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Switzerland's Treaties in the Transparent New World

By TreatyPro Editorial
01 June, 2012

In this feature, we look at how Switzerland is gradually falling into line with internationally-agreed standards on tax transparency by modifying its extensive network of bilateral tax treaties and underlying legislative framework, and committing to specific information exchange arrangements.

Switzerland is perhaps the country above all others that is synonymous with banking secrecy, a phrase which, in the modern parlance, carries rather negative connotations. There are of course two ways of looking at this: Switzerland can be considered one of the last bastions of personal freedom, where one’s personal financial information, which these days tends to be traded about much like any other commodity, is sacrosanct; the other side of the coin is that Switzerland’s strong banking secrecy laws allow wealthy foreigners (more specifically those with no intention of paying all the tax they owe in their own countries) to squirrel away large amounts of income and assets out of sight and out of mind of the tax man. It isn’t the purpose of this feature to make the case for either position; but what has become clear is that most of the world (by which we mean national governments and multilateral groups like the OECD for the purposes of this feature) is trenchantly of the latter viewpoint and therefore Switzerland is coming under intense pressure to assist fellow nations in their pursuit of tax evaders, banking secrecy or no banking secrecy.

This isn’t to say that Switzerland has been the specific target of the decade-old campaign against offshore and ‘secrecy’ laws, something which has gathered fresh momentum since the April 2009 G20 Summit in London, at the depths of the financial crisis; all nations were required to achieve the minimum standards of tax transparency set at that summit, to avoid a ‘blacklisting’ by the OECD. But with the Swiss private banking industry worth an estimated CHF10 trillion, and with banking secrecy almost defining the country itself, it is not surprising that Switzerland has found itself at the eye of the storm.

The UBS affair, which erupted back in 2008, brought many of these issues to the fore, when the US government accused certain senior staff of the Swiss bank of helping US clients to evade US taxes by setting up various complex financial vehicles hidden by the veil of Switzerland’s banking secrecy laws. Initially, the US judicial authorities demanded that the bank hand over details of 52,000 account holders – a request that was never going to be agreed to by the Swiss authorities. Eventually, Washington and Berne reached an administrative agreement to allow a more limited handover of about 4,500 names, but the case only heaped further pressure on the Swiss government to force through changes to its banking and administrative assistance laws and negotiate the necessary changes to its double tax agreements to more readily facilitate mutual administrative assistance and the exchange of information for the purposes of investigating alleged tax crimes.

A major bone of contention though has been Article 26 of the OECD Model Tax Convention, which sets out the rules for the exchange of information between two contracting states. In the words of the OECD, “Article 26 creates an obligation to exchange information that is foreseeably relevant to the correct application of a tax convention as well as for purposes of the administration and enforcement of domestic tax laws of the contracting states. Countries are not at liberty to engage in ‘fishing expeditions’ or to request information that is unlikely to be relevant to the tax affairs of a given taxpayer. In formulating their requests, the requesting state should demonstrate the foreseeable relevance of the requested information. In addition, the requesting state should also have pursued all domestic means to access the requested information except those that would give rise to disproportionate difficulties.”

Article 26 was updated in July 2005, at which time paragraphs 4 and 5 were added. These paragraphs make it clear that a state cannot refuse a request for information solely because it has no domestic tax interest in the information (paragraph 4) or solely because it is held by a bank or other financial institution (paragraph 5).

However, there is a belief that Article 26 conflicts with Switzerland’s banking and confidentiality laws. For this reason, at least 79 of the 96 DTAs that Switzerland has signed, and which include information exchange provisions, are not aligned with the internationally-agreed standard in the view of the OECD – which in other words means agreements that do not adhere to Article 26.

The OECD disputes this argument of course. “Bank secrecy is not incompatible with the requirements of Article 26, and virtually all countries have bank secrecy or confidentiality rules,” it says. “Meeting the standard of Article 26 requires only limited exceptions to bank secrecy rules and would not undermine the confidence of citizens in the protection of their privacy.” However, this didn’t stop Switzerland, along with Austria, Belgium and Luxembourg – all states with strong banking secrecy laws - entering reservations to Article 26 when it was updated in July 2008.

Then the financial crisis hit, and with ‘offshore’ taking much of the blame for the collapse of government finances (Switzerland isn’t ‘offshore’, but is frequently lumped together with these jurisdictions), each of these countries, in March 2009, notified the OECD that they were withdrawing their reservation to Article 26, just prior to the G20 London Summit - a time when banks were hardly flavour of the month!

So, in the teeth of resistance from within the Swiss parliament and the banking industry, but also under heavy international pressure, the Swiss government has had little choice but to incorporate these new standards into the country’s own legislation. A substantial step towards this was taken in March 2012, when the Swiss National Council, or lower house of parliament, voted in favour of the government’s new law on administrative assistance in tax matters, by 113 votes to 58. The National Council also voted in favour in principle of the planned revisions to the Swiss-US double tax agreement (DTA).

The provisions contained in the new administrative assistance law are designed to complement the new version of double taxation agreements that Switzerland has signed with over 20 different countries since 2009, providing for greater fiscal cooperation and respecting the OECD standards. Replacing the previous regulation providing for international administrative assistance in tax matters, the new law paves the way for implementation of the planned Swiss-US double tax treaty, which allows for grouped requests to be submitted based on patterns of behaviour by individuals or by financial institutions. However, this right will only be granted in the first instance to the US authorities. Previously, under the terms of bilateral agreements, information would only be provided by the Confederation if the foreign tax authorities were in receipt of the name or banking details of the suspected taxpayer concerned. In future, other forms of identification may also be submitted.

The new law, which was previously approved by the Swiss Council of States, or upper house, back in December, should serve to facilitate on-going negotiations with the US at a time when eleven other Swiss banks are being prosecuted by US authorities for allegedly having “encouraged” their banking clients to commit a fiscal offence. In accordance with the provisions contained in the amendment, administrative assistance will in future be granted in cases of suspected tax evasion as well as tax fraud, as is currently the case. This means that the new provisions are in line with the OECD standard.

Defending the government’s new law, Swiss Finance Minister Eveline Widmer-Schlumpf insisted that administrative assistance would only be provided in cases of strong evidence of wrongdoing and would not be forthcoming on the basis of information obtained illegally. Widmer-Schlumpf also emphasized that grouped requests for assistance are expected to be included in the revised OECD standards before the end of the year, and underlined the need to act now to confront the issue.

Significantly, the Federal Council has also recently taken the decision to agree to the international standard on administrative assistance not only in double taxation agreements, but also in tax information exchange agreements (TIEAs). Therefore, if adopted, the law will bring Switzerland into compliance with a request from the Global Forum on Transparency and Exchange of Information for Tax Purposes, and allow mutual administrative assistance in accordance with the international standard with interested countries and territories. At the same time, the Federal Council approved a report drawn up by the Federal Department of Finance in cooperation with the Federal Department of Foreign Affairs on the possibility of arranging information agreements of this nature with developing countries.  A contribution could thereby be made to preventing illegal flows of capital and strengthening the integrity of Switzerland's financial centre, this report concluded.

One developing country which has made the campaign against ‘black money’ a particularly high priority is India, and, after several months of talks with Switzerland, the Indian government has succeeded in getting Article 26 of the model convention included in the recently-signed Protocol to the 1994 DTA, which, according to a statement from the India’s Ministry of Finance on April 31, will allow for a “liberal interpretation” of the identity requirements before the exchange of information.

Under the 1994 DTA, the requesting country’s authorities had previously to provide the name of the person under examination and the name of the foreign holder of the information as part of the identity requirements, without which the information will not be shared by the other country. This was considered to be “a restrictive provision and not in line with the international standards”. Switzerland has now agreed to a different interpretation of the identity requirements, in that it will be “sufficient if the requesting state identifies the person by other means than by indicating the name and address of the person concerned, and indicates, to the extent known, the name and address of any person believed to be in possession of the requested information”. The Ministry added that “the conditions, as clarified by Switzerland, will enable India to get information even if we have only limited details regarding the person having bank accounts in Switzerland”. Although the protocol was signed on April 20 this year, it is deemed to have come into effect at the same time as the tax information exchange protocol to the DTA, which was itself signed on August 30, 2010, and entered into force on April 1, 2011.

A dispute on proposed amendments to the DTA between Switzerland and Italy to give the latter country better access to information on undeclared income of Italian residents in Swiss accounts looks set to rumble on a while longer, however, despite several rounds of talks between the two sides. Some progress was made during recent discussions, held on May 9, when Swiss and Italian officials agreed to the establishment of a working group to resolve the outstanding tax problems between their two countries. This meeting discussed Switzerland's place on the Italian ‘black list’ of non-cooperative countries, and the necessary modifications that would need to be made to the (previously agreed but uncompleted) DTA between the two countries with regard to the exchange of tax information so that Switzerland could be taken off that list, as well as possible changes to the existing agreement on the taxation of Italian cross-border workers. The first meeting of the working group was held in Rome on May 24 as planned, with both sides reporting that discussions were very cordial and constructive. It is questionable how much real progress was made however, and it would appear that the only concrete outcome was an agreement for the group to reconvene before the end of June in Rome. The issue is also expected to figure prominently in talks between Italian Prime Minister Mario Monti and President Widmer-Schlumpf in the Italian capital on June 12.

The talks did, however, cover the possibility that Italy and Switzerland could sign a separate withholding tax agreement that would enable the Italian authorities to tax the income of Italian residents accruing in undeclared Swiss bank accounts. As part of the bargain, these account holders would retain anonymity, although they would be likely to face quite high rates of tax on previous and future income.

Such agreements have already been signed between Switzerland and three other European countries, Austria, Germany and the UK. Others are likely to follow, possibly including Greece, Russia and the United States. The main features of the signed agreements are as follows.

Austria: Applicants face a flat-rate one-off tax for regularizing past income of between 15% and 38%, depending on the duration of the banking relationship and the amount of assets concerned.  A single rate of 25% then applies for the taxation of future investment income, corresponding to Austria's capital gains tax.
Germany: Applicants face a one-off tax of between of 21% and 41% (higher than the 19% to 34% range initially agreed). Future investment income and capital gains would be covered by a final withholding tax at a single rate of 26.375%.
UK: Applicants face a one-off tax of between of 21% and 41% (again, higher than the 19% to 34% range initially agreed). Final withholding taxes of 48% and 27% will be charged on future investment income and capital gains, respectively.

The agreements are controversial however, and left-leaning parties in the respective parliaments of the signatory countries have complained that they let Switzerland off the banking secrecy hook. All three of these agreements still need to be ratified before they enter into effect on January 1, 2013, and this is by no means a formality.

As mentioned, the OECD confirms that, so far, only 11 of Switzerland’s 96 agreements with information exchange provisions meet the internationally-agreed standard. These include the DTAs with Canada, Germany, India, Ireland, Malta, the Netherlands, Singapore, Spain, Sweden, Turkey and the United States. This is a list that is expected to grow in the months and years ahead however, as Switzerland continues to be viewed through the OECD’s microscope.


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