In a landmark decision, the Administrative Court of Zug has clarified that the profit margin of a group company cannot be averaged over several years to reduce the tax burden for the current year. The court ruled that each tax year must be assessed independently and that taxpayers have no right to retroactively offset alleged over taxation from previous years (judgment of 5 December 2024 (Case A 2023/1, final judgement)
Background
At the center of the dispute is a legal entity headquartered in the Canton of Zug that belongs to an international pharmaceutical group and has been acting as a limited risk distributor since 2018. In its 2018 tax return, the company reported a negative operating margin of minus 21.8 %. To defend this result, the taxpayer argued that a three year average from 2016 to 2018 offered a more accurate picture of its economic performance. A year-end adjustment in 2018 compensated for the excessive profits of previous years, resulting in an average margin of 1.2% over three years. This margin is within the interquartile range in a multi-year comparison.
Position of the tax authority
The cantonal tax administration rejected the year end adjustment, arguing that the 2018 margin did not comply with the arm’s length principle and could not be justified by multi year averaging. For the 2018 fiscal year it applied a margin of 1.1 %, corresponding to the lowest value in the interquartile range of a benchmarking study prepared for the taxpayer. This adjustment increased the taxable profit by approx. CHF 9 million.
Taxpayer’s arguments
Before the court, the taxpayer invoked the OECD Transfer Pricing Guidelines, which allow the use of multi year data to determine arm’s length prices. It contended that smoothing margins over 2016–2018 justified the 2018 result and provided a more complete view of the company’s performance, noting that margins in previous years had been excessively high and therefore warranted a correction in 2018.
Court’s reasoning
The Administrative Court of Zug rejected the taxpayer’s arguments, emphasizing the Swiss principle of periodicity, which requires each tax year to be assessed independently. Multi year smoothing is impermissible, particularly in the absence of exceptional circumstances that could explain the 2018 loss. According to the court decision, every business entity must be taxed on the economic value it generates each year. It is not permitted to offset a negative annual result by averaging it with prior positive years.
Implications for transfer pricing practice
The court decision reinforces the central role of the periodicity principle in Swiss tax law. High margins in earlier years cannot later be flattened through adjustments, even if supported by transfer pricing studies based on multi year data.
Companies operating in Switzerland should ensure that all IC transactions are priced in accordance with the arm’s length principle and that the results for each financial year reflect the financial performance for that year.