Distinction between tax-free capital gains and taxable income

While all recurring and one-off income such as wages, compensation for special services, commissions, allowances, or monetary benefits from employee participation are taxed, capital gains are tax-free. However, as shown in the Federal Court decision in the article, not all payments can be clearly delineated.

The distinction between tax-free capital gains and taxable income is often difficult. According to the Federal Court, tax-free capital gains are those that arise from the mere management of private assets or occur on a random opportunity. If an activity is, however, aimed at earning, it is assumed that there is independent gainful activity, which is taxed. Nevertheless, each delineation of a situation requires an individual appraisal.

In case 2C_731/2017, for which the Federal Court issued a judgment on November 12, 2018, the qualification of a payment of 854,003 Fr. as taxable income or tax-free capital gain was disputed. The complainant, who was liable for tax in the canton of Solothurn, had sold his share in a corporation to a third company on June 1, 2012. According to a clause in the sales contract, he was to maintain his employment relationship with the corporation for a further three years. After the three years, he would receive a payment totaling 854,003 Fr. Should the employment relationship be terminated earlier due to incapacity to work or by mutual agreement, the sales contract provided for the immediate payout of the sum. On November 18, 2013, the employment relationship was terminated by mutual agreement, and the 854,003 Fr. was paid out to the taxpayer. On June 29, 2016, he and his wife were assessed, wherein the payment was added to their taxable income. The couple unsuccessfully contested this by filing objections and taking the matter to court, arguing that the so-called holdback was not taxable income but a tax-free capital gain.

The complainants argued that the holdback was not a counter-performance for work performed. The salary had continued to be paid. Moreover, the payout in case the employment relationship is terminated and thus precisely no work is performed, strongly argues against its qualification as earned income. However, they were unable to convince the Federal Court, which assessed the question in the same way as the lower courts. It emphasized that all recurring and one-off income is subject to direct federal tax. In particular, income from private-law or public-law employment relationships, including subsidiary income such as compensation for special services, commissions, allowances, service-longevity and anniversary gifts, bonuses, tips, profit shares, or monetary benefits from employee participation. In the present case, the taxpayer received the payment because the employment relationship was terminated and no work was done, which corresponds to a severance payment, which also counts as taxable income.

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