Twelve months ago, when American multinational Kraft announced it had taken a long-term lease on new corporate headquarters in Zurich, the business sector presumed the move was driven solely by the fiscal prudence of low tax rates. The US firm, which owns a portfolio of famous brands, such as Philadelphia cream cheese, Kenco coffee and Terry’s Chocolate Orange, was following in the footsteps of Procter & Gamble and Colgate-Palmolive, which have all shifted their European headquarters to Switzerland.

The Alpine country’s attractive tax regime was one reason. But there were others, including lifestyle, quality and cost of accommodation, and excellent public transport.

In a statement at the time Kraft said that the company had conducted a survey of different headquarter locations and Zurich came top. The statement cited the ease of getting about: good transport to the airport, good rail links. “We have a lot of expatriate staff so availability of schools and good quality accommodation are important.” Biogen Idec, a US pharmaceutical company, last year decamped from Paris to Zug, a canton which boasts a corporate tax rate of nil.

In the more cosmopolitan Zurich, the normal range of corporation tax is between 15 percent and 24 percent but foreign holding companies using Zurich as an administrative base are exempt from tax on their non-Swiss earnings.

A recent World Bank survey bolstered the view that Switzerland is highly rated for its favourable rates and ease of paying taxes. And research released in July 2007 also appeared to confirm Switzerland is attracting companies for tax reasons. It found that a record number of firms had set up shop in the country in the first six months of 2007.

The World Bank survey ranked Switzerland 24th worldwide in terms of total tax rate – all taxes that businesses pay – and second in Europe, behind Ireland. The Pacific island of Vanuatu headed the table with a fiscal rate of just 8.4 percent. With a total tax rate of 29.1 percent, Switzerland is only 0.2 percent behind top-ranked Ireland with 28.9 percent, said the Bank.

Switzerland was placed ahead of eastern European and Baltic countries, which have nominally lower corporation taxes but which carried the burden of higher capital tax and social insurance costs as well as customs and transport levies. And it did considerably better in the world listings than its neighbouring countries: Germany (50.8 percent, ranked 124), France (66.3 percent, ranked 157) and Italy (76.2 percent, ranked 168).

Tension
But the results come at a time of niggling tension between Switzerland and the European Union over the Swiss corporate fiscal system. Brussels wants the Swiss authorities to scrap a practice applied by some of its cantons that exempts company profits generated in EU countries from tax. It claims doing so violates a 1972 free trade accord.

Switzerland has repeatedly refused to negotiate with the EU over the issue. The government says that corporate taxes are a cantonal issue and are not covered by the trade agreement. The Swiss position is straightforward: that the 1972 free trade accord does not apply to the tax benefits granted to foreign companies by a number of cantons. It argues that the 1972 agreement is only applicable to certain goods such as agricultural and industrial products.

The EU is calling on Switzerland to give up the tax practice and adapt to its demands. Switzerland has so far refused, although the possibility of some distant compromise emerged in October 2007 when the two sides at least agreed to talk. One of the key questions for Switzerland in 2008 is whether the talks will proceed amicably, or whether the EU will stay on the front foot and turn this into a larger conflict.

If the tax spat is striking a somewhat discordant note in otherwise harmonious relations, there was more cause for concern, however minor, at the beginning of 2008 when the president of the Swiss National Bank, Jean-Pierre Roth, said the threat of inflation is rising, along with possible risks to the Swiss economy.

Mr Roth seemed to suggest Switzerland would not be immune from fallout from the sub-prime lending crisis in the US. He said there were ‘question marks’ over the economy, especially concerning possible knock-on effects from problems in the US. He warned that economic growth in Switzerland could fall below the Bank’s forecast in December of around two percent for 2008.

None of this is dissuading multinationals from setting their sights on Switzerland as a cost-effective and attractive base.

According to Ernst & Young, Switzerland is the leading European choice of international companies for locating an International/European headquarter, an R&D centre, or a centre for administration/accounting functions.

The company’s “Swiss Attractiveness Survey – What Foreign Companies Say” Ernst & Young conducted of international executives currently working within Switzerland shows that 74 percent of the executives surveyed would choose Switzerland again as a business site.

Other factors
While traditionally taxes have been one of the key reasons for locating and investing in Switzerland, Ernst & Young says the relative importance of other factors is definitely increasing. A key reason Switzerland rates so highly is its outstanding quality of life, which 71 percent of the executives rated as very attractive. Almost 80 percent of those surveyed also rated as very attractive Switzerland’s clear and stable political, legislative and administrative environment, with 65 percent rating the stable social environment very highly as well.

Other particularly strong features include the flexible labour laws and the favorable tax environment or tax incentives, with 56 percent of those surveyed giving each factor the highest rating.

Ernst & Young said Switzerland’s enduring focus on developing a highly skilled and specialised labour force, as well as a competitive business environment, have allowed it to take advantage of the changes created by globalisation. “Once a company has settled down in Switzerland, it will most probably stay,” Ernst & Young concluded.

This assessment seems to be borne out by figures that show 2006 was a record year of investment within Europe and Switzerland continued to be one of the most attractive locations for foreign direct investment.

Globalisation
One of the reasons for rising FDI in Switzerland is the country’s increased level of globalisation. In the 1970s, Switzerland was hampered as a global investment centre by its traditionally isolationist policies. Even as recently as 1996 the OECD warned that the Swiss federal government and the cantonal authorities needed to strengthen and approves Switzerland’s attractiveness as a place to do business.

This call for political action stemmed primarily from Switzerland’s rejection of EU membership. But it also came from a recognition that the internal Swiss market was not fully integrated, with lack of competition in some areas resulting in higher operating costs for foreign investors.

Liberalisation of internal markets has been slow and sometimes controversial, but progress has been made. Switzerland has to all intents and purposes become a “virtual member” of the EU and this has also increased the pace of globalisation. A referendum in 2001 went against opening talks on joining and Swiss-EU relations continue to be based on an extensive range of bilateral agreements.

Ties became closer in 2005 when a referendum backed membership of the EU Schengen and Dublin agreements, bringing Switzerland into Europe’s passport-free zone and increasing cooperation on crime and asylum issues. A further referendum in 2007 saw the bilateral agreement on the free movement of people come into force for the ‘old’ 15 EU member states, Malta and Cyprus as well as Efta nations Iceland, Norway and Liechtenstein.

Flood prevention
In other words, residents of these countries were suddenly free to compete for jobs in Switzerland alongside the Swiss. But a clause will allow Bern to place limits on immigration if too many EU citizens flood into the country (10 percent above the average of the past three years). Parliament will decide in 2008 the extent to which it will confer similar rights to the people of Bulgaria and Romania.

According to Switzerland’s Federal Migration Office, both Bern and Brussels favour a gradual, controlled opening of the Swiss job market. But whatever parliament decides, voters will have the final say in a referendum later in the year or in 2009 since such a move requires a change to the constitution.

This has all helped increase the pace of Switzerland’s globalisation. Indeed, in Economic Institute KOF’s 2008 Index of Globalisation, which compared 122 countries, Switzerland came fourth – up two places on 2007.

Zurich-based KOF said globalisation in Switzerland has increased continuously since the 1970s and particularly since the 1990s. Since 1991 Switzerland has been among the world’s 10 most globalised countries. The 2008 position was partly the result of a substantial rise in foreign direct investment, said KOF. One aspect of Switzerland’s cosy stability that has never seemed under threat is its politics. Switzerland’s long-standing neutral status has given it the kind of political cohesion envied by just about every other nation.

And yet last year, in the run-up to federal elections in October, Swiss cities saw riots on a scale rarely known. The unrest was the result of protests against the right-wing Swiss People’s Party (SVP), which ran what many saw as an overtly racist campaign. The party’s controversial leader, Christoph Blocher, was accused of wrongly depicting Switzerland as a society under siege from immigrants who have scant regard for the country’s laws and customs. Violence flared in the capital of Bern when left-wing protesters tried to stop a pre-election SVP rally. There were similar incidents in Lausanne and Geneva.

The level of concern over the tactics of the SVP was such that the United Nations refugee agency strongly condemned the party for an advertising campaign in which it appeared to blame the country’s rising crime rate on asylum seekers.

Success

But Mr Blocher’s rhetoric, and his embracement of traditional Swiss values, struck a chord with the electorate. The SVP was the most successful party at the election with 29 percent of the vote at the October 2007, but moved into opposition following parliament’s refusal to re-elect Mr Blocher to the Cabinet.

Analysts believe the political scene will remain unsettled in 2008 as the SVP settles into its opposition role. But this is still Switzerland, and “unsettled” is relative. The new government is expected to last the full four years, and its policy goals remain bullish.

Despite remaining outside of the EU, the Swiss economy will become more closely integrated with those of its neighbours as a new series of bilateral agreements comes into effect. The government also plans to continue efforts to improve micro-economic conditions to boost GDP growth. This includes measures to increase competition by liberalising previously sheltered industries such as electricity, energy, telecommunications and postal services.

Switzerland special place in Europe – part of it, but not part of it – seems destined to remain little changed, at least in the medium term. Bilateral agreements will be a necessary part of that arrangement as long as there is an EU and the ‘island’ of Switzerland in the middle of it.