The Swiss Forfait Tax Under the US Foreign Tax Credit Rules

As a US tax accounting firm in Switzerland, we are often asked whether tax paid to Switzerland under a “forfait” or “pauschal” ruling (“forfait tax”) is creditable against the US income tax under the US foreign tax credit provisions. The US foreign tax credit is a dollar-for-dollar credit with respect to foreign taxes paid and is intended to alleviate the burden of simultaneous taxation by two countries on the same income.

This is not a frequent occurence in any event as there are relatively few US persons residing in Switzerland, and even less US persons who are on this special tax regime. However, we have been asked this question frequently so we thought it would be helpful to those rare birds to which this approach applies.


Switzerland imposes personal income tax on persons who are tax resident in Switzerland. But by application, an individual may be permitted to be taxed on a more favorable basis rather than by an assessment of his or her actual income. The general basis on which the tax is imposed is a multiple of the annual rental income value of the individual’s residence in Switzerland, the multiple usually being five. This amount is then subjected to normal Swiss personal income tax rates, as if it were the individual’s income. This is the “forfait” tax. Foreign entertainers, sportsmen, and other wealthy individuals have long enjoyed the possibility of migration to Switzerland without unduly burdensome taxation by means of the forfait regime.

An individual’s right to forfait taxation is only granted by a ruling. Some Swiss cantons, such as Zurich, do not grant the forfait tax arrangement. For the ruling to remain valid, the individual cannot work or pursue gainful economic activity (e.g., a profession) within Switzerland, although he or she may do so elsewhere.

In addition, the amount of the tax due under the forfait ruling must not be less than the individual’s normal Swiss income tax would be with respect to income from Swiss sources (e.g., dividends, interest paid by Swiss companies or banks, income from Swiss real estate) and income from non-Swiss sources on which foreign tax is reduced or eliminated by a tax treaty. In this latter situation, the forfait holder does not lose his forfait ruling, but must pay the higher of the two taxes.


Under the 901 Credit rules, an individual is allowed to offset, or credit, against his or her US federal income tax liability the amount of “any income, war profits, and excess profits taxes” he or she pays to another country, subject to limitations not relevant to this analysis. Under the 903 Credit rules, the term “income, war profits, and excess profits taxes” includes a tax paid “in lieu of” a tax on income, war profits, or excess profits otherwise generally imposed by a foreign country. So, if a foreign income tax qualifies as a 903 Credit an individual is also allowed to offset the 903 Credit against his or her US federal income tax liability.

The question we often receive is whether the forfait tax qualifies as either an “income tax” under the 901 Credit rules or an “in lieu of” tax under the 903 Credit rules.

A. The Forfait Tax Is Not a 901 Credit

Whether a foreign tax qualifies as an “income tax” within the meaning of the 901 Credit rules depends primarily on whether the tax constitutes an income tax in the US federal income tax sense. The key requirement for so qualifying is that the foreign tax must fall on net income/gain. Generally, a foreign tax will satisfy this requirement if it is levied on an amount computed in such a manner that it is very unlikely that the taxpayer will have to pay the tax in the absence of net income/gain.

Without going into detail, we have previously concluded that the forfait tax does not qualify under the 901 Credit rules, and thus is not a tax creditable under these rules. A recent liberalization trend regarding foreign tax credits has developed under court cases and IRS guidance in the past few years, which may undercut the strength of that conclusion, yet most practitioners still hold the forfait not to qualify as a 901 Credit. Regardless of that conclusion, the forfait does qualify as a creditable tax under the 903 Credit rules.

B. The Forfait Tax Should Satisfy 903 Credit Rules as an “In Lieu Of” Tax

The 903 Credit rules were designed to permit a tax that would not otherwise satisfy the 901 Credit rules as a creditable “income tax” to be treated as an “income tax,” and thus to be creditable. Like the 901 Credit rules, the 903 Credit rules set certain standards for a foreign tax to qualify as an “in lieu of” tax.

First, the foreign tax must be a “tax”, which means that the tax must be a compulsory levy by a foreign government, but cannot be a fine, penalty, customs duty or the like, and cannot be in exchange for a specific economic benefit (e.g., a license fee). There seems little doubt that the Swiss forfait tax satisfies this criterion.

Second, the tax must be a substitute for, and not an addition to, an otherwise generally imposed income tax. The Swiss forfait tax would appear to satisfy this criterion. The fact that the individual might be subject to additional tax as a result of Swiss-source income exceeding the forfait tax base amount would not appear to disqualify the forfait tax from US foreign tax creditability.

The forfait tax should thus be treated as an “in lieu of” tax under the 903 Credit rules. Most importantly, the 903 Credit rules make it clear that the net income/gain requirement of the 901 Credit rules do not apply to foreign taxes that are “in lieu of” taxes.

Our conclusion in this regard is also supported by an IRS advice (called a Field Service Advice). In this particular IRS advice, a Swiss corporation obtained a ruling from the Swiss tax authorities which provided that instead of paying normal Swiss corporate taxes, the corporation paid a tax computed as a percentage of its expenses. The IRS advice concluded that the tax qualified as 903 Credit. It made reference to the fact that the net/gain requirement of the 901 Credit rules do not apply. The Swiss tax in the IRS advice bears a strong resemblance to the Swiss forfait tax for individuals.

Consequently, the IRS should view the Swiss forfait tax as a tax that can be credited against US tax liability under the US foreign tax credit rules (viz., the 903 Credit).

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