The End of Bank Secrecy?

The End of Bank Secrecy? August 26, 2009   Bill Witherell, Chief Global Economist

This past week the Swiss Government agreed to reveal to the US Internal Revenue Service the names of 4450 Americans holding offshore accounts at UBS. In the previous week Liechtenstein agreed to a tax-information sharing treaty with the UK. This agreement is expected to serve as a model for treaties with other countries.  Also, the Organization for Economic Cooperation and Development (OECD), the international institution leading this transparency drive, announced that the British Virgin Islands and the Cayman Islands have implemented their compliance with the internationally agreed tax standards by signing 12 bilateral tax-information exchange agreements. They are the fifth and sixth jurisdictions to do so since April. Back in March, Switzerland signaled a major change in its long-time maintenance of a strict bank secrecy regime by saying it would accept the international standards on tax-information sharing and would negotiate bilateral treaties to this effect.

In an August 16th editorial welcoming these developments, the Financial Times said: “Independent nations do, of course, have a right to allow their banks and their citizens to skulk in the shadows. And citizens are fully entitled to arrange their finances in whatever legal manner minimizes their tax burden. But states also have the right to raise revenue from their people. Countries that make a living by abetting tax evasion in foreign jurisdictions deserve no sympathy. Using muscle in the assault on such tax banditry is perfectly justifiable.” 

In this note we give some background on the new era in international efforts to counter tax fraud and evasion that is unfolding, and discuss what still lies ahead, including some implications for investors and markets.

An important factor behind this year’s developments was the international pressure coming out of the April 2 G-20 London Summit meeting of the leaders of the World’s largest economies. Their communiqué stated that, “We agree: to take action against non-cooperative jurisdictions (that, is jurisdictions that have not accepted the international standards on transparency and tax information sharing), including tax havens.  We stand ready to deploy sanctions to protect our public finances and financial systems.  The era of banking secrecy is over.”  Switzerland, not a participant in the G-20, evidently felt the pressure, as did the six smaller jurisdictions that completed their implementation of the OECD tax standards.

These events represent a milestone in international cooperation by tax administrations that began with the OECD in 1996, when its Fiscal Affairs Committee launched its “harmful tax practices” project.  The objectives were summarized recently by the OECD Secretary-General in remarks to a June 23 ministerial meeting in Berlin, Germany as follows: “Tax evasion deprives governments of revenues needed for hospitals, schools and roads, forcing honest taxpayers to pick up the tab. It also prevents them from lowering taxes for all. In an increasingly borderless world, cross-border tax evasion has become a bigger threat. It also undermines the tax base of developing countries, making it harder for them to achieve the Monterrey goals of mobilizing their domestic resources.”

The OECD initiative focused first on eliminating preferential tax regimes within OECD member states.  By 2004 all but one of the identified preferential tax regimes had been abolished, amended, or found not to be harmful.  In 2000 the OECD identified a number of tax havens and sought their commitments to accept and implement the principles of transparency and the effective exchange of tax information.  There was great resistance to this effort but eventually thirty-five jurisdictions made formal commitments to this effect.  The OECD also encouraged other non-OECD economies to associate with this effort.  Bringing in non-OECD economies that shared the OECD concerns about tax evasion, as well as countries that had accepted the tax standards and wanted to join the effort to encourage others to make the move and thereby level the playing field, has proved to be instrumental to the initiative’s success.

The tax authorities of OECD and non-OECD jurisdictions that have made commitments to transparency and the effective exchange of information are brought together in the Global Forum on Transparency and Exchange of Information. The Global Forum developed the 2002 Model Agreement on Exchange of Information on Tax Matters, which has been the basis for over 100 bilateral agreements. Since 2006 the Global Forum has published annual assessments of the legal and administrative frameworks for transparency and exchange of information in 84 countries. In an August 14, 2009 brief, “Overview of the OECD’s Work on Countering International Tax Evasion,” the organization reports that “All 84 countries surveyed by the Global Forum have now endorsed the standard.”  Efforts of the Forum will now emphasize establishing a robust peer-review mechanism and monitoring the implementation of the agreed tax standards. (The brief can be found at http://www.oecd.org/topic/0,3373,en_2649_33745_1_1_1_1_37427,00.html .)

While the US IRS is evidently pleased with these recent developments, it recognizes that a great deal of further enforcement effort lies ahead.  In Switzerland, for example, UBS is only one of the numerous Swiss banks.  While the settlement announced last Wednesday involved 4450 secret accounts, the Wall Street Journal reported in its August 20 edition that “The US government investigation and settlement could ultimately produce some 10,000 account identities.”  Douglas Shulman, US Commissioner of the IRS, pulled no punches at a press conference last Wednesday: “This agreement sends an unmistakable message to people hiding income and assets offshore. The IRS will vigorously pursue tax cheats around the world, no matter how remote or secret the location.”

So are we witnessing the end of tax secrecy? In one sense the answer is clearly “No.”  All countries have some form of bank secrecy.  The international tax standards that are being incorporated in bilateral tax-information exchange agreements and tax treaties provide that bank secrecy can be lifted in well-defined circumstances to enable countries to enforce their own tax laws and to respond to requests for information, so that treaty partners can administer their own laws. The bilateral tax treaties and agreements contain rules to ensure that information is to be used only for authorized purposes and thereby protect taxpayer privacy rights. The fact that all 84 countries surveyed by the Global Forum now accept these standards and are moving to implement them implies that tax authorities will eventually be able to obtain information on offshore accounts located in most corners of the globe.  Implementation of the standards will take time and will be uneven, but in none of the 84 countries will banks be able to offer assurances that accounts will be protected from inquiries by tax authorities. (The above-cited OECD brief includes a table showing the situation for each of these countries as of August 14, 2009.)

Individuals with offshore accounts that would raise issues with the tax authorities if the identities behind the accounts became known will have to decide whether they would fare better by coming forward voluntarily, in advance of the increasing likelihood of being identified. Some countries may provide amnesty programs to encourage such action.

It is very difficult to estimate the amount of cash that has been stashed away in offshore accounts to avoid taxes, but it is believed to be substantial. The eventual proceeds from this international tax-enforcement effort will be a welcome addition to the strained finances of governments around the globe, many of which suffer from far greater tax evasion than is the case for the US.

Jurisdictions that have prospered in the past from a lack of transparency and the stifling of an effective exchange of tax information will likely suffer. This is particularly true for some of the small island tax havens that have few resources for economic development.  On the other hand, there are a number of other jurisdictions that have developed sufficient financial and regulatory infrastructure and knowhow to permit them to continue to compete for financial service business. Good examples are Switzerland, Guernsey and Jersey, and Liechtenstein.

Cumberland will continue to monitor these developments.  We will be particularly watchful for any situation in which a country becomes so deficient in its implementation of its commitments that it comes under strong pressure from the Global Forum and faces threats of the sanctions by individual countries alluded to by the G-20. That would likely have a significant effect on international investors’ attitudes towards that country.

Cumberland Advisors is registered with the SEC under the Investment Advisors Act of 1940. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in states and/or international jurisdictions where Cumberland Advisors is either registered or is a Notice Filer or where an exemption from such registration or filing is available. New accounts will not be accepted unless and until all local regulations have been satisfied. This presentation does not purport to be a complete description of our performance or investment services.

Please feel free to forward our commentaries (with proper attribution) to others who may be interested.

For a list of all equity recommendations for the past year, please contact Therese Pantalione at 856-692-6690,ext. 315. It is not our intention to state or imply in any manner that past results and profitability is an indication of future performance. All material presented is compiled from sources believed to be reliable. However, accuracy cannot be guaranteed.