How the US forced the Swiss to end a long tradition of secrecy

The world, India included, is currently focusing on combating international tax evasion.
The case of the international bank UBS (‘the bank’) provides interesting insights into how the US can make other nations bend before it when it comes to tax evasion by its citizens.

It all started when the US Inland Revenue Service (IRS) last year issued a summons (John Doe Summons) on the bank to hand over account information on US clients who may have used Swiss bank accounts to evade US income taxes.

Switzerland’s secrecy laws being central to its financial services, it was hardly surprising that there was stiff resistance from Switzerland to parting with any information. The bank challenged the summons in the US since its enforcement would result in the bank violating Swiss legislation on banking secrecy which was inconsistent with US-Swiss treaty.

Switzerland was of the view that it could exchange information under the Swiss-US tax treaty only in the case of a tax fraud. However, the US federal judge in Miami rejected its claim and upheld the validity of the summons.

The Swiss Supreme Court had interpreted the tax fraud provision and held that it required fraudulent behaviour for exchange of information and mere tax planning was not covered. As long as the crime is mere tax avoidance, not tax fraud, the substantive requirements of the treaty are not met and no information exchange is required.

However, in a marked departure, the Swiss Federal Council decided to permit the bank to disclose client data and lift the Swiss bank secrecy in the interest of the stability of the Swiss and global financial systems, even in a situation where no actual fraud was detected but merely the suspicion of fraud. This could only have been because of immense pressure from Big Brother.

What was at stake?
If the bank was found to have violated US law, it could have been subject to rigorous audits of past accounts and oversight by a federal monitor for some period of time. The US could also threaten many other sanctions against Switzerland and the bank, such as expelling Swiss banks from the clearing system or, in a worst case scenario, revoking the bank’s license to carry out banking in the US.

How did the Swiss bank get involved?
The Qualified Intermediary (QI) program in the US is designed, intentionally, to bottle up client information offshore so that the US does not have to give it over to treaty partners.
The bank was QI-registered with the US IRS. Under US tax laws, a QI is permitted to report payments made to its direct foreign account holders on a pooled basis rather than reporting payments to each account holder specifically.

Hence the US was not required to provide details of US-sourced income paid to account holders under their respective treaties with the US. The QI program effectively preserved bank secrecy and enabled foreign investors to make investments in the US without fear of income being reported back by the US to their home country.

The bank’s arrangements showed that the QI program was routinely and rather easily abused by US citizens. A typical setup involved the US account holders contributing their US investment assets to a tax haven corporation run by a Liechtenstein board, which gave the shareholder no power over its investments.

The bank assisted its US clients in setting up offshore corporations to hold their US investments. It had either actual knowledge or reason to know that the beneficial owner was a US resident. Because the QI program did not look through corporations to find the beneficial owner, the bank would, in literal compliance with the rules, not look through corporations for this information either.

The bank apparently accepted the beneficial ownership certificate from these corporations and treated them as the beneficial owners of the accounts. Under US domestic law, the bank was obliged to identify and report its US clients and their income to the US government.

However, if the bank was not in possession of form W-9 from the US account holders or the latter’s permission to release its information, which would constitute a breach of bank secrecy, then the bank should have withheld tax as a backup. The bank apparently relied on the view that offshore corporations were the beneficial owners of the accounts and hence did not apply for backup withholding

How many accounts were involved?
While the number of accounts reported in the press is about 52,000, US IRS does not expect the number to be so high. That number may include all the accounts with US clients regardless of whether the account was properly disclosed. These accounts have held assets totalling approximately $18 billion at some point during the past eight years.

Voluntary Disclosure
The US IRS is trying to keep up the pressure on US resident individual holders of undisclosed foreign bank accounts to submit their details to the voluntary compliance programme by September 23. Clients who receive notices from the bank before the September 23 deadline will remain eligible for the programme. However, they will no longer benefit from the programme once their information is provided by the Swiss government.

For anyone with hidden offshore assets, whether at the bank or elsewhere, the IRS wants to send a clear message: the clock is ticking but there is still time for you to get right with your government.

Impact of the settlement
The bank’s case has opened the door for other governments to walk in and make similar demands to assist in home-grown tax evasion charges. This will create an additional burden on the Swiss government to either allow the same concession or defend their stand of not intervening on issues that, at least technically, are out of their jurisdiction.

The Canadian revenue authorities also plan to meet with the bank in the coming weeks in a bid to uncover Canadian fortunes that might be hidden in offshore accounts.In the light of a quantity of tainted money lying in bank accounts in Switzerland, the government of India has already begun persuading the Swiss authorities to discuss and begin negotiations on the amendment of the tax treaty in respect of the exchange of information. So, if you have Swiss bank accounts, beware!