Value adjustment of a participation in an over-indebted company: remittal to determine the fair market value (federal direct tax and cantonal and municipal taxes Zurich 2014)

Facts

The appellant, [A. AG] (the taxpayer), with its registered office in [U.] /ZH, manufactures and develops products. The sole owners are the married couple [B.] . The couple also holds [C. AG] , which held all shares in [D.] , based in [W.] (Turkey), until the end of 2013. The taxpayer has maintained business relations with [D.] for many years and has provided it with capital since 2000.

At the end of 2013, [D.] carried out a capital increase. The taxpayer participated and has since held 88.16 % of the capital. The contribution was paid by converting a claim of CHF 2'071'216.-- against [D.] . The participation was capitalised as of 31 December 2013 at this amount. In the financial year 2014, the taxpayer reduced the book value of the participation through profit or loss by CHF 500'000.-- and declared a taxable net profit of CHF 0.--.

The cantonal tax office of Zurich assessed the taxpayer for 2014 with a taxable net profit of CHF 384'200.--, not recognising the value adjustment of CHF 500'000.--. It reasoned that an independent third party would not have participated in the capital increase given the over-indebtedness of [D.] . Upon objection, the cantonal tax office reduced the taxable net profit on 3 January 2019 to CHF 317'300.--, as the addition justified an increase in a tax provision. The cantonal remedies remained unsuccessful (decision of the Zurich Tax Appeals Commission of 11 November 2019; judgment of the Administrative Court of the Canton of Zurich of 29 April 2020).

By public law appeal of 23 June 2020, the taxpayer requests to be assessed for the federal direct tax and the cantonal and municipal taxes 2014 with a taxable profit of CHF 0.-- each, alternatively that the matter be remitted for supplementation of the facts and for a new decision. The cantonal tax office and the Administrative Court request dismissal. The Federal Tax Administration requests dismissal with respect to the federal direct tax and waives a request with respect to the cantonal and municipal taxes.

The subject matter of the dispute is whether the value adjustment of the participation in the over-indebted [D.] of CHF 500'000.-- is to be recognised for tax purposes, in particular whether it is to be added back as not justified by commercial reasons (Art. 58 para. 1 lit. b, Art. 62 para. 4 DFTA).

Considerations

The Federal Supreme Court examines questions of law freely and ex officio (Art. 106 para. 1 FSCA, Art. 95 lit. a FSCA). The factual findings of the lower court may only be corrected in cases of manifest error (arbitrariness) (Art. 105 paras. 1 and 2 FSCA). As the joint assessment of federal and cantonal taxes is admissible, both taxes are dealt with together.

For the determination of profit, the principle of conformity with commercial accounts applies (Art. 58 para. 1 lit. a DFTA). Participations which qualify for the participation deduction may, pursuant to Art. 62 para. 4 DFTA, only be taken into account for tax purposes to the extent that the value adjustments are justified; to that extent there is a tax-law obligation to write up. If a company acquires an asset from a related person at a price above the fair market value, commercially only the fair market value may be capitalised (Art. 960a para. 1 CO). If the subsequent write-down exceeds the fair market value, it is to be added back for tax purposes.

In the present case, it is undisputed that [D.] is a related person. The participation was capitalised at the nominal value of the contributed claim. If it had been recorded clearly above the fair market value determined by third-party comparison, the value adjustment would not be recognised for tax purposes. According to the binding findings, [D.] was over-indebted without the conversion, so the claim was not (or no longer) fully recoverable and the contribution was a restructuring measure. However, the relevant fair market value of the participation as of the end of 2013 would have to be determined independently of the contribution and irrespective of the recoverability of the former claim, according to the valuation methods generally applicable to participations (earnings value, net asset value, mean value or practitioners' method). The lower court did not do this, and the factual findings required for it are missing.

The lower court also wrongly equated the question of the commercial justification of a hypothetical value adjustment of the claim with the value adjustment of the participation. The…