Switzerland has recently signed tax treaties — introducing something called “the final withholding tax” — with the United Kingdom and Germany. These treaties have aroused the interest of other governments in Europe (and overseas as well) and have given rise to significant public discussion. What is the final withholding tax and how does it work?
For tax authorities in industrialized countries, one of today’s great challenges is how to deal with the undisclosed assets of their citizens. Voluntary disclosure initiatives are often costly and burdensome for governments. In the UK, for example, two recent voluntary tax disclosure initiatives needed the involvement of some 7,000 taxpayers to raise US$351 million in taxes.
In the light of these efforts, the tax treaty which the UK recently signed with Switzerland appears to provide substantial budgetary income with significantly less administrative effort. Switzerland — or, rather, Swiss banks — will pay the UK a lump-sum, up-front payment of 500 million Swiss francs (US$542 million) which will be refunded to them as sufficient tax revenues are raised from UK resident clients. This sum will be topped up with further payments based on a oneoff, flat-rate tax on existing undisclosed assets and, also, a withholding tax on future capital income.
A similar agreement has been signed with Germany. The initial lump sum payment to Germany is even higher, amounting initially to 2 billion Swiss francs (US$2.17 billion), again followed by further payments.
A new financial market strategy
Two years ago, following the upheavals and changed market structures on global financial markets, the Swiss government decided to follow a new strategy with regard to the Swiss financial centre. The main elements of this new policy are the strengthening of international competitiveness and resilience to crises. At the same time, the new strategy sought to improve access to financial markets and to guarantee the integrity of Switzerland as a financial centre. The new strategy affirmed Switzerland’s longstanding policy of fighting financial crimes, including money laundering, and of returning illicit assets of politically-exposed persons to their countries of origin, and complemented this objective by ensuring full international cooperation against tax evasion.
The decision by Switzerland to concentrate on the management of taxed monies in its banks is thus embedded in its financial market strategy. It might be useful to recall at this stage that the financial sector is a supporting pillar of the Swiss economy. Its contribution to the country’s 2010 gross domestic product (GDP), at current prices, of US$598.9 billion, is approximately 12 percent.
How does the final withholding tax work?
Switzerland is not interested in untaxed money. In order to provide a satisfactory solution to partner states to tax the undisclosed assets of their citizens, Switzerland has developed the model of the final withholding tax. This tax guarantees the full remittance of taxes claimed by partner states on the existing untaxed assets and future income of their citizens in Switzerland. The tax is deducted from the credit balance of the relevant person on an anonymous basis. More specifically, the Swiss bank deducts a flat-rate tax sum on existing assets from UK and German resident clients (past) and on investment income and capital gains (future) respectively, and forwards these sums to the Swiss Federal Tax Administration. The latter then transfers these monies to the respective British and German tax authorities.
Once the tax has been levied, the tax liability is deemed to have been settled — hence the term final withholding tax. The tax rates that will be applied have been negotiated with both the UK and Germany and are aligned with the tax rates applicable in these countries, in order to avoid any distortion of competition with regard to taxes.
Privacy is guaranteed
The question may then be asked whether this is the end of bank secrecy — one of the pillars of the Swiss banking sector. This is definitely not the case. The aim of the system is to transfer to partner states the taxes due on the past and future income of their citizens. However, the taxation is anonymous. Therefore, the protection of privacy and the discreet treatment of bank clients in Switzerland are still guaranteed.
The final withholding tax enables people to invest their assets in a safe and politically reliable financial centre in the heart of Europe, with legal security and a stable currency, yet at the same time, to settle their tax obligations to their home countries anonymously.
As an alternative to anonymous taxation, clients have the choice of disclosing their bank data to the tax authorities of the UK or Germany. In such cases, they will be subject to retrospective taxation on an individual basis. Clients who are unwilling to accept either system will be obliged to close their accounts in Switzerland.
Safeguard mechanism
As for new untaxed investments from the UK or Germany entering Switzerland, the system offers a safeguard mechanism, allowing the partner state to launch a specific number of queries to Switzerland each year. As an additional facet of Switzerland’s new policy, this type of exchange of tax information goes further than the OECD standard; it does not set any specific pre-condition for the enquiry to be initiated. In response to such queries, Switzerland will provide the account number of the particular citizen to the relevant partner state (assuming that this person holds a Swiss account). The double taxation treaty will then provide other opportunities to the partner state to learn account details as well as further relevant information.
Although Switzerland is ready and willing to exchange tax information on a treaty basis, as prescribed by the international standard set by the OECD, it is decidedly not in favour of an automatic exchange of tax information. The automatic exchange of information generates vast amounts of data which is often unusable and irrelevant. The final withholding tax system deducts the tax where it is due without generating an additional administrative burden for the partner state to analyze superfluous data.
The system has raised much recognition and interest so far. Of course, there are also adversaries to the final withholding tax, who claim that it can be circumvented by using post-box companies, trusts and other “specialized vehicles.” A closer look at the treaties, however, reveals that this is not the case. Swiss banks are bound by strict money-laundering regulations, which oblige them to identify the ultimate beneficiary behind such structures. The information exchange system provided in the treaties obliges Switzerland to inform the partner state of the existence of assets of their citizens in cases where funds are held in the name of a “specialized vehicle.”
An efficient alternative
The final withholding tax has had a successful start, and it is likely to be the leading and preferred alternative to the automatic exchange of information in the future. Both the UK and Germany have indeed acknowledged that the agreed system will have a long-term impact that is equivalent to the automatic exchange of information in the area of capital income. While the treaties have been signed with both Germany and the UK, they will probably go into force beginning in 2013 (subject to parliamentary approval in both partner countries). D
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