This article provides an overview of the steps taken concerning internationally agreed standards of tax information exchange and disclosure. National incentives to reduce the use of IFCs to avoid tax are considered (with a focus on FATCA), and the future role of IFCs is considered.
This article is part of the PLC Private Client multi-jurisdictional guide. For a full list of jurisdictional Private Client Q&As visit www.practicallaw.com privateclient-mjg
Since the introduction of the Magna Carta in 1215 to the present day, the foundation of common law jurisprudence has always been that the individual is free and that the common law exists to protect the individual's property and privacy. In current times, where people of varying financial standing are free to travel, work overseas and own assets all around the world, the basic tenets of privacy and property ownership are rapidly evolving and inevitably taking on a new form of meaning.
The shift in the levels of individual mobility and wealth across nations has expanded concurrently with the globalisation of technology and information exchange. Taxpayers across the world can now make, hold and manage investments through international financial centres (IFCs).
Earlier this year, a number of celebrities were "named and shamed" in the UK newspapers for holding large sums of money in offshore schemes or structures, significantly reducing their UK tax liabilities. Large multinational companies operating in the UK have been similarly excoriated by the parliamentary Public Accounts Committee for paying little or no UK corporation tax, while earning significant profits in other jurisdictions via complex corporate structures. These very public expositions of tax avoidance are symbolic of a fundamental shift in our attitudes towards tax avoidance, and the regulators are keen to take advantage of this shift. For the very first time, global information on beneficial ownership and the financial affairs of individuals is now available and readily transferable across countries, institutions and computer platforms. Tax authorities have naturally been eager to use this to their best advantage, to improve the enforcement of domestic tax legislation and, as a consequence, enhance revenues.
The Tax Justice Network estimates that tax evasion loses revenues of up to GB£120 billion a year in the UK (as at 1 October 2012, US$1 was about GB£0.6). Tax evasion is increasingly a problem, and no country is safe from it. It poses a significant threat to the whole premise upon which the modern taxation system is based (namely, to sustain the expenditure levels of each country's government).
The main causes of tax evasion are generally considered to result from:
The fact that each country has its own isolated taxation system.
The diversity between each country's taxation system.
Since individuals can pick and choose where they keep their assets with relative ease, tax evasion becomes possible.
As early as 1998, the Organisation for Economic Co-operation and Development (OECD) launched a programme to promote financial transparency and information exchange. At the time, it was envisaged that this would be a moderate system of information exchange based largely on exceptional circumstances and responses to specific requests. Since then, the concept has evolved to the extent that it is now acceptable practice for government institutions to collect comprehensive financial data on individuals. Nowhere is this rapid evolution more evident than in the introduction of the US Foreign Account Tax Compliance Act (FATCA), which is discussed in more detail below.
It is the introduction of this automatic information exchange by the taxation authorities that we consider to be the most pressing current issue, and one that requires immediate contemplation and action by both clients and their advisers.
Provides an overview of the steps taken concerning internationally agreed standards of tax information exchange and disclosure.
Reviews national incentives to reduce the use of IFCs to avoid tax, with a particular focus on FATCA (possibly the most ambitious tax compliance programme attempted to date).
Concludes that the role of IFCs within the global sphere of taxation has irreversibly shifted.
IFCs are countries and territories with low tax rates and other features that make them attractive investment locations. They play a key role in the international financial system, improving the availability of credit and encouraging competition in domestic banking systems. However, these characteristics also raise concerns that IFCs can:
Erode tax collections.
Divert economic activity.
Otherwise burden nearby higher tax countries.
IFCs have been subject to ever-increasing scrutiny and criticism in recent years. Higher tax countries are attempting to persuade IFCs to raise taxes (for example, there has been pressure on Jersey and Guernsey to impose a 10% corporation tax in place of the nil rate). Just as banks and bankers have been subject to accusations of tax evasion, illegality and unfairness, IFCs are now being put under the microscope, with pressure to either change their laws, disclose greater quantities of information or work together with international taxation authorities as a means of increasing transparency and mitigating tax evasion on a global scale.
The fundamental purpose of a tax system for every country is to pay for the expenditure the national government makes. Mineral rich countries do not need to ask their citizens for taxes, but rather impose a levy on sales to raise revenue. Similarly, international financial centres that cover a small geographical area (with often fewer than 100,000 citizens) have limited needs for finance. In contrast, a G20 country has a lot of bureaucracy and wide international obligations. As a result, it is unlikely that the first two types of country need to charge the same rates of taxation as a G20 country. In turn, this increases rates of investment from taxpayers in G20 countries, which makes high levels of domestic taxation even less necessary.
The difficulty that G20 governments face is that many individuals and corporations operate on a global basis. As an economic reality, they may no longer have a specific jurisdiction to which they owe a taxing allegiance. In those circumstances and until national governments successfully re-evaluate domestic taxation and tax competition, tax arbitrage with lower tax jurisdictions seems bound to continue.
Across Europe, the US and an increasing number of developing countries, governments are putting new initiatives in place to try to combat non-compliance with tax laws and non-disclosure of assets by their citizens.
The scale of the assets and tax liabilities disclosed under these measures has led to the perception among national governments that very significant undeclared funds remain in a number of jurisdictions which formerly operated their banking in secrecy. The UK and US governments believe that the sums disclosed in their respective disclosure facilities are only the tip of the iceberg. The chief of the IRS Criminal Investigation division, Eileen Mayer, has indicated that voluntary disclosures made through the Internal Revenue Service's (IRS) offshore voluntary disclosure programme have represented account balances ranging from US$10,000 to US$100 million (as at 1 October 2012, US$1 was about EUR0.8). IRS collections of tax, interest and penalties from the disclosures made exceed US$3 billion to date.
The now very realistic prospect of raising such vast sums of income has inevitably encouraged governments to promote voluntary tax reporting by their citizens, an ambition that is reinforced with the negotiation of tax information exchange agreements.
Over 100 countries are now officially committed to the OECD international standard of transparency and exchange information on request. The EU has recently adopted Directive 2011/16/EU on administrative co-operation in the field of taxation (Mutual Assistance Directive) and the Convention on Mutual Administrative Assistance in Tax Matters (Multilateral Convention), which is open to all countries.
In 2009, the G20 countries undertook to take action against countries that fail to meet the international standards for tax transparency. In November 2011, this was bolstered by every government in the G20 signing up to the Multilateral Convention, which offers a broad range of tools for cross-border tax co-operation. It includes the automatic exchange of information, multilateral simultaneous tax examinations and international assistance in the collection of tax due. More than 50 countries have either become signatories or have stated their intention to do so. The Multilateral Convention provides an impetus for the automatic exchange of information across developed and developing countries alike. The agreement also imposes safeguards to protect confidentiality of information exchanged.
One of the most significant reporting regimes to be introduced recently is FATCA, which was enacted by the US government in 2010 as part of the HIRE Act 2010. The objective of FATCA is to combat the use of non-US bank accounts and financial institutions as a way for US persons to evade tax.
FATCA imposes an obligation on non-US financial institutions to report certain information on US account holders to the IRS. To ensure compliance, FATCA comes armed with a big stick. If a non-US financial institution does not comply with the reporting requirements, then a 30% US withholding tax will be imposed on all US payments to that institution.
Due to the global nature of investment, non-compliance with FATCA is not really a viable option for any financial institution, wherever located, as it is almost impossible to avoid some connection with the US. This is particularly true for financial institutions which are based in small international financial centres for whom international regulatory compliance can be a good way of counteracting any negative views of institutions which operate out of such a jurisdiction.
Initially, FATCA was a unilateral disclosure programme. However, following concerns from financial institutions on issues such as data protection, governments from all over the world have entered into negotiations with the US government to try find an approach which would satisfy the objectives of FATCA, without breaching their own domestic law.
A model agreement was published in July 2012. This agreement was produced through discussions between the US and a group of European countries (the UK, France, Germany, Italy and Spain), supported by the European Commission. Unlike other multilateral disclosure programmes, the model agreement was designed to be a bilateral agreement between the US and each separate country. Therefore each separate country negotiates its own terms based on the model agreement.
Under the terms of the agreements, broadly, each country will essentially agree to act as agent for the IRS. Financial institutions situated in the relevant jurisdiction will report certain information to their local taxing authority. The local taxing authority will then automatically report that information to the IRS. This ensures compliance with any relevant local law and, in theory, makes it easier for the financial institution to be compliant. Any financial institution which complies with the terms of the agreement between the country in which it is situated and the US will be considered compliant under FATCA and no further reporting will be necessary.
The intergovernmental agreements also provide for the automatic information exchange which means that both the US and the country with which it is contracting will benefit from entering into the agreement. Potentially, the intergovernmental agreements entered into as a result of FATCA could prove to be as beneficial for the other party as it is for the US.
The first country to sign an agreement was the UK, though there are now over 50 different countries in negotiations with the US to put these agreements in place before the reporting requirements of FATCA come into force. These countries include many small international financial centres including Bermuda, the British Virgin Islands and Liechtenstein.
Jersey, Guernsey and the Isle of Man are also in negotiations with the US government and, interestingly, they have chosen to act together during their negotiations. Acting together is likely to be beneficial to them for two reasons. The first is that it may give them more strength in negotiating terms with the US. FATCA is fundamentally a disclosure regime: it is not really intended to be a withholding regime. The more countries that sign the bilateral agreements, the more effective the FATCA regime will be at providing information to the IRS. Institutions based in Jersey, Guernsey and the Isle of Man will have a significant share of the offshore investment market between them, and for this reason the US is more likely to enter into an agreement to have easy access to information within that share of the market.
Second, as seen when the corporate tax regimes in these international financial centres came under scrutiny from the EU (and their use of a zero-ten system was criticised), by taking the same approach as each other they can all remain competitive. As these financial centres are closely connected geographically, it can often be easy for clients to switch jurisdictions if any one jurisdiction becomes uncompetitive. Therefore, by working together to ensure the relative similarity of offerings, each of the jurisdictions can benefit financially.
FATCA is still evolving and the introduction of new intergovernmental agreements ensures that, from an international perspective, it will continue to evolve. Small international financial centres would be well advised to act together when approaching the US and try to enter into intergovernmental agreements. This level of co-operation will show their commitment to the international goal of tackling tax evasion and also aid any financial institutions situated within their borders in complying with FATCA, as reporting to a local body is generally easier than reporting directly to the IRS.
Therefore, the general message when considering FATCA and advising clients is that, unless the client has no connection whatsoever to the US, a certain amount of diligence will need to be done if only to ensure that FATCA itself (or one of the intergovernmental agreements) does not apply to that particular client. The provisions of the regime are broadly drafted to catch entities and individuals who would not think they were necessarily a financial institution or a US person. For this reason, until FATCA compliance has been considered and dismissed, it should not be ignored.
Although FATCA is perhaps the most comprehensive country reporting regime, others have been applied and are developing across Europe, together with voluntary disclosure programmes, a trend that is equally worthy of attention.
In 2012, the Spanish government announced a tax evasion amnesty for undeclared assets or those hidden in tax havens. Repatriation would be allowed by paying a 10% tax, with no criminal penalty.
Among the Nordic countries, a large amount of information must be exchanged automatically with the country of residence. Denmark's tax amnesty programme offers Danish taxpayers the possibility of voluntarily declaring undisclosed income and assets to the Danish Tax Authority at a reduced penalty and without risk of a prison sentence, with a maximum fine of 60% of the Danish taxes payable on the undisclosed income.
In The Netherlands, a voluntary disclosure scheme encouraged taxpayers to report more than EUR1 billion in capital in foreign savings accounts by December 2009. From 1 January 2010, the voluntary scheme was scaled back and instead taxpayers faced a fine for non-disclosure of 300% of the amount held in the undisclosed foreign account, but with reduced penalties from July 2010 of 30% in cases of voluntary disclosure.
In addition to the OECD influence on these regimes, other international organisations are affecting similar practices. Directive 2003/48/EU on taxation of savings income in the form of interest payments (Savings Directive) is an agreement among the member states of the EU to automatically exchange information with each other about customers who earn savings income in one EU member state but reside in another. While several countries within the EU do not yet operate automatic information exchange and instead choose to withhold taxes from interest payments before it is paid to the investor, there is increasing political pressure to remove this in favour of the automatic exchange of information going forward. In addition, there is speculation that the Savings Directive could be extended to catch wider classes of income and ownership structures, including trusts and offshore companies.
A further indication of the pressure being applied by international organisations (such as the EU) towards harmonisation are demonstrated by the changes made by the Crown Dependencies, Guernsey, Jersey and the Isle of Man to the "zero ten" regime of corporate taxation. These changes were implemented following pressure from the EU.
The regime applies a zero rate of taxation on the income, profits and gains of entities based within those jurisdictions. Certain financial institutions are subject to a 10% rate of taxation of the same.
The regime has come under fire from the EU Code of Conduct Group (CCG) which aims at imploring member states to both:
Amend existing laws which are considered to constitute harmful tax competition.
Refrain from introducing harmful measures in the future.
In response to pressure from the CCG, all three Crown Dependencies implemented changes to their zero ten legislation. The changes were aimed at removing the "deemed distribution" provisions of the regime which meant that island residents who were shareholders of island companies paid personal income tax on any unallocated company profits, whilst anyone living off-island did not.
However, the Crown Dependencies do not have any official relationship with the EU. The EC Treaty stipulates that EU measures only apply to non-EU jurisdictions insofar as is necessary for the operation of the customs union, free movement principles and the application of competition law and state aid provisions in agriculture and fisheries. Tax policy is clearly not within the scope of the EU's reach.
Nevertheless, the CCG has regularly reported on the harmful nature of certain aspects of the zero ten regime and recommended that changes be made to these regimes. Likewise, in recent years, the Crown Dependencies have begun to collaborate with the CCG, attempted to adhere to their recommendations and sought out approval from them in relation to possible amendments to their legislation.
The explanatory notes to Guernsey's Billet d’état of 27 June 2012, which legislates for the removal of deemed distributions provisions from Guernsey's zero ten legislation, indicates that the amendments are a direct result of the CCG's work in reviewing "harmful" regimes. The notes make reference to a voluntary commitment on Guernsey's part to adhere to the principles underpinning the CCG's work, and details the process of review and collaboration that has been completed between Guernsey and the CCG.
It still seems likely that offshore financial centres such as the Crown Dependancies will continue to differentiate themselves by operating lower levels of tax than the onshore jurisdictions, and for as long as they do so, taxpayers will have the ability to structure their affairs through low tax jurisdictions. Nevertheless, these jurisdictions are clearly moving into a new phase of collaboration with international organisations such as the EU. The political pressure on them to do so is clear. It is also clear that it is better for these jurisdictions to be included in decision making which will, inevitably, affect them, rather than allowing conditions to be imposed without discussion.
The current coalition government in the UK has a flagship policy of eliminating the budget deficit over its term of office. It has entered into negotiations with several international financial centres, forecasting that these negotiations will net the Exchequer GB£10 billion in total. Bilateral UK agreements with Liechtenstein and Switzerland are each expected to deliver GB£3 billion.
More recently, HM Revenue & Customs (HMRC) entered into agreements for information exchange with the British Virgin Islands, Liberia, the Bahamas, Grenada and Aruba, as well as implementing a number of initiatives aimed at bringing in resistant taxpayers and associated revenues, including:
Liechtenstein Disclosure Facility (LDF). This scheme specifically relates to taxpayers who wish to declare unpaid tax liability linked to investments or assets in Liechtenstein. Provided a Liechtenstein connection is established, the LDF can be used as an umbrella for the disclosure of any tax liability connected with an overseas asset. Therefore, it may be unnecessary for all overseas assets to be transferred to Liechtenstein to qualify for the LDF. However, from 1 September 2012 onwards, Liechtenstein institutions will require the individual to deposit a minimum of 20% of their assets (or CHF3 million) (as at 1 October 2012, US$1 was about CHF0.9) with the institution in order to take advantage of the LDF. The LDF is scheduled to run until 5 April 2016. Under the agreement between the UK government and Liechtenstein relating to the establishment of the LDF, all Liechtenstein financial intermediaries will review their UK clients to identify those who need to confirm their position with HMRC. If a UK investor is unable to confirm that they are compliant, the Liechtenstein institution must withdraw its services from that client. Other countries may decide to follow this bilateral model.
The LDF is seen by some as the most attractive opportunity afforded to holders of undisclosed bank accounts. It has turned out to be more popular than HMRC expected, with HMRC last year revising its predicted yield from GB£1 billion to GB£3 billion. This expected boost in yield is attributed to the more favourable terms offered by the LDF in comparison with those terms offered by the UK-Swiss deal (see below). The terms of the agreement between the UK and Liechtenstein provided that Liechtenstein banks were obliged to identify all of their UK customers by 1 October 2011. The banks then had three months to notify their customers of their obligations. Once a notice has been received from a Liechtenstein bank, customers have 18 months to either declare themselves as being tax compliant, or register to make a disclosure under the LDF.
UK-Swiss Confederation Taxation Co-operation Agreement. On 6 October 2011, the UK and Switzerland signed an agreement (to come into force from 1 January 2013) to introduce a mandatory withholding tax on undeclared Swiss bank accounts operated by UK-resident individuals (that is, a person whose principal private address is in the UK). This allows these individuals to regularise their tax affairs. The new withholding tax applies to funds in bank accounts and security portfolios (including assets such as gold bullion) held at 31 December 2010 and remaining open at 31 May 2013. In respect of those accounts, the Swiss banks who have signed up to the scheme will pay a one-off payment of between 19% and 34% to HMRC, depending on how long the assets have been held. Once this payment is made, UK resident account holders, even though their identities will not be known to the UK tax authorities, will generally be regarded as having fully complied with their UK tax obligations as they relate to their undeclared Swiss assets unless HMRC has already become aware of those liabilities from their own investigations. After that initial payment, Swiss banks will be required to impose the following annual withholding taxes on their UK resident clients who wish to preserve their anonymity:
48% on past and future interest payments;
40% on dividend income; and
27% on capital payments.
These UK-resident clients will have to pay to HMRC a one-off tax payment of between 19% and 34%, depending on how long the assets have been held. Once this payment is made, UK-resident account holders will generally be regarded as having fully complied with their UK tax obligations as these relate to their undeclared Swiss assets unless HMRC has already become aware of these liabilities from their own investigations. As an alternative, UK residents may disclose their Swiss accounts to HMRC, and while not subject to withholding taxes, they will have to pay back-taxes.
UK-resident Swiss bank account details will remain secret unless a legitimate and specific request is made for an account holder's name. HMRC will only be allowed to submit a limited number of banking information disclosure requests each year, to check that the withholding taxes are being applied. The Swiss regime has become less secretive, but is still a long way from offering automatic information exchange with the UK.
The UK-Swiss agreement includes opt-out procedures for non-domiciled individuals (known as non-doms). Swiss banks will accept as an exempt non-dom any UK resident who submits certification of his non-dom status. The certificate must be provided by a lawyer, accountant or tax adviser who ''is a member of a relevant professional body''.
One effect of the UK-Swiss agreement is that Liechtenstein may become a comparatively more attractive alternative for the non-compliant UK-resident Swiss bank account holder. The LDF only requires payment to HMRC for the period from April 1999 onward, rather than the total value of the assets, and penalties are limited to 10% of unpaid taxes for the period up to 5 April 2009. UK-resident Swiss bank account holders with a large liability to income tax or capital gains tax (CGT) pre-dating April 1999 can, even without having a long-term connection with Liechtenstein, seek to avail themselves of the relatively more favourable LDF terms.
The UK-Swiss agreement represents a departure from HMRC's statement of December 2009 that withholding taxes do not meet the OECD's standards for transparency because client identities still remain secret. Before its signing this month, the EU warned that the proposed UK-Swiss agreement would not be allowed to supersede EU demands for an automatic exchange of tax information. If there is a conflict, European law always takes precedence over bilateral agreements.
Increased penalties. The Finance Act 2011 introduced higher penalties for taxpayers who fail to account for the full amount of their income or CGT liabilities, where the failure is linked to an offshore matter. The new penalty framework applies to tax periods commencing on or after 1 April 2011. This law (with certain limited exceptions) applies the same penalties as for deliberate onshore non-compliance, regardless of whether the offshore non-compliance was deliberate. The aim is to increase the scale of the financial deterrent against holding funds offshore. The penalty rates are dependent on the source of the information, and are as follows:
where a jurisdiction automatically shares information with the UK: the penalty rate is the same as the standard penalty;
where a jurisdiction only exchanges information with HMRC on request: the penalty rate is one and half times the standard penalty (up to 150% of tax); or
where non-compliance arises in a jurisdiction which has not agreed to exchange information with the UK: the penalties are double (up to 200% of tax).
These developments have created new considerations for legal advisers. The following section considers:
Advising non-compliant clients.
Advising clients on the use of international financial centres.
It would be preferable if all clients were starting from a fully compliant historic base. But if, in reality, there is still a significant element of non-disclosed funds, the question arises as to what can or should be done.
Advisers should bear in mind the following points:
There is now limited scope to use a jurisdiction which maintains full banking secrecy. Those few jurisdictions which still offer secrecy are likely to come under increasing pressure from the G20 nations going forward. Advisers should anticipate that the bigger countries, especially the US, UK and EU countries, will implement strong countermeasures.
Professional advisers in many jurisdictions now have legal duties to disclose to the relevant authorities if they suspect that a client has funds which are non-compliant. Failure to disclose may lead to criminal sanctions for the adviser. As part of the ongoing drive towards implementation of the agreed international standards on anti-money laundering, advisers in more jurisdictions will be subject to the same standards. Clients will find themselves increasingly controlled by their advisers on behalf of the relevant revenue authorities.
In these circumstances, a client wishing to evade tax will have very few places left to hide.
Therefore, the only possible advice to such clients must be to come clean. Where there is an amnesty or favourable disclosure regime available, this would seem to be an obvious place to start. Where there is no such facility, or it is no longer open to newcomers, the taxpayer should obtain the best advisers available and make a voluntary approach to the revenue authorities without delay.
Despite the tendency of tax authorities to conflate tax avoidance with tax evasion, it remains the case that in most countries it is perfectly legitimate for a client to wish to mitigate his tax liability within the limits of the law. This includes, where exchange control rules do not apply, placing assets in jurisdictions outside of the home jurisdiction.
Therefore, the emphasis for advisers will be on:
Placing funds in reputable financial centres.
Ensuring full compliance and disclosure with the relevant tax authorities.
Clients will increasingly rely on their advisers to ensure they do not fall foul of the increasing number of applicable rules.
Clients who continue to use and establish structures in international financial centres will tend to be larger value structures and international families. This is because the increasing compliance costs will tend to act as a barrier to entry for smaller value structures or clients with smaller amounts to place in offshore banks. These existing structures and accounts may be looking to unwind and repatriate funds to the home jurisdiction.
The client will require their advisers to:
Draw on their expertise in the key jurisdictions to advise on important issues such as:
succession to any family business;
investment and distribution policies.
Deal with new issues arising from new regulations or changes to existing regulations, including:
complex overlapping tax compliance; and
disclosure requirements across a number of jurisdictions.
Detailed and reliable record-keeping, to meet the differing requirements of all relevant jurisdictions, will be essential. This is likely to be a further expense, but one which is necessary to ensure compliance.
More than ever, advisers will need to understand and walk their clients through the increasingly complex international landscape.
Although tax rules and tax rates will always differ across countries, the means by which domestic taxation laws can be enforced will increasingly conflate and become dependant on international co-operation between taxation authorities, particularly when it comes to high net worth individuals.
As we have seen with the Crown Dependancies and the EU Savings Directive, this wave of harmonisation is occurring as a result of various factors, including supranational law and political pressure. Aside from the greater philosophical arguments regarding this change, the practical fiscal incentive cannot be overstated. There is an increased appetite for greater government revenue during this time of financial austerity and crippling national debts.
As the tide of transparency and information exchange gains greater momentum, the obstacles of confidentiality and data protection will continue to be raised by financial institutions and individuals alike. However, the use of intergovernmental agreements for the enforcement of FATCA shows that governments can, and will, find a way to overcome any practical (or indeed moral) impediments to tax information exchange. The old adage remains: where there's a will, particularly one worth a large chunk of government budget, there will most certainly be a way.
Qualified. England & Wales, 1970
Areas of practice. International private client.
Qualified. England and Wales, 2002
Areas of practice. International private client.
Qualified. England and Wales, 2008
Areas of practice. International private client.
Qualified. England and Wales, 2012
Areas of practice. International private client.