Swiss Developments in 2010

Following the seminal change of facilitated exchange of information, which the Swiss Federal Government decided to adopt in March 2009, many observers predicted the “end of banking secrecy”.

With considerable haste Switzerland negotiated the necessary 12 revised Double Tax Agreements which the OECD stipulated were needed to be removed from its ‘grey list’. By the end of 2010 Switzerland has initialled, signed, or ratified a total of 31 new or revised DTAs, providing for administrative exchange of information provisions.

The revised DTAs contain an extended administrative assistance clause in accordance with Article 26 of the OECD Model Convention. The adoption of the OECD standard on administrative assistance in tax matters, according to Article 26 of the OECD's Model Tax Convention, means that Switzerland shall no longer distinguish between tax fraud and tax evasion.

In accordance with the provisions of said Article 26, the new treaties will not provide for any automatic exchange of information, which the European Union practices and advocates, but which Switzerland and other financial centres reject. Administrative assistance will therefore only be provided upon formal written request of a contracting state. In order to clarify such procedure the Swiss Federal Council adopted the Administrative Assistance Ordinance on September 1, 2010.

If a country submits a request for administrative assistance on the basis of a DTA concluded with Switzerland, then the Federal Tax Administration will conduct a preliminary examination.

The Administrative Assistance Ordinance will apply to all administrative assistance requests only within the scope of new or revised DTAs, which entered into force after the enactment of the ordinance on 1 September 2010. There will be no retroactive effects.

Requests from other countries will be rejected following the preliminary examination by the federal authorities if:

1. it is not compatible with the fundamental values of Swiss law or contravenes the essential interest of Switzerland,
2. the demand does not respect the principle of good faith, or
3. it is based on information obtained or transmitted by acts punishable under Swiss law (for example data theft).

Furthermore, as a necessary condition for the opening of a procedure for administrative assistance, the authority requesting it must supply the following information for the preliminary examination:

1. explicit mention of the applicable legal basis;
2. identification without doubt of the person concerned;
3. identification without doubt of the holder of the sought information;
4. a description of the information and its form in which the requesting state wishes to receive the information;
5. the tax objective and reasons why the information sought is pertinent for achieving that goal;
6. grounds for the reasons underlying the belief that the information requested is in the possession of the presumed holder of the information;
7. the tax period (starting and ending date) to which the request of information relates to; and
8. a declaration stating that the requesting state has beforehand exhausted all usual sources of information existing under its internal taxation procedures.

Finally, the request for information may not relate to the search of unauthorised evidence and may only refer to the scope of application of the DTA at hand.

The parameters decided by the Swiss Federal Council in March 2009 are thus implemented, whereby Switzerland will not provide administrative assistance in the case of so-called ‘fishing expeditions’.

The procedural rights of those concerned will in any case remain fully safeguarded. A person subject to a request of information demand may file an appeal with the Federal Administrative Court against the conclusive decrees of the Federal Tax Authorities, upon which the provision of administrative assistance is based and which determine the extent of the information to be provided.

However, before even testing the new treaty system, the European Union and some of its member states proclaimed early in 2010 that information request on demand was only an intermediate step to the full automatic exchange of information.

In response to this perceived “threat” and in anticipation of the EU Savings Directive withholding tax re-negotiations, the Swiss Banking Association then proposed a future withholding tax to be levied in Switzerland, not just on savings income as is presently the case.

The proposal (called ‘Rubik’) was intended to extend withholding tax on EU citizens to include dividend income generated by stocks and mutual funds, as well as capital gains. In accordance with the EU’s Taxation of Savings Income Directive, Switzerland has already levied a withholding tax on EU citizens since 2005, but it covers only income from certain types of investment, principally from bonds. According to the proponents of Rubik, the proposal “would generate tax revenues while respecting the privacy of bank clients and it would represent an efficient alternative to a system of automatic information exchange”.

Indeed, several EU and OECD member states already operate a system of flat rate or withholding tax for the taxation of capital income of natural persons. Interest, dividends and, in some cases, capital gains on securities are taxed by so-called paying agents. They assess and withhold the tax due on the interest, dividends and capital gains for the client at a proportional rate and transfer the tax payable directly to the tax authorities. For instance, in the case of the flat rate tax on investment income introduced in Germany on 1 January 2009, the bank as paying agent deducts the tax on the investment income (capital gains, interest and dividends) at source and transfers it to the relevant tax authority without naming the tax subject involved.

The Swiss flat rate tax proposal is aligned to the Italian and German models which protect the client's privacy, while at the same ensuring definitive (‘libératoire’) payment of the latter's tax. Switzerland offers to collect the flat rate tax on income paid on balances of foreign domiciled clients for countries that wish to avail themselves of the service. This tax is deducted by the paying agent (the bank) and credited to the tax authorities of the client's tax domicile.

In essence the consequence of such a system means that the client's/tax subject's obligations to the tax authorities of his/her/its country of domicile are fulfilled and therefore the client's anonymity protected. The issue of automatic exchange of information thus becomes obsolete.

The primary subjects concerned are natural persons resident in a treaty state.

The flat rate tax model also applies to domiciliary companies such as domestic or foreign legal entities, companies, Anstalten (establishments), foundations, fiduciary companies or similar associations that do not engage in any commercial or manufacturing business or any other form of commercial operation the beneficial owners of which are natural persons domiciled in a treaty state.

When the Rubik principle was launched in early 2010, the initial international reaction ranged from reserved to outright critical. “I cannot see Rubik as being able to convince our member countries,” Pascal Saint-Amans, head of international cooperation and tax competition at the Paris-based OECD, told the delegates at the British Swiss Chamber of Commerce in Geneva. While the OECD has no official position: “I cannot see how you can explain to a jurisdiction, Germany, France, the US, whoever, that you will levy the taxes for free if it doesn’t hide something,” he said.

Then in the spring of 2010 the Euro crisis triggered by Greece appears to have changed the game. Switzerland massively supported the Euro on foreign exchange markets and the attacks on the Swiss financial system subsided over night.

In October 2010 Germany and England accepted the Swiss Rubik proposal for withholding tax in exchange of the continuation of banking secrecy. Whilst the details for the implementation of withholding taxes will still need to be negotiated, clearly pragmatic national Treasury needs have gained the upper hand.

More importantly, the United Kingdom and Germany have placed there national interests over the lofty EU Commission goals of automatic exchange of information. In addition, this bilateral strategy has irked and confused other EU member countries, who insist that any negotiation with Switzerland must be subjected to the EU’s mandate for the re-negotiation and extension of the EU Savings Directive withholding tax. Finally, the OECD has clearly stated that exchange of information on request was the universal standard and that automatic exchange of information was “not on the agenda”.

In the midst of all this confusion, enter the Ireland bailout and second Euro crisis. Capital flight continues from Europe to Switzerland and Asia, while for many clients systemic Euro risk considerations have taken precedence over tax optimisation considerations.

Looking towards next year, the FATF drive to qualify and thus criminalise tax evasion as a predicate money laundering offence deserves full attention. This would render administrative exchange of information almost redundant, as only the application of Mutual Legal Assistance Treaties for penal matters would apply! In this (brave new?) world anti-money laundering laws, initially, intended to fight drug trafficking etc, would be used against citizens whose criminal activity is limited to the non-payment of outstanding taxes.

In practice, such standards would have very far reaching consequences not only for all financial intermediaries but for economic actors in general. Financial intermediaries would need to apply foreign tax laws to respect their own national anti-money laundering laws.

It is questionable to what extent financial intermediaries should evolve into quasi tax compliance arms for the benefit of foreign tax authorities. However, if tax evasion were indeed one day qualified as a preliminary act to money laundering, all creditors would be affected and obliged to verify the tax compliant source of funds before accepting payment. The logical consequence would be that the shadow economy as such would need to be re-qualified as money laundering. It is estimated that the shadow economy in Germany represents over 14 per cent of GDP, which translates into €352 billion! In Greece, Spain and Italy the shadow economies represent 28-22 per cent of GDP. In this context it should be emphasised that most economists agree that the current economic and financial crisis will lead to an expansion of the shadow economy in almost all OECD countries.