UK v Switzerland

ANDREW GOODALL CTA discusses recent developments with the European savings directive.

SWITZERLAND CONTINUES TO resist attempts to persuade it to end its notorious banking secrecy and sign up to the European Union's proposed savings directive.

This has serious implications for the honest taxpayer. Even if European Union Member States succeed in winning over 'third countries' by their self-imposed December deadline, there is still a long way to go in the struggle to protect national tax bases in the global economy.

The Swiss in particular seem implacably opposed to the systematic exchange of information. Now, press reports indicate that European Union finance ministers may be considering a tax amnesty to encourage its citizens to close Swiss bank accounts.

Effective taxation

How did we get here? The European Union's objective is 'to ensure a minimum level of taxation on interest income paid in each Member State to individuals who are resident for tax purposes in another Member State'.

The savings directive will 'ensure a minimum of effective taxation within the Community of savings income in the form of interest payments' accruing to nationals of European Union Member States. It is said to be 'in line with the desire to combat harmful tax competition', and is being developed alongside the initiative of the Organisation for Economic Co-operation and Development on harmful tax practices, arising from the 1996 G7 Summit.

Switzerland did not meet that Organisation's criteria for 'tax haven' status but, as a member of it, Switzerland abstained in council on approval of the Organisation's 1998 report, saying that its work was 'partial and unbalanced'. In particular, concerns were raised over the exchange of information.

Switzerland considered it 'legitimate and necessary to protect the confidentiality of personal data'. It argued that a system of withholding taxes was preferable and cheaper to administer than exchange of information, and said it would 'not be bound in any manner by the report or its recommendations'.

The European Union's website on taxation of savings income warns that the introduction of the euro adds urgency to the task of agreeing international measures on taxation of cross-border interest payments, saying:

'As things stand, it is still possible, without common rules, to avoid paying tax on cross-border interest income from savings investments. This situation not only distorts the allocation of capital according to economic criteria but, moreover, cannot be tolerated at a time when the Member States are demonstrating budgetary discipline and making efforts to restore the balance in terms of the burden of taxation between the different factors of production, with the aim of promoting job creation.'

Proposals to date

The European Commission's initial proposal in 1989 was for a directive to introduce a single system of withholding tax. This did not win unanimous support and was replaced in 1998 by a 'more pragmatic' approach.

A 'flexible co-existence model' was proposed, whereby each Member State would choose between two options - either levy withholding tax of at least 20 per cent, or provide information automatically (without request) to other Member States on interest paid to individuals resident there. The Commission proposed also that Member States' dependencies and associated territories, as well as some 'third countries', should be asked to participate.

The co-existence model was abandoned in 2001 in the face of United Kingdom opposition to withholding taxes. The present proposal would require every Member State to provide information to other Member States, on interest paid in that Member State to individuals residing in other Member States.

There would be a seven-year transitional period in which Belgium, Luxembourg and Austria would be allowed to levy a withholding tax at a rate of 15 per cent and then 20 per cent instead of exchanging information, 'to allow them more time to adapt their legislation'. Most of the withholding tax would be passed to the Member State where the account holder is resident.

Adoption of the 2001 proposal is 'subject to compliance with the general preconditions relating to discussions with the Member States' dependent or associated territories (Channel Islands, Isle of Man and the Caribbean territories) and with non-European Union countries (United States, Switzerland, Liechtenstein, Monaco, Andorra, San Marino)'.

A rocky road

A look at the proposed directive reveals that even if agreement is reached, implementation is not going to be easy. Several issues will give rise to difficulty, including:

• the definitions of 'paying agent' and 'interest' ,
• the steps required to identify beneficial ownership, and
• the need to identify the payee's country of residence.

Clearly, there is much to be done before any directive has an impact. In the meantime the negotiations with Switzerland have become rather heated.

William Hall, Zurich correspondent for the Financial Times, estimated that Switzerland manages around $1,300bn for wealthy foreign individuals. Its gross domestic product is around $230bn. Hall said this underlines the success of the country's private banks:

'Together, they have an estimated one-third share of the world market for wealthy individuals who want to do their banking "offshore" and out of sight of their domestic tax authorities.'

Hall doubted whether there were any compelling reasons for wealthy European Union citizens to place their funds in Switzerland 'other than to avoid tax'.

Enticing tax benefits

PricewaterhouseCoopers' Swiss website invites readers to locate their business operations in the country, which 'offers some of the most enticing tax benefits in the world today, particularly for businesses looking to structure their foreign operations onshore'. As well as 10-year tax holidays for headquarter companies, it offers an 'open and friendly relationship between tax authorities and taxpayers'.

KPMG's guide to banking and finance in Switzerland says:

'… any person who divulges secret information or tries to induce another person to divulge secrets, is liable to up to 6 months imprisonment or a fine of up to SFr.50,000 … legal precedent supports the assumption that nothing should be disclosed which might in any way harm the interest of a customer of a bank or impinge on his or her rights to confidentiality. In practical terms this means that absolutely no information about customers can be given by a bank to third parties - public or private - without the customer's specific approval. An important exception to this rule applies in criminal cases, bankruptcy or debt collection procedures, where relevant disclosures are mandatory.'

Speaking at the 5 November meeting of ECOFIN, Gordon Brown said that the Swiss system was unique amongst the world's leading financial centres 'in that it allows clients of its banks to be shielded from their own tax authorities'.

In recent weeks the threat of European Union sanctions against Switzerland seems to have infuriated the Swiss, who have been encouraged by reports that some United States officials were also opposed to the European Union proposals. The Chief Executive of the Swiss Bankers' Association, Urs Roth, told the Financial Times:

'Switzerland does not see why it should turn its legal system on its head to satisfy the internal needs of a neighbouring economic bloc. We have made a serious offer of a genuine "equivalent measure" in the form of a withholding tax which is in harmony with our legal system. We have 60 years' experience of a withholding tax which, as the Swiss state appreciates, not only is an effective deterrent against tax evasion but also has the advantage of yielding money rather than information.'

While European Union officials were reported to be suggesting that certain Member States were aiming to scupper the whole process, the Chairman of UBS, Marcel Ospel, urged a return to the co-existence model, as the 'only appropriate way of ensuring mutually respectful relationships between neighbours'.

Tough talk

Gordon Brown told the ECOFIN meeting why he rejected the withholding tax route:

'A withholding tax on cross border income flows will almost invariably result in the wrong amount of tax being paid, and in the wrong country. It will always be the wrong amount unless the tax is levied at the same rate as the individual's marginal tax rate in his home country.

'And it will be paid to the wrong country because authorities will collect tax in the country in which it is deposited, rather than the country where the citizen is resident. You would need a cumbersome revenue sharing arrangement to get the money back to where it belonged.

'Besides which, people who cheat on tax are generally interested not only in evading tax on interest income but in hiding their wealth. Withholding taxes do nothing to address this issue. And they typically have huge avoidance problems.'

In contrast, he said, 'exchange of information enables governments to apply correctly the tax rules voted for by their people, without constraining their capacity to indulge in fair tax competition. And exchange of information addresses the issue of capital, as well as income, offshore'.

The European Union proposals are based on a simple principle. If you live in a country, you should pay your share of taxes to that country wherever your savings happen to be. The combined impact of freedom of capital flows and secrecy threatens the tax bases of national states. The Internet makes it very easy to move savings around the globe at great speed. Allowing taxpayers to continue to evade tax by taking advantage of another country's secrecy laws is asking for real trouble in the Internet age.

Andrew Goodall, chartered tax adviser, is a director of Tax in Practice Limited: www.taxinpractice.com.

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