Net Tax Rate Method

When calculating and declaring VAT in Switzerland, not all companies have to follow the conventional effective billing method. This blog explores the net tax rate method as an alternative to the effective billing approach. We outline what the net tax rate method is, who can use it, and how it works in practice. We also examine the relative advantages and disadvantages of this approach and conclude on when it makes sense to use it.

What is the net tax rate method for calculating VAT?

The easiest way to understand the net tax rate method for VAT is to compare it to the conventional effective billing method.

Effective billing method

All Swiss companies with an annual turnover exceeding CHF 100,000 must register for and pay VAT in Switzerland. The conventional way to calculate and account for VAT is known as the effective billing method. In short, it involves declaring the VAT collected on sales turnover (usually at the standard rate of 8.1 %) and deducting the VAT paid on production costs (input tax).

The difference is the VAT amount the company owes to the Swiss tax authorities. With this method, VAT is accounted for and paid quarterly.

Net tax rate method

Not all companies are required to use the effective billing method for calculating VAT thanks to an alternative approach known as the “net tax rate method”, sometimes called the “balance tax rate method”. The net tax rate method was introduced to ease the administrative burden for small and medium-sized enterprises (SMEs) and simplify the VAT accounting process.

The method involves calculating the VAT liability at a flat rate of turnover while ignoring input tax deductions. The flat rate used is lower than the statutory VAT rate of 8.1 %, and therefore implicitly factors in the input tax deduction without companies needing to calculate them separately. In other words, it makes an implicit estimate of the input tax which is reflected in the lower net tax rate percentage.

Each industry has its own specific net tax rate based on the expected average input costs of the industry in question. For example, service-related industries such as legal services tend to have a higher net tax rate of 5.9%, because one would expect their input tax to be quite low compared to their output.

In contrast, industries involved in selling goods with a high production cost and relatively low mark-up, such as a new car trader, have a much lower net tax rate of 0.6%, as their input tax value is expected to be quite close to the value of their output tax.

With the net tax rate method, the VAT owed is calculated and settled every 6 months as opposed to quarterly.

Who can use the net tax rate method?

The net tax rate method was specifically created to simplify VAT accounting for SMEs. Therefore, larger businesses with a higher turnover may not be eligible to settle their accounts using this approach. In general, a company may opt to use the net tax rate method if they meet the following two criteria:

• Their annual taxable turnover (including VAT) does not exceed CHF 5.005 million.
• The tax owed does not exceed CHF 103,000 per year. This is calculated by multiplying the total taxable turnover by the net tax rate which applies to their industry.

The consequence of the second point is that, for industries with a higher net tax rate, the taxable annual turnover needs to be well below CHF 5.005 million. For example, an architectural office with a net tax rate of 5.9% may only be allowed to use the balance tax rate method if their annual taxable turnover does not exceed CHF 1.74 million.

How does the net tax rate method work in practice?

The net tax rate method simplifies the administrative burden for companies in two ways:

• Firstly, the input tax statement is no longer required.
• Secondly, the VAT statement only needs to be prepared once every 6 months, compared to quarterly with the effective method.

However, there are some practical aspects to keep in mind for companies applying the net tax rate method:

Invoicing using the statutory VAT rate

Firstly, even when using the balance tax rate method for calculating their final VAT liability, the correct statutory VAT rate must still be shown on invoices for billing customers. This is usually the standard rate of 8.1 % but could also be the reduced rate of 2.6% or 3.8% depending on the products or services provided.

It is important that the correct statutory VAT rate is shown on the invoice. If, for example, the company quotes a tax rate that is too high (e.g. 8.1 % instead of the correct reduced rate of 2.6 %), they will have to cover the difference between the VAT calculated using the stated tax rate and the correct VAT in accordance with the appropriate statutory rate.

This is in addition to the VAT calculated using the appropriate net tax rate. Therefore, the cost of incorrect invoicing of statutory VAT can be high for those using the net tax rate method.

Net tax rate on turnover including statutory VAT

It is also important to note that the net tax is calculated as a percentage of the final turnover including the quoted statutory VAT amount. The company bills its customers an amount which includes statutory VAT, and it is the total of this turnover that is used when calculating the net tax applicable.

Payment to the Federal Tax Administration

The final VAT payment made to the Federal Tax Administration (FTA) is the amount calculated by multiplying the total taxable turnover (including statutory VAT) by the approved flat net tax rate (industry specific, set by the FTA). This value could be higher or lower than the actual effective tax amount if input and output tax had been separately calculated.

What are the applicable net tax rates?

The approved net tax rates are industry-specific and range from 0.1% to 6.5%. It is important that businesses who opt to apply the balance tax rate method use only the approved rate applicable to their industry. The FTA allows taxpayers a maximum of two applicable net tax rates. This may be needed for those who have turnover across more than one industry. A full list of the industry rates can be found here.

How does a company opt to use the net tax rate method?

Businesses who would like to use the net tax rate method must inform the FTA in writing and fill out the relevant form when registering for the first time. If you want to use the net tax rate method from the start of your tax liability, you must notify the FTA in writing within 60 days of receiving your VAT number.

If you fail to do this, you must first use the effective method for at least three full years before you can request to change to the net tax rate method at the beginning of a new tax period.

To be granted permission to use the net tax rate method, the total taxable turnover must not exceed CHF 5.005 million and the calculated tax owed using the applicable net tax rate must not exceed CHF 103,000 in the first year of tax liability or in the year before changing from the effective method to the net tax rate method.

Advantages and disadvantages of the net tax rate method

The net tax rate method was designed to simplify the VAT administrative process for SMEs, and therefore offers several benefits. However, there are also some potential downsides to consider.

Advantages of the net tax rate method

• Reduced settlement frequency: Businesses who use the net tax rate method only need to settle their VAT liability twice a year as opposed to every quarter.
• Simplified calculation: The net tax rate method simplifies the VAT calculation process, making it more straightforward for businesses with limited resources or complex transactions. Input tax need not to be calculated because it does not get deducted from the tax liability. 
• Predictable tax liability: Since the net tax rate is a fixed percentage of turnover, businesses can predict their VAT liability more easily, aiding in financial planning.
• Administrative ease: The streamlined nature of the net tax rate method reduces the administrative burden associated with VAT calculations and reporting. This can also save costs.

Disadvantages of the net tax rate method

• Lack of precision: The net tax rate method is based on industry averages and may not accurately reflect the actual VAT liability for all businesses. This can, in some cases, be advantageous to businesses who would have otherwise had a higher VAT liability when calculated with the more accurate effective billing method. However, other businesses may overpay VAT if the predetermined percentage exceeds the actual VAT liability based on effective billing.
• Limited applicability: The net tax rate method may not be suitable for all businesses, especially those with diverse and complex transactions. Such businesses may also not be able to clearly determine which industry rates they should apply and may fall into more than the maximum two allowable balance tax rate categories.
• Additional expertise required: Even though the balance tax rate method is designed to simplify the VAT reporting process, changing methods from the conventional effective billing method to the net tax rate method requires knowledge and expertise of both methods.

When does it make sense to opt for the net tax rate method?

The net tax rate method was designed to make the VAT reporting process simpler and less burdensome for SMEs with limited administrative and accounting resources. However, it can also bring additional advantages in the form of actual tax savings.

On the other hand, it can result in an increased tax burden. It all depends on the individual company and how their input expenses compare to the industry average.

If your company has significantly lower expenses than your industry average, there is the opportunity to save on taxes when using the net tax rate method (which implicitly makes an estimate of your input tax based on the industry average).

On the other hand, if your expenses are higher than average, then using the net tax rate method can result in overpayment of VAT. This can occur especially in your first years of operation, during which time expenses may be high compared to the turnover you realise, or you may even be making a net loss.

For this reason, if you can handle the administration, it may make sense to first use the effective tax rate method for the first three years and then shift to the net tax rate method once it is clear it would bring financial and administrative advantages.

For companies whose expense and income profile are relatively close to the industry average, using the net tax rate method would not make a significant difference in terms of tax liability. In this case, the benefits would be purely in the form of simplified administrative with fewer VAT reporting periods in the year.

This itself can be a major draw for small companies who don’t have the time or resources to apply the more complex effective billing method.