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A closer look at the crackdown on banks that help the rich avoid taxes.
The assault on Switzerland’s cherished banking secrecy began as a perfect storm of pressure from the world’s biggest economies.
For months, Germany’s finance minister Peer Steinbrueck has been on a crusade to overturn Switzerland’s status as a tax haven, arguing that Germany loses billions of Euros in unpaid taxes on money deposited in foreign bank accounts. Steinbrueck threatened his neighbor with “the whip,” and once compared the Swiss to “Wild West Indians” cowering under the influence of the financial industry’s cavalry.
Then, this February UBS bank was forced to reveal some 225 presumed tax evaders and to pay $780 million fine after a U.S. Internal Revenue Service investigation uncovered the bank’s elaborate schemes for helping U.S. clients stash money in secret Swiss accounts.
Finally, at the April G20 meeting in London, finance ministers — saddled with crisis-driven deficits — threatened to compile a black list of uncooperative tax havens unless countries agreed to abide by the OECD’s banking transparency standards.
The list would include Austria, Liechtenstein, and Singapore. One of the biggest targets would be Switzerland, which manages 27 percent of the world’s offshore wealth, according to an estimate by the Boston Consulting Group.
It was at that point that the wealthy alpine nation balked.
The Swiss have reacted to the onslaught with a mixture of shock and outrage, particularly to the Germans.
A member of parliament responded to the German finance minister by calling him a “Nazi henchman.” The leader of the ultranationalist Swiss People’s party traded in his Mercedes for a Renault. And the biggest tabloid in Switzerland called Mr. Steinbrueck “the ugly German.”
Numbered, confidential accounts might be the fodder of spy novels and James Bond movies, but in Switzerland they are regarded as a basic right. The country prides itself as a bastion of security, characterized by discretion, banking expertise and the stable Swiss franc.
In contrast to American banks, which are compelled to report depositors’ interest earnings to tax authorities, in Switzerland divulging bank account details is a criminal offense, punishable by several months in prison. The law dates back to 1934, as neighboring France and Germany increased state intervention in private monetary affairs.
In a 1984 referendum, Swiss citizens voted overwhelmingly to maintain the secrecy law. A recent poll by the Swiss Bankers Association, an industry association, found that 78 percent of the population support it.
The support is hardly surprising considering what’s at stake for the country. Banking employs some 180,000 people and generates as much as 12 percent of the country’s GDP. According to the Bankers Association some 40 percent of all assets in Swiss banks are held by foreign clients. It’s anyone’s guess how much foreign money that exactly is, but figures ranging between 2 and 3 trillion dollars are bandied about. The entire nation’s GDP is less than $500 billion.
The Swiss have fought international pressure to relax their financial secrecy since the law was passed. But they regarded the dressing down at the G-20 meeting in London as a humiliation. Many faulted their government for reacting too slowly to the pressure. Officials finally took note.
Worried that the country would be slapped with retaliatory measures that could harm its multinationals – such as Hoffman-La Roche, Nestle and ABB Group – officials accepted the OECD standards.
Swiss officials agreed to exchange information with other countries on a case-by-case basis, if requests were “specific and justified.” It signaled that it would start to renegotiate all of its bilateral taxation agreements — with some 70 countries.
Still, the issue is far from resolved.
Taxation without prosecution
The major issue stems from Bern’s unorthodox distinction between tax fraud and tax evasion. Under Swiss law, forging documents and actively lying to authorities are considered tax fraud, a criminal offense. In criminal proceedings (including money laundering, corruption, and insider trading as well as tax fraud) banking secrecy no longer applies.
Yet tax evasion — failing to declare income or assets — is only a civil offense that can result in a fine. More importantly, the secrecy of a defendant’s accounts are maintained. In other words, if you want to avoid taxes, essentially all you need to do is to neglect to report them, and avoiding forging documents. Few other countries recognize this distinction. Switzerland has agreed to look into ways to revise that distinction.
The Swiss told German officials that if they wanted information for tax purposes in the future they would have to approve an amnesty for existing customers. While Berlin needs all the Euros it can get, this is politically problematic during the financial crisis, an election year in Germany.
“Tax amnesties never work, because tax payers don’t trust the government to really let bygones be bygones” says one retired central banker. Yet he says that a coordinated tax amnesty by Switzerland’s neighbors Germany, France and Italy could spell trouble for Swiss banks.
Meanwhile, the IRS has hardly finished its drubbing of UBS.
UBS under the gun
The saga started as an IRS investigation into a California real estate mogul, but eventually yielded a tax evasion guilty plea from a midlevel UBS banker who agreed to be a government whistleblower. The banker, Brad Birkenfeld, told investigators how UBS personnel went to elaborate length to help US clients stash money in secret Swiss accounts.
Despite the $780 million fine and the name disclosure, UBS still faces a civil suit filed by the IRS. This time the U.S. wants the names of another 52,000 American customers. UBS has denounced this as a fishing expedition, and has argued that it would be violating Swiss criminal law by yielding to the demand.
At risk could be UBS’s U.S. banking license. At roughly $2 trillion, the bank’s balance sheet is four times as large as Switzerland’s gross domestic product.
Even without the IRS case, UBS has recently suffered major damage to its reputation, announcing $53 billion in write-downs on U.S. sub-prime securities. Last year the country’s central bank had to step in with a $6 billion cash injection.
The UBS case has begun to demonstrate how deeply an end to banking stability and secrecy could affect Switzerland. John Cryan,UBS’s chief financial officer, admits that each time the bank finds itself in the news, client money pours out of its wealth management business — to the benefit of its competitors.
For now, the money appears to be staying in Switzerland, and flowing to UBS’s main rival, Credit Suisse, which has stayed out of the limelight. In the first quarter of 2009, Credit Suisse reported a net new money inflow of $10 billion and a $1.8 billion profit; UBS reported outflows of $23 billion and a $1.8 billion loss. Some of the money appears to be moving to other banks, perhaps including the smaller cantonal banks, which have some of their assets secured by the government.
The question is, what if other banks are forced to relinquish secrecy the way UBS has?
Business as usual
Yet most observers think that talk of the demise of Swiss private banking is premature. Despite Switzerland’s assurances to the G-20, so far it seems that Switzerland is playing for time.
Swiss President Hans-Rudolf Merz has reassured the country and its clients, that banking secrecy remains intact. He has warned foreign governments that renegotiating some 70 taxation treaties “won’t be fast” as each would have to be approved by the Swiss parliament. New treaties could even be subject to a national referendum, a very time consuming but integral feature of the Swiss political system.
Likewise, Thomas Sutter, spokesman for the Swiss Bankers Association says, “We have not seen any assets leaving the country and we don’t expect to, because bank secrecy is intact and as a financial center we offer expertise, good services and political and economic stability.”
While the U.S., Germany, France and Italy seem to crack down on its citizens taking their money to Swiss secret accounts other countries like Russia, Middle East, Latin America and parts of Asia remain valid as customers.
For those clients Switzerland’s political stability, its accessibility and safety is important even if the bank secrecy undergoes a transformation.
“It is important to keep in mind that not all foreigners who have accounts in Switzerland are tax cheats,” says Gian Giacum Klainguti, Director of Adler &Co Privatbank. He welcomes a clarification of bank secrecy rules, if it puts an end to tax fraud.
If Switzerland can delay or stave off meaningful reform, its banks would benefit. As the Swiss Banker’s Association notes, foreign clients now have nowhere else to go since most countries have now accepted the OECD’s information sharing standards.
It might be Swiss citizens themselves who get have the last word on bank secrecy: proponents of the principle are collecting 100,000 votes needed to trigger a national referendum. If passed, banking secrecy would be enshrined in the constitution.