Summer in Geneva is normally a period of gentle relaxation with tranquil days spent beside a lake framed by Alpine peaks swathed in wild flowers. However, for the Swiss finance industry the summer of 2009 has been anything but idyllic.
While a number of local investment managers and private banks were still counting the losses incurred in the wake of the Madoff fraud, the Swiss government took the unheralded step of announcing on 13 March that Switzerland would withdraw its reservation to Article 26 of the OECD Model Tax Convention and would implement the OECD standard on administrative assistance. This major reversal of prior policy was announced in advance of the G20 meeting in London on 2 April, but was not sufficient to remove Switzerland from the OECD’s grey list of financial centres that had committed to the internationally agreed standard, but had not yet substantially implemented that undertaking. Swiss negotiators are working toward the signature of 12 revised or new tax agreements.
However, as always, the devil will be in the detail and there is a strong probability that under the Swiss constitution a public referendum will be needed to validate the terms of the first agreement to come into effect. While the Swiss government is adamant that tax information will only be supplied upon request and in strictly specified circumstances, there is no doubt that this commitment signals the end, in an international context, to the distinction traditionally made in Switzerland between tax fraud and tax evasion.
A further blow to banking secrecy, of a mortal nature according to many foreign commentators, was struck when the Swiss government and the Internal Revenue Service of the USA signed an agreement on 19 August that effectively put an end, for the time being, to the court action brought by the IRS against the UBS as a result of the criminal activities of certain employees in North America. Under this agreement the Swiss authorities undertook to examine duly submitted requests under the Swiss-USA tax treaty relating to 4,450 American tax payers who were clients of the UBS. The requests must relate to cases that prima facie meet the treaty test of “tax fraud and the like…”, but the detailed parameters have yet to be published. Again, the Swiss government has made it clear that any request will be examined with rigour and targeted account holders will have a right to appeal to the Swiss Federal Administrative Tribunal to attempt to block disclosure.
How many of the 4,450 account holders will decide to exercise their right of appeal remains to be seen. We can certainly expect that the IRS will attempt to obtain information from other Swiss banks with US clients holding undeclared funds. Other countries, such as Canada, France and Germany, may also be encouraged by the success of the IRS to bring pressure on Switzerland to disclose information about their non-compliant taxpayers holding Swiss bank accounts.
What effect this will have on the Swiss finance and banking centre remains to be seen. One leading Geneva private banker has been widely quoted in the media as predicting that Switzerland could lose up to one half of the privately-owned funds currently managed in this country. According to him the contribution that the Swiss finance industry makes to the country’s GDP could be cut from its present level of 12 per cent to between 6 or 7 per cent. This, one hopes, is an overreaction in the aftermath of the agreement with the United States. Although the outcome of those painfully protracted negotiations was hailed as a victory for both the USA and Switzerland, it must be conceded that the outside world is more likely to see the Swiss government’s agreement as a capitulation. While from a purely technical point of view Swiss banking secrecy remains intact, at least on the domestic level, the general perception abroad, and so much of this depends on perception, is that the strength of confidentiality has been further eroded and the cherished distinction made for decades by Switzerland between tax fraud and tax evasion has been swept away.
In retrospect, one could have predicted the inevitability of these changes. For many years the Swiss response to the accusation that the country was a haven for undeclared funds was that the fault lay not with Switzerland as the willing recipient of these funds but rather with those countries which failed to pursue sound budgetary policies and prudent social spending, resulting in the imposition of taxes at penal rates. But with worldwide personal tax rates falling over the last decade this argument began to wear thin. And since the scandal of the holocaust funds in 1997 it has been increasingly difficult for Switzerland to maintain its position on the moral high ground against the opponents of banking secrecy.
Switzerland was particularly aggrieved to find that it appeared on the OECD grey list in April 2009, while such jurisdictions as Jersey and Guernsey, perceived at least by some sectors of the Swiss financial community as rivals in the offshore world, were given a clean bill of health. This added further fuel to the argument, beloved of conspiracy theorists, that the war against offshore financial centres, and Switzerland in particular, is led by the USA and the United Kingdom, themselves major finance centres that seek to draw funds into their own banking systems. A popular line of attack by some Swiss commentators against the ‘Anglo-Saxon conspiracy’ is to point out that the common law trust is as widely used as an instrument of fraud and concealment as a Swiss bank account. This is a particularly pernicious and counter-productive argument to make at a time when Switzerland, following ratification of the Hague Trust Convention in 2007, is seeking to position itself as an increasingly popular jurisdiction for the conduct of trust business and the formation of local trust companies.
Although the dispute with the United States may be cooling off, at least temporarily, there is further pressure likely to focus on Switzerland from the direction of Brussels where the concerted efforts of France and Germany are likely to cause further problems for Switzerland in its relations with the European Union. Fortified by its success in obtaining, in controversial circumstances, information about Liechtenstein accounts held by German residents, the German Finance Ministry headed by Peer Steinbrück is waging a war against the Swiss banks, and their counterparts in Austria and Luxembourg – three countries branded by Herr Steinbrück as being “on a par with Burkina Faso” when it came to the OECD’s grey list of tax heaven. Whether Peer Steinbrück will be able to continue his campaign against these European financial centres will depend largely on the outcome of the German federal elections later this year, but it seems that the EU Commission is determined to close a number of perceived loopholes in the EU Savings Tax Directive and this will impact Switzerland as well as the other non-EU territories that have signed up to the Savings Tax Directive.
So against this background, what does the future hold for Switzerland as an international financial centre? One thing is absolutely clear: the traditional business model based on the impermeability of Swiss banking secrecy is now finished. The industry must seriously re-think its marketing strategy and capitalise on the other advantages offered by the country and its financial institutions: political and economic stability, sensible but not repressive regulation, investment management expertise and currency trading skills. This means that Swiss banks will have to compete on equal terms with those in other financial centres and that the cost of banking in Switzerland, which is never the cheapest option, will have to be competitive. Customers will no longer be prepared to pay a premium for the perceived protection of banking secrecy, now shown to be seriously eroded.
To be fair to the Swiss banking industry, many of the leading players have already anticipated these changes and have decided to move from an offshore to an onshore business model. Certainly Switzerland is well placed to offer sophisticated services in the field of investment management, trust administration and estate planning and a number of cantons have sought to attract hedge fund managers from London and other centres, where taxes or new regulatory measures make Switzerland seem an interesting alternative base. However, to successfully attract this business in any volume some changes in the Swiss tax treatment of carried interest received by promoters and managers of those funds will be necessary.
Switzerland will continue to offer wealthy retirees an attractive location for permanent residence, with the certainty and simplicity of the lump-sum tax arrangement. This special deal is available only to foreigners and has been a feature of the Swiss fiscal system for many years. Recently the lump-sum deal has come under internal attack, and in February this year the Canton of Zürich voted to terminate this special arrangement at cantonal level. The French speaking Cantons of Geneva, Vaud and Valais, which account for more than 60 per cent of the total 4,000 foreign lump-sum tax payers, are unlikely to follow the example of Zürich.
For many years Switzerland has been able to withstand a succession of attacks against bank secrecy. Without powerful allies to support its cause it has become progressively more difficult to sustain an effective defence of its special rules of confidentiality rooted in legislation enacted on the eve of World War II. The concessions that have now been made may result in a flow of some funds away from Switzerland, although it is not immediately evident where that money might go. The Swiss banking industry will have to adapt to the new era of exchange of information in tax matters, but while bank secrecy may no longer be absolute, the other attractions of the jurisdiction remain, and the industry will do well to promote those in order to maintain its position as leading financial centre for private wealth management.