are reinvested within a reasonable period of time for the acquisition (or construction) of another Swiss property that serves the same purpose. The law does however not require a minimum period of stay at the new place. The Court emphasized that the term “permanent” is defined by federal law exclusively. The cantons and municipalities therefore have no discretion at all when it comes to the interpretation of that term. They must especially not require that additional conditions be met for a tax deferral than the ones already provided for by federal law. It was therefore not permissible for the municipality to revoke the tax deferral on the basis of the subsequent departure. The fact that Mr. X had established a genuine domicile at the new place in Graubünden was decisive (and sufficient) for the Court. The departure after 22 months was not harmful. A domicile under Swiss law does not need to be established “for all eternity”. The Court made it clear that the intention to leave a place at a later stage (due to non-foreseeable circumstances) did not exclude the valid constitution of a domicile.

The Court also put an end to a long-standing practice of the Zurich tax authorities. Based on a circular letter of the Zurich finance department, the Zurich tax authorities require that a taxpayer stay at least five years at the new place in order to benefit from the tax deferral. The Court found that this five-year “standstill” rule violated federal laws as well as the constitution and thereby confirmed the claim made by Mr. X from the outset of the procedure. That particular circular letter was not explicitly quoted by the Zurich authorities as an immediate basis for the revocation of the tax deferral for Mr. X. In the past, the Zurich Administrative Tribunal has however repeatedly stated that it considered that standstill rule to be compliant with federal legislation. Incidentally, it also confirmed this assessment its judgement concerning Mr. X.

Pursuant to the Court’s judgement the five-year standstill rule has become immediately null and void and may not be applied to other ongoing procedures either. The Zurich finance department will thus have to revise its circular letter. Should other cantons require the fulfilment of similar conditions, then the Court’s findings can be invoked by taxpayers and applied to them as well.

Generally speaking, the judgement confirms the Swiss Supreme Court’s traditionally tough stance on the cantons and the municipalities when it comes to the question of their compliance with harmonized federal tax laws.

Should you have any questions on the Swiss Supreme Court’s judgement or on its implications please do not hesitate to contact Robert Desax (direct line: +41 58 658 52 77 or robert.desax@walderwyss.com).

Judgement of the Swiss Supreme Court of 7 March 2017, 2C_306/2016, to be published in the Court’s official bulletin. The judgement is available here.