The European Commission is irked by Swiss tax federalism:

Canton Obwalden, in central Switzerland, slashed its corporate tax rate to just 6.6% at the start of 2006; it attracted 376 new companies in just 11 months. The European Commission has warned that this may constitute an unfair subsidy under the European Free Trade Agreement.

“Talk to any tax expert,” said Michael Reiterer, the commission’s new ambassador to Switzerland. “This is recognised as a subsidy. And there we think Switzerland should think a bit whether behaviour which is clearly outlawed in the EU is the best policy to follow in such a close relationship between two partners.” [BBC]

I am not a tax expert, but I’ll comment anyway. Here is the only article in the EEC-Switzerland FTA of 1972 pertaining to taxation:

Article 18

The contracting parties shall refrain from any measure or practice of  an internal fiscal nature establishing, whether directly or indirectly, discrimination between the products of one contracting party and like products originating in the territory of the other contracting party.
Products exported to the territory of one of the contracting parties may not benefit from repayment of internal taxation in excess of the amount of direct or indirect taxation imposed on them.

I am unable to find any literature suggesting that tax federalism has resulted in export tax rebates for firms located in particular cantons. Summaries of the policy shift (such as this one) simply describe variations in the corporate income tax rate. So I doubt that Article 18 is violated.

The European Commission appears to be arguing that another article is relevant:

On top of cut-price corporate tax for all, that vary from region to region, some cantons offer additional concessions for foreign firms that do not have direct business activities in Switzerland. 
These kind of Domiciliary foreign companies can pay no tax or just one-tenth of their regular net income in some cantons, according to the Swiss Economic Ministry.
European Commission officials allege that the practice amounts to an unfair subsidy, violating a free trade agreement between the EU and Switzerland. [Portugal News]

The 17-page document gives detailed information about the tax regimes of cantons Zug and Schwyz in central Switzerland and the privileges they give to holding companies and other firms. But the argumentation on the main issue is vague. The draft claims that these tax practices distort trade between Switzerland and the EU, and therefore contravene the bilateral free trade agreement… According to article 23 of the free trade accord, it is enough if a privilege “threatens to distort” trade. [<A href=”SwissInfo]

Here’s Article 23:

1. The following are incompatible with the proper functioning of the agreement in so far as they may affect trade between the Community and Switzerland:

i. all agreements between undertakings, decisions by associations of undertakings and concerted practices between undertakings which have as their object or effect the prevention, restriction or distortion of competition as regards the production of or trade in goods;

ii. abuse by one or more undertakings of a dominant position in the territories of the contracting parties as a whole or in a substantial part thereof;

iii. any public aid which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods.

2. Should a contracting party consider that a given practice is incompatible with this article, it may take appropriate measures under the conditions and in accordance with the procedures laid down in article 27.

I read that article as pertaining to anti-trust practices and competition policy, not tax levels or subsidization, but I have no legal training, so I hope someone from the International Economic Law and Policy Blog tackles this story.

If free trade agreements can be reinterpreted more than three decades after the fact to have behind-the-border implications such as tax harmonization, then one can only imagine the dangers associated with signing TIFAs and PTAs addressing non-trade issues today.

[Hat tip on this story: Daniel Mitchell

Classic reference on harmonization: Bhagwati & Hudec]