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Automatic information exchange: an end to banking secrecy?

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The G8 has committed to work with the OECD to push for automatic exchange of information to become the new standard. Whilst the crown dependencies and British overseas territories are falling into line, other banking centres are very far behind – so will we ever see automatic exchange across the world? And does this mean the end for the ‘final’ withholding tax type of agreement signed by the UK with Switzerland – which preserves banking secrecy but allows tax authorities to receive what is due to them? That may depend on what happens next in Switzerland – with the government due to report on strategy in September.

Banking secrecy is often seen as tax evasion’s best friend. If a bank is never obliged to disclose information about its customers’ accounts, money can be hidden away from tax authorities. This is an obvious thing to point out, but it has taken many, many years for governments across the world to really do anything about it.

Times are a-changing and many countries – the UK among them – are close to concluding treaties with financial centres previously known for secrecy, which will provide for certain tax information to be exchanged on a routine or ‘automatic’ basis – making it more difficult for someone to hide assets.

But there also remains an alternative, complementary approach, developed by Switzerland, which protects banking secrecy while ensuring tax authorities collect what is due to them – namely allowing a bank’s customer to opt-out of information exchange and instead suffer a ‘final’ withholding tax on income and gains which is passed anonymously to the relevant country and extinguishes the customer’s liability to tax. Where does this now stand?

A potted history of information exchange

Information exchange has come a long way. Early treaties between tax authorities in different countries were often restricted to information needed to pursue criminal prosecution cases. In 1998, the OECD published a study on harmful tax competition and, in 2002, the OECD and EU Council published a Multilateral Convention on Mutual Administrative Assistance in Tax Matters which, among other things, provided for information to be exchanged where just needed for the administration of tax.

After a slow start, offshore financial centres began to adopt the standard, after facing international pressure following the financial crisis in 2007/08. In 2010, the standard was amended to beef up its provisions and to open it up to non-OECD member countries – after which a large number of countries refreshed their agreements or came on board for the first time.

But even the 2010 standard only obliges a contracting state to respond to a valid request for information. It also restricts ‘fishing expeditions’ – which is no use if the requesting state doesn’t know the whereabouts of the secret accounts. The standard, whilst noting that parties can enter into automatic exchange of information arrangements, does not require them to do so.

The turning point

Automatic exchange of tax information between countries in order to tackle tax evasion has been talked about as the gold standard for many years. The EU implemented a form of automatic exchange in 2005 but this applied only to interest paid on savings held by an individual, rather than a company, so was easily avoided in practice. Otherwise, countries across the world have been remarkably slow to push for automatic exchange. It took the long arm of the US to begin to really make a difference.

From 2007, fortified by a whistleblower’s intelligence, the US began to apply pressure on Swiss banks that had been helping US citizens to evade taxes. Other countries also began to take note, especially following the theft of data in 2008 from a leading institution in Liechtenstein, adding to the pressure on both countries. Liechtenstein moved first and in 2009 entered into a novel agreement to allow UK taxpayers to regularise the past on favourable terms.

The UK also leant on Switzerland and in 2011 negotiated another very novel deal – namely, the anonymous ‘final’ withholding tax system mentioned above, which cancels the taxpayer’s liability to tax yet allows him to keep his identity secret. Austria entered into an equivalent agreement, as did Germany, although the deal was in the end rejected by the German parliament.

However, the US has adopted a very different approach. Using its position as a leading country for inward investment, it has enacted legislation to apply a 30% withholding tax on income from US investments paid to a foreign financial institution, unless that institution, directly or through its government, gives the US certain information on a routine basis about specified US persons. This FATCA legislation was the real breakthrough for automatic exchange of information.

The UK’s role

The UK, along with the rest of the G5 group, negotiated a model intergovernmental agreement (IGA) with the US to implement FATCA, and earlier this year became the first country to enter into an IGA with the US based on the model.

The UK also used constitutional leverage over the crown dependencies and British overseas territories (CDOTs), which arguably could not independently conclude their own agreements with the US, to agree with them that they would also enter into IGAs with the UK based on the model standard.

The G5 group has also recently announced it would use the model IGA to pilot automatic exchange with each other. The CDOTs announced they would join the pilot, as did a number of other EU states, Norway and Mexico, meaning that all these countries will receive information about their residents with assets held in the CDOTs. To get this agreement from a group of offshore centres represented another major breakthrough.

Emboldened, the UK has used its presidency of the G8 to push the agenda more broadly. In what has become known as the Lough Erne declaration, all the G8 countries have agreed to work with the OECD to pursue a single global model for automatic exchange of information.

What about other offshore financial centres?

With so many countries falling over each other to adopt automatic exchange, one would be forgiven for thinking that all is a bed of roses. However, although the CDOTs have agreed to automatic exchange with countries other than the US, other jurisdictions known for banking secrecy are some way behind.

It may be surprising to learn that many countries, quite apart from not yet embracing automatic exchange, still do not require their financial institutions to forestall and report tax evasion under their anti-money laundering (AML) regimes. It may be even more surprising to learn that it was only in February 2012 that the global policeman for AML standards, the Financial Action Tax Force, amended its recommendations to include tax evasion as a reportable offence.

Singapore, which has the world’s fourth largest banking centre, changed its AML regime to include tax evasion on 1 July 2013, as it was keen to avoid becoming the ‘new Switzerland’ – a reputation given more credence by the revelation this year that Jérôme Cahuzac, the former French Budget Minister, had moved the contents of his secret bank account to Singapore in 2010 when the heat was being turned up on Switzerland.

Hong Kong, although it had changed its own AML rules in 2009, announced in April 2013 that it would be carrying out audits to make sure financial institutions were properly observing the rules in practice. Other countries, including Switzerland, continue to fudge the issue by requiring the evasion to be ‘serious’, and often requiring it to involve falsification of documents to qualify.

As for information exchange, Singapore (but not Hong Kong) has entered into negotiations with the US over FATCA, but neither country has yet expressed any interest in adopting automatic information exchange with any other countries. There will no doubt be other countries reluctant to embrace the new standard. It will be interesting to see how serious the G8 is – it may need the G8, along with the EU (it if is able to act en bloc), to use their positions as leading centres for inward investment to follow the US example and impose a withholding tax, if countries that want to deal with them are not willing to exchange information.

Register of beneficial ownership

The other issue pushed by the UK during its presidency of the G8 is the creation of registers of beneficial ownership of companies and other entities. Before the Lough Erne talks, the UK announced it would be creating a register for all companies incorporated in the UK, available in the first instance to law enforcement agencies, and would consult on whether to give the public access. The G8 countries have agreed to improve access to information about beneficial ownership but without specifically committing to a register, let alone to public accessibility. The CDOTs have largely given registers a lukewarm reception.

Emerging markets

And therein lies the rub. Clearly, tax evasion makes up a very large part of the reasons why people keep money in jurisdictions with banking secrecy. But it is not the only reason and any policy must recognise that there can be legitimate reasons for wanting to keep one’s personal wealth or business dealings secret – for example, because of personal security risks, or capricious governments or politicians.

In these cases, tax evasion is perhaps a necessary by-product, because the individual cannot disclose his wealth to his home tax authority for fear of leaks. Here, the ‘final’ withholding tax option developed by Switzerland – which allows the individual to choose to keep his identity secret and the tax authority to collect its tax – might be a better answer.

If you want corroboration that some people value their privacy for reasons other than tax evasion, HMRC has estimated it will net anything between £150m and circa £1bn a year from the final withholding tax collected by Switzerland (although there is considerable doubt over the accuracy of these figures). And the UK is a benign country.

Where next?

What happens next rather depends on Switzerland. A group of experts commissioned to advise the government on financial market strategy has recommended that it should adopt a global standard for automatic exchange of information if competitor banking centres do so as well, provided adequate provision is made for the regularisation of past untaxed assets. The government has, however, not ruled out signing final withholding tax agreements with new countries – and indeed the two are not mutually exclusive. If Switzerland continues to negotiate such agreements, they will probably catch on in other banking centres. All eyes will therefore be on Switzerland in September when the government will respond formally to set out its strategy. Final withholding tax agreements are not yet dead. Will banking secrecy get a reprieve?