Zurich Could Become One of the Most Attractive Locations for Establishing Charitable Foundations in Switzerland and Internationally

1. Starting Point

Switzerland as a whole is one the most attractive locations in the world to establish a charitable foundation. The country has over 13,000 charitable foundations with assets totaling almost CHF 100 billion. Half of all the charitable foundations in Switzerland have been established in the last 20 years. The country has six times more charitable foundations than the USA or Germany on a per capita basis. Charitable foundations in Switzerland distribute between CHF 2 and 2.5 billion annually.[1] Within Switzerland, with 2,219 charitable foundations that manage estimated combined total assets of over CHF 18 billion, Zurich is the most popular location for establishing a charitable foundation because of its role as an international financial center.[2]

Switzerland is popular for establishing charitable foundations because of the country’s political stability economic development, the liberal charitable foundation law and the intention of founders to make a contribution to the pursuit of idealistic purposes.[3]

In Switzerland, charitable foundations play an important role in the promotion of art, culture, science and research and support various social projects. They perform functions that relieve the burden on the state, create social and economic added value and are of great importance for Zurich and Switzerland as a financial center and for Zurich as a location for innovation, research and social welfare.[4] In addition to their traditional funding activities, charitable foundations are increasingly acting as «promoters of innovation and experimentation», «social investors» and «venture capitalists» through entrepreneurial forms of funding.[5]

With the latest practice adjustments and other accompanying measures[6], the Canton of Zurich is implementing the central measures of the initiative launched at the beginning of 2023 to strengthen Zurich as a foundation location, based on a study[7] and an expert opinion by Professor Andrea Opel.[8]

2. Charitable Foundations – Basic Principles and Tax Exemption

As an establishment, the foundation is the only institution under private law in Switzerland that has no owners or members.[9] By setting up a foundation, founders dedicate their assets or parts thereof to their own purposes as set out in the foundation deed, thereby perpetuating their will for the duration of the foundation’s existence (principle of separation and solidification). As the foundation cannot form its own will, it does not have a will-forming body.

A foundation’s board represents and manages each charitable foundation. Alongside the auditors, it is often the only organ of the foundation. If the founder leaves the foundation board scope for decision-making, it is incumbent on the foundation board to carry out the founder’s wishes in accordance with the foundation’s purpose as set out in the foundation deed. This includes, in particular, the organization of funding activities. Board members are liable to the foundation under contract.[10]

The supervisory authority created for foundations, as a state supervisory authority and counterbalance to the lack of owner or member interests, must ensure that the foundation assets are used by the foundation board in accordance with their intended purpose. In doing so, the supervisory authority must review the legality of the actions of the foundation board; it is not entitled to exercise discretionary control.

With regard to tax exemption, it is generally advisable to contact the cantonal tax authorities before the foundation is set up. The tax authorities make their approval of tax exemption dependent on various conditions, which should be taken into account when drafting the foundation deed or regulations.[11]

According to Art. 56 lit. g of the federal law on direct federal tax (DBG), «legal entities that pursue public or charitable purposes are tax-exempt for profits that are exclusively and irrevocably dedicated to these purposes. In principle, entrepreneurial purposes are not charitable. The acquisition and management of significant equity interests in companies are considered charitable if the interest in maintaining the company is subordinate to the charitable purpose and no business management activities are carried out».[12] The tax exemption due to public or charitable purpose is justified by the fact that the state should not burden private activities with taxes if a public task is performed and the state is thus relieved.

The term «charitable» in the law is undefined and therefore subject to interpretation, whereby, according to case law and practice, it requires both an activity in the public interest and an altruistic activity. An altruistic activity does not exist if self-help or profit-making purposes are pursued. Which purposes are to be regarded as «charitable» is interpreted differently by the cantons in some cases.[13] In practice, it is also important to ensure neutrality of competition when assessing applications for tax exemption.[14]

As a basis for interpreting the meaning of «charitable», the cantonal tax offices have at their disposal the case law of the Swiss Federal Supreme Court, Circular No. 12 of the Federal Tax Administration dated July 8, 1994, and the practical instructions of the Swiss Tax Conference dated January 18, 2008.

3. The Changes in Practice of the Zurich Tax Office

3.1 Appropriate Compensation for Foundation Board Members of Charitable Foundations

The new practice of the Zurich cantonal tax office now provides that appropriate remuneration of foundation board members does not preclude a tax exemption for charitable foundations. In doing so, the tax office has discontinued its requirement that foundation board members act in an honorary capacity.

In accordance with Art. 84 para. 2 and 84b of the Swiss Civil Code (ZGB), compensation arrangements for foundations must be reviewed by the foundation supervisory authorities. The Zurich cantonal tax office will therefore assume in principle that the compensation paid to the board of a charitable foundation has been reviewed and approved by the foundation supervisory authority for its appropriateness. The foundation supervisory authority must check whether the foundation’s assets are being used for the intended purpose, which may be doubtful in the case of excessive compensation payments. The cantonal tax office will only carry out its own checks in the sense of an «abuse control» if the appropriateness of compensation payments made is doubtful. To this end, it will obtain an opinion from the responsible foundation supervisory authority.

In the case of associations (and other organizations) whose compensation arrangements are not reviewed by an independent supervisory body, the Zurich cantonal tax office will, however, review the appropriateness of the board members’ compensation itself from the outset.

As a result of the remuneration of the foundation board now being deemed compatible with the tax exemption by the Zurich tax office, the supervisory authority will have to develop a practice for the appropriateness of the foundation board members’ remuneration. We agree with Professor Opel that the remuneration paid should be market-based and commensurate with time and performance, which will have to be assessed on a case-by-case basis.[15]

The change in practice of the Zurich tax office towards the permissibility of remuneration of the foundation board is particularly correct in view of the fact that the law does not prohibit the remuneration of the management body of non-profit legal entities. Rather, it is up to the foundation’s founder to regulate any remuneration of the foundation board in the foundation deed.[16] Appropriate remuneration of the foundation board is also in line with the interests of the foundation board due to the high level of responsibility it bears.

Zurich’s new practice regarding compensation puts Zurich as a philanthropy location in a pioneering role and diverges from the majority of cantons, which maintain the requirement of honorary office for tax exemption. On 29 January 2024, for example, the tax office of the canton of Vaud clarified its guidelines on the remuneration of the upper management bodies of charitable organizations, but in principle continues to adhere to the requirement of honorary work.[18]

3.2 International Activities of Charitable Foundations

For tax purposes, Zurich now treats charitable foundations’ (and other organizations’) foreign activities the same as charitable activities in Switzerland. For a tax exemption, funding activities abroad are now possible regardless of the type and location of the activity, provided the activities are worthy of support from a Swiss overall social perspective and the loss of tax revenue to Switzerland is justified. For activities abroad to be justified, they must have a positive spillover effect in Switzerland or they must be perceived as worth promoting in Switzerland. To be compliant, charitable foundations’ activities abroad must be thoroughly documented. This requires complete information regarding the flow of funds to the recipient abroad. The Zurich cantonal tax office will work closely with the foundation supervisory authorities in this regard.

Provided the necessary transparency is ensured, the compatibility of international foundation activities by charitable foundations with the tax exemption is very welcome, particularly in view of cross-border social challenges such as the protection of the climate, wildlife or oceans, demographic change, migration or digital transformation.[19] The law and the requirement to act in the public interest do not limit the activities of charitable foundations to Switzerland.

Zurich presents itself as progressive with regard to international charitable foundation activities. Several other Swiss cantons, however, still require certain funding activities in their own canton or at least in Switzerland.[20]

3.3 Entrepreneurial Funding Models

According to the new practice of the Zurich cantonal tax office, entrepreneurial funding models (loans [in particular Social Impact Bonds[21] and Development Impact Bonds], participations, convertible loans[22]) do not preclude the tax exemption of a charitable foundation, even if a return flow of funds (repayments and interest on loans, income from participations, profit-sharing) to the non-profit institution is possible. It must be demonstrated that the funds are used in areas where no market (yet) exists and thus investments are made that profit-oriented third parties would not make. The investments are only permitted within the scope of the actual funding activity. In addition, the returned funds must be used for the charitable purpose.

Charitable foundations now often make active investments in social enterprises (so-called entrepreneurial philanthropy). In contrast to pure donations, entrepreneurial forms of support do not exclude a return of funds from the outset. However, the investments in question can actually be comparable to pure donations, as investments are generally made in companies for which no private investors can be found due to the high risk of default and lack of return prospects.[23] In the case of entrepreneurial forms of support, however, as opposed to pure donations, the charitable foundation retains the opportunity of the potential economic success of the supported company, thereby possibly receiving a return, which is why corporate philanthropy ultimately serves to realize the foundation’s purpose.

In order to comply with the new practice stipulations of the Zurich tax office, in the case of entrepreneurial funding models, charitable foundations will generally have to prove that a normal market return cannot be achieved with the investment in question, thereby demonstrating that there is no competitive situation.[24]

4. Open Questions

In the context of entrepreneurial philanthropy, the question arises as to how the Zurich cantonal tax office will proceed if a charitable foundation is unable to prove that there is not yet a market in the requested area. For example, it is questionable whether, with regard to tax exemption, the tax office will allow charitable foundations to use funds in areas in which profit-focused third parties are only prepared to make investments to a limited extent, in particular only up to a certain threshold, while the charitable foundation would be prepared to use funds beyond this. In our opinion, such an activity should not, in principle, stand in the way of tax exemption. This is because if such an activity is classified as gainful employment, it is generally considered to be altruistic and is therefore not detrimental to tax exemption, provided that the pursuit of the entrepreneurial purpose is subordinate to a main charitable purpose.[25]

Furthermore, it remains to be seen how the cantonal tax office will position itself with regard to the participation of charitable foundations in companies if they exercise influence over the supported companies. As mentioned, according to Art. 56 lit. g DBG, in the case of significant participations, the interest in maintaining the company must be subordinate to the charitable purpose and no management activities may be carried out. We are of the opinion, however, that a certain degree of influence by the participating charitable foundation should not be detrimental to the tax exemption, as it is precisely this influence that can ensure business practices in line with the foundation’s purpose.[26]

5. Conclusion

The changes to the practice of the Zurich tax office regarding the tax exemption of charitable foundations are very welcome. The public appreciation of charitable foundations as important civil society actors by politicians associated with the change in practice will strengthen the sector.

It is to be expected, among other things, that the new compatibility of appropriate remuneration of the foundation board with tax exemption in Zurich will initiate a generational change in the boards of charitable foundations and lead to a professionalization of the foundations’ sector.

The liberalization of activities of charitable foundations abroad and the far-reaching compatibility of entrepreneurial funding models with the tax exemption create more freedom for both foundation founders and the foundation board members of charitable foundations.

The canton of Zurich is a location for charitable foundations with international appeal. The new regulations of the Zurich tax office not only create new leeway and open it up to innovative forms of charitable activities, but also create more legal certainty. The changes in practice promise the relocation of charitable foundations from other cantons to the Canton of Zurich and the establishment of new internationally active and innovative charitable foundations in Zurich.

[1] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 8, 49.
[2] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 5.
[3] Grüninger, BaK ZGB, before 89-89a para. 2.
[4] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 5 et seqq.
[5] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 5, 34.
[6] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 8, 49.
[7] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 8, 49.
[8] https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf, p. 8, 49.
[9] Grüninger, BaK ZGB, before 89-89a para. 4.
[10] Jakob, KUKO ZGB, Art. 83 paras. 8 et seqq.
[11] Grüninger, BaK ZGB, before 89-89a para. 29.
[12] According to Art. 23 para. 1 lit. f StHG and § 61 lit. g StG/ZH, the same applies at cantonal level, whereby assets are also taken into account here.
[13] Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf, p. 13.
[14] Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 14 et seq.
[15] Opel in: https://www.zh.ch/bin/zhweb/publish/regierungsratsbeschluss-unterlagen./2021/1482/RRB-2021-1482_Stiftungen_im_Kanton_Zuerich.pdf , p. 34.
[16] Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 24.
[17] Cf. further Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 36 et seqq.
[18] In the canton of Vaud, exceptions to the principle of honorary office of the board of charitable organizations is henceforth being granted, in particular depending on the number of hours spent per mandate, cf. details at https://www.vd.ch/fileadmin/user_upload/organisation/dfin/aci/fichiers_pdf/Directives_indemnit%C3%A9s_PUP_2024.01.29.pdf.
[19] Similarly Grüninger, BaK ZGB, before 89-89a para. 31.
[20] Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 40 et seq.
[21] Cf. in detail von Schnurbein/Fritz/Mani, Social Impact Bonds, p. 1 et seqq.; Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 49 et seq.
[22] Cf. in detail von Schnurbein/Fritz/Mani, Social Impact Bonds, p. 1 et seqq.; Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , S. 49 et seq.
[23] Greter/Greter in: Zweifel/Beusch (Hrsg.), Art. 56 DBG para. 34a.
[24] Cf. in detail von Schnurbein/Fritz/Mani, Social Impact Bonds, p. 1 et seqq.; Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 49 et seq.
[25] Greter/Greter in: Zweifel/Beusch (Hrsg.), Art. 56 DBG para. 32.
[26] See also Opel in: https://www.zh.ch/content/dam/zhweb/bilder-dokumente/footer/news/2024/02/Gutachten_Opel_Stiftungspraxis_2024.pdf , p. 56.