Global banking in a tax compliant world

"The tax authorities have turned more men into liars than marriage did," is a well-known bon mot of former German television host Robert Lembke, which referred to a world of the past where it was not uncommon for taxpayers to conceal some of their assets from the tax authorities. However, the world dramatically changed once the global community – driven by the financial crisis – implemented assorted measures to fight tax evasion by exerting pressure on financial institutions to refrain from assisting taxpayers in hiding their taxable funds.

Over the past 20 years money laundering and tax havens have attracted increasing international scrutiny. Recent developments show Switzerland's willingness to participate in a global tax transparency standard.

Based on the December 2012 report of the Federal Council, there are three pillars which will constitute a tax compliant financial centre. These are (1) international withholding tax agreements (as with Austria and the UK), (2) an enhanced legal and administrative cooperation according to international standards, and (3) enhanced due diligence obligations for financial institutions.

In October 2013, the Federal Council also signed the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (MCMAA), which provides for various forms of cooperation and exchange of information (EoI) in taxation.

In 2012, revised recommendations to the international standards on combating money laundering and the financing of terrorism and proliferation of weapons of mass destruction were released by the Financial Action Task Force (FATF) (FATF Recommendations). According to the FATF Recommendations, "serious tax crimes" related to direct taxes and indirect taxes should be included in the predicate offence catalogue for money laundering.

The Federal Council launched a consultation procedure in March 2013 for a revised Anti-Money Laundering Act (AMLA) implementing the FATF Recommendations. The AMLA includes articles on enhanced due diligence for financial institutions regarding the tax compliance of new assets accepted. Based on the proposed articles of the AMLA, financial institutions are obliged to perform a risk-based analysis regarding the tax compliance of their clients. A risk-based analysis means that higher and lower risk factors, indicating whether transferred assets are more likely or less likely to be non-compliant, must be targeted and identified.

Enhanced risk indicators include a client's wish for heightened confidentiality, frequent cash transactions, the use of complex structures absent a sound business rationale, a beneficial owner different from the account holder and evidence of current penal proceedings for tax fraud and other tax offences. Decreased risk indicators include the self-declaration of a client, permission to disclose account details to tax authorities, the provision of evidence "making credible" that the transferred assets are taxed and the existence of an international withholding tax agreement. According to the proposed articles of the AMLA, an analysis of tax compliance must be done only where the value of the assets exceeds a certain minimum threshold and where additional suspicious facts suggest money laundering. The financial institutions are furthermore responsible for implementing the necessary organisational measures and training their staff accordingly.

Based on the proposed wording in the draft AMLA, the "self-declaration of a client" means the client asserts "that the transferred assets and the respective investment income are taxed or will be taxed". However, it is the responsibility of the bank to define other key terms such as "enhanced risks" or "make credible".

Where the financial institution reasonably suspects that the assets of new clients are not tax compliant, it must refuse to accept them and decline a business relationship. Additionally, in connection with such transfers of new assets for existing clients, financial institutions are obliged to conduct a subsequent review of the existing assets of the clients for tax compliance purposes. In this circumstance, and also if a legitimate suspicion of tax non-compliant assets on existing accounts otherwise arises, the financial institution must ask the clients to prove the tax compliance of his or her account. Where no such evidence is provided, the client relationship has to be terminated, unless the client demonstrates within a set timeframe that the assets have been regularised. The termination of the client relationship should only be the ultima ratio measure.

On November 23 2013 the Federal Council suspended the consultation procedure in connection with the enhanced due diligence on tax compliance in consideration of the signature of the MCMAA and the expected automatic information exchange (AIE). However, the intent remains to implement tax fraud as an underlying offence for money laundering within the revised law regarding fiscal offences. Furthermore, on February 13 2014, the OECD released the Common Reporting and Due Diligence for Financial Account Information Standard (CRS), intended to adapt the FATCA intergovernmental agreement (IGA) structure and methodologies into the technical framework for the implementation of a global tax transparency system. The model CRS specifies detailed reporting and due diligence rules for financial institutions.

Hence, it is advisable that banks accept the responsibility to ensure (and continue to monitor) that client assets are properly declared.

What does this mean for the future? The Swiss Bankers Association (SBA) stated clearly – in a letter dated November 29 2013 – after the announcement of the suspension of the consultation procedure that their members are willing to follow the strategy of enhanced due diligence regarding the tax compliance of assets. In this case, any regulatory measures for an enhanced due diligence process as planned by the Federal Council becomes dispensable. The banks must choose a tracking method that takes into consideration the place of residence of their clients and the civil, political, tax and supervisory environment in their respective country of residence to assess whether a client relationship is still acceptable. Such enhanced due diligence will be applied in particular for clients resident in European countries.

The question remains to what extent a financial services provider can be treated as the long arm of the legal authorities or as the control system to prevent tax evasion. To wit, how far is a bank willing to go? How can banks take responsibility for the tax honesty of their clients? The bank has to rely on the documents received from their clients, as well as on the validity of official documents received from abroad (received from foreign lawyers or other professionals). What recourse does a bank have in the case of a disingenuous client?

Certain financial institutions already implemented guidelines regarding enhanced due diligence in relation to the tax compliance of their clients. For example, UBS inserted into their general terms and conditions a provision compelling clients to clarify their tax situation if the bank requests them to. Other similar provisions might enable the bank to terminate a client relationship in the event of a reasonable suspicion of tax non-compliance.

However, even if a financial institution decides to implement enhanced due diligence procedures, many questions still will remain open, for instance the definition of the term "justified suspicion", catalogue of indicia, relevant amounts, focus of reviewed person/entities and countries and so on. Furthermore, what do the terms "self-declaration" and "make credible" mean? Is it sufficient that a client just ticks the box with the question "yes, I will fulfil all tax duties..."? In connection with clients resident in a country where no taxes are levied or no tax returns have to be filed, how can they provide a self-declaration?

The Swiss Financial Market Supervisory Authority (FINMA) stated in October 2013 that the application of the enhanced due diligence process should be focussed on a certain circle of persons/entities and should be adapted based on the environment of the client's country of residence. Such a catalogue of indicia should respect clients who may face imprisonment or damaging media campaigns in their country of residence.

An advisable approach would analyse the requirements and possibilities on a country-by-country basis and create a country matrix. On the basis of the civil, political, tax and supervisory environment, indicia and corresponding measures can be designed.

Banks should not only consider the tax compliance of new assets, but also should perform a review of their existing accounts. The Federal Council included the regularisation of the past in their position paper "Report on national and international financial and tax questions 2013" (released in January 2013) as a task to ensure the credibility of the Swiss financial system.

Assuming that a bank should only have tax compliant clients and tax compliant assets at some point, what does this mean for the banking business in the future?

The new clientele of tax compliant clients will impose higher service demands on their bank. In the old world, a tax evader typically only wanted to place his or her funds in a safe and secret location. In order to mitigate the risk that the tax authorities discovered the bank account, such customer was not interested in being regularly contacted by the bank or receiving regular bank statements. In the new world, where the bank clients are all paying their taxes, clients will expect to receive bank statements that will allow them to properly declare the assets in their tax return. In addition, such clients will also be interested in receiving advice on which financial products suit them based on the taxation rules in their home country and to reduce any withholding taxes suffered on their investments, whereever possible.

A client who wants to properly declare his or her bank account and the generated investment income in his or her individual tax return typically needs specific information about the income and capital gains realised in accordance with the taxation rules in his or her home country. For example, many countries have different tax rates on dividend income, interest income and capital gains. Also a distinction between short-term capital gains versus long-term capital gains may be relevant, and to calculate the capital gain the cost basis of the assets sold needs to be known. Typically, this information is not available on basic account statements that can be produced by the current IT systems of many banks. To provide clients with the relevant information to complete their tax return, country-specific tax reporting is required. Some solutions enabling this type of service already exist in the market for a few key client countries, but most banks are not yet providing such services.

Further, tax compliant clients not only want to know the tax impact of their investments when they have to file their tax returns, ideally they should already know the tax consequences at the time they purchase an asset. Based on local tax rules it may be more favourable for an investor to select one product over another, even if the market exposure would be the same for both. Moreover, in countries with tax rates that distinguish between short-term and long-term capital gains, an investor should know the requisite holding period for the more favourable tax rate. In sum, the return after taxes matters more and more. Therefore, a bank that advises its clients on the suitability of investment products based on their individual tax situation will have a commercial advantage over its competitors that do not.

Also many investment countries apply withholding taxes on dividend or interest payments on securities issued by a local institution. A foreign investor is entitled to claim a reduction of the withholding tax based on a double tax treaty or a similar agreement between the source country of the income (that is, the investment country) and the domicile country of the investor. In theory, such reduction may be claimed either via a reduction at source or a refund procedure, though most countries permit a refund procedure only. For example, in case a foreign investor receives dividends on shares in a Swiss company, the investor typically only gets an amount of 65% of the dividend paid, while an amount of 35% Swiss withholding tax is remitted to the Swiss Federal Tax Administration. Provided the investor is domiciled in a country that has concluded a double tax treaty with Switzerland, he or she can in most cases claim a refund of 20% of the tax, thereby incurring a final tax rate of 15%. Pulling together all required documents to file such refund requests can be quite cumbersome, in particular, if income is generated through complex multi-level fund structures. In the past, withholding tax reclaims have not been on the radar of tax evaders, as one of the documents usually required was a residency certificate issued by the investor's local tax authorities. This requirement is not a deal-breaker for tax compliant clients, who will appreciate if their bank can assist them pulling together the necessary documents and/or filing these reclaims.

Implementing the above-mentioned additional services will require a bank to enhance its IT systems and to build up detailed knowledge of the applicable local tax laws. In light of the implementation costs, few banks, if any, will provide these services for all countries. Rather it is expected that banks will focus on key markets for which such services can be offered. Clients in other countries will then receive more basic banking services or have their banking relationship terminated. Some large Swiss banks already started to terminate banking relationships with offshore clients who either hold insufficient assets or are, irrespective of their wealth, domiciled in a country for which it is no longer regarded as worthwhile to provide banking services from a commercial perspective.

The path towards tax transparent clients is paved with many challenges for banks in particular in Switzerland. In the wake of the abolition of retrocessions, the low interest rate environment and the related erosion of margins, this is yet one more challenge for the banking industry. However, every economic cloud has a silver lining. Those banks that prepare in advance and are able to tailor their services to the needs of a new tax compliant and more demanding clientele may come out ahead and be better positioned than before.

The tax compliance of clients will be a condition sine qua non for a bank in the future. Hence, banks must adopt a strategic decision concerning these market developments. It is possible to decide to retreat from a market or country and/or to sell specific client portfolios (toxic clients). In this way a bank may achieve excellence in specific markets or countries, thus obtaining a comparative advantage over other banks.

The authors would like to thank Annemarie Rüegger, director, and Paul Millen, senior manager, for their support as senior subject matter experts.

Biography
		Markus Weber Partner, Financial Services Tax Leader Deloitte, Switzerland Tel: +41 (0)58 279 7527 Email: markweber@deloitte.ch Website: www.deloitte.ch Markus Weber heads the Financial Services tax practice for Deloitte in Switzerland and has 13 years of extensive experience in consulting banks, asset managers and investment vehicles in domestic and international tax issues and from working in financial institutions in Switzerland and abroad.

Biography
		André Kuhn Senior Manager, Financial Services Tax Deloitte, Switzerland Tel: +41 (0)58 279 6328 Email: akuhn@deloitte.ch Website: www.deloitte.ch André Kuhn is a senior manager in the Financial Services tax practice with more than nine years of experience in international corporate taxation. He is specialised in the taxation of banks and investment funds.

Biography
		Petra Köppel Manager, Financial Services Tax Deloitte, Switzerland Tel: +41 (0)58 279 6339 Email: pkoeppel@deloitte.ch Website: www.deloitte.ch Petra Köppel is manager at Deloitte in Switzerland and a Swiss certified tax expert. She has more than five years of experience in national and international corporate tax consulting services and as part of the Deloitte Financial Services Team she has a great experience in consulting investment vehicles and financial institutions regarding various tax issues.