Lucerne 2002 meeting

New US, UK and EU Reporting Requirements
Proposed US rules would require banks to report interest paid to all foreign individuals
Similar UK reporting requirements took effect in 2001 as to fully-reportable countries
The revised proposed EU savings directive allows 3 countries to withhold tax instead
Strangely none of these rules apply to payments made to companies or other entities
Will these rules become fully effective in 2004 as the EU and other governments intend?
Proposed new rules in the United States would require banks to report interest paid to all foreign individuals, but at the moment no information is revealed about foreign depositors (except Canadian individual residents), and no tax is withheld on bank deposit interest. The EU prompted the US proposals. The United Kingdom accepted similar rules in 2001 – but limited to “fully reportable countries” – the EU countries, the Channel Islands, Gibraltar, the Isle of Man, Norway, most UK dependent territories, US, Canada, Japan, Australia, New Zealand and Korea. If the EU Savings Directive is adopted by December, the US proposals will probably be implemented. This essentially turns on what Switzerland will do. If the Directive goes ahead, Austria, Belgium and Luxembourg will be temporarily exempt from the requirement to exchange information, but will instead withhold tax at a rate of 15% rising to 20%. Until recently, no form of reporting or withholding has been known : even the withholding taxes levied by Switzerland and Hong Kong were routinely avoided by fiduciary deposits. Switzerland is under intense pressure to conform with the EU Directive by the end of the year.

None of those rules deal with payments to trusts and companies. No doubt this will come later. Whereas the EU Directive is limited to residents of EU countries, the US proposals extend to all countries with which it has tax treaties (over 60) or Tax Information Exchange Agreements (over 20) . How will this affect the 1.7 trillion dollars deposited in the US by foreign residents? Residents of other countries, notably those of South American countries, are worried about e.g. kidnapping : the US has TIEA’s with Peru and a tax treaty with Venezuela; it has signed a TIEA with Columbia.

The speaker’s paper on the “Outrageous History of the Caribbean Tax Treaties with OECD Member States” will be included in the Yearbook section of the ITPA website by the end of June.

The nature of banking secrecy? What makes banks so special?
Do I want to know who my client is?
Neutrality and banking secrecy
The impact of anti money-laundering and anti-terrorist measures on banking secrecy
Banking secrecy in Austria, Luxembourg, Switzerland
Secrecy versus low profile
Bank secrecy is similar to professional secrecy and not essentially different from other kinds of business secrecy. Banks are more subject to government regulation than other businesses, and governments have long shown an interest in obtaining information about account holders – notably for tax purposes, for investigation of crime and to give help to other governments. A bank needs to know a lot about its borrowers, but less about its lenders. Passbooks and other anonymous “bearer” deposits have practical disadvantages. The numbered account was never truly anonymous, but the use of a tax haven company with bearer shares has provided a high degree of anonymity.

Austria and Switzerland have a “neutral” attitude to foreign disputes: this attitude embraces the Red Cross as well as bank secrecy. But some compromise is necessary. In Switzerland – as in Austria and Luxembourg – the secrecy can be pierced for criminal investigation, but not for tax collection. In this sense, bank secrecy protects citizens against their governments. The “neutral” countries are not merely asserting their sovereignty : they feel they have principles to defend. Legal assistance requests go to various authorities in Switzerland and no aggregate figures are available, but they are undoubtedly numerous.

In Switzerland, Article 28 of the Civil Code protects the freedom of the individual and his privacy. The terms of the bank/client relationship are essentially a matter contract between the parties. Bank secrecy is supported by civil and criminal procedural rules, and in particular by the provisions enacted in the 1930’s making it a criminal offence to reveal confidential banking information. The US/Swiss treaty is frequently used. The new rules – and especially the anti-money laundering rules – have diluted bank secrecy. The situation in Austria and Luxembourg is essentially the same, though information about it is not so easily obtained, and they are more exposed to EU pressure. Luxembourg has, however, succeeded in postponing – perhaps indefinitely – an EU requirement for exchange of information about interest payments. Compliance with anti-money-laundering rules, however, is making greater inroads into bank secrecy. Nevertheless, piercing bank secrecy is very much a minority event, and the mass of law-abiding clients have little to fear.

The participation exemption, 2002 changes
The Dutch participation exemption, the basics
The 2000 anti-tax haven amendments as enacted in 2002
The Dutch ruling policy on conduit transactions
The Advance Tax Ruling Regime
The Advance Pricing Agreement system
The participation exemption was a stable system for over 20 years. It was overhauled in the 1990’s, but the basic outline remains: a 5% long-term capital interest in the underlying company, subject to tax, is required, which is not a “portfolio” investment. The exemption requires the claimant to be a Dutch taxpayer: a Dutch branch of a foreign company can qualify. The “subject to tax” requirement does not require tax actually to be paid – e.g. a Hong Kong company with non-Hong Kong income will, in principle, qualify.

Article 13g implements the EU Parent/Subsidiary Directive, setting aside for this purpose the non-portfolio requirement. The rules are complicated and lead to a number of problems. Article 28b does not entirely mesh with Article 13g. The changes took effect in January 2002, and are perceived as an anti-tax haven measure.

The Dutch ruling policy on rulings was modified on 30th March 2001. This was the Dutch Authorities’ response to international pressure. It affects financial services companies: a ruling will only be given if there is sufficient substance in the Netherlands and if significant risk is undertaken by the company. The Dutch advance pricing agreement system is in conformity with the OECD guidelines.

Case studies
Employee options generally relate to stock. The bull market of the 1980’s made them very popular. They were mostly tax-motivated but the emphasis nowadays is on raising employee commitment. An option is an asset in the form of an entitlement; it is granted to an employee; it vests on the happening of some future event and is then capable of being exercised. It is subject to a number of restrictions imposed by law. It may relate to new securities, or to a trust fund or investment fund or even to phantom stock – which is essentially a stock-related formula for computing a cash entitlement. Securities law may have an impact, but the trend is to exclude option plans from Public Offering requirements and for a plan approved in one EU country to have automatic approval in others. Company law considerations need to be born in mind, as do the requirements of the relevant labour law and the social security and tax impacts. Portugal, for example, taxes the discount on vesting as income, and subsequently taxes the capital gain on exercise and disposal.

The case study involved employees resident in Australia, California and Portugal.

Countries covered include United Kingdom, United States, France, Italy and Spain
Direct Ownership: principal private property exemption; mortgage interest payments; “In tontine” arrangements in France; wealth tax considerations; inheritance tax on transfer to heirs; taxation of rental income if let; appointment of fiscal representative; forced heirship laws of succession
Indirect Ownership: ownership through offshore trusts; ownership through offshore companies; benefits in kind; interest deductions to mitigate capital gains tax; withholding tax issues; use of insurance policies; protection of double tax treaties
Residential Development: Jersey route for UK development; Luxembourg route for French and Italian development; acquisition of vineyards; Dutch limited partnerships; management companies; other structures
The UK resident who plans to live in Spain does not always appreciate that this involves exposure to Spanish income tax and forced heirship rules. He would, however, be able to give himself an uplifted base cost of his assets by way of a share-for-share exchange. He might be advised to hold his Spanish property through a UK company acting as trustee. Investment in single premium bonds would reduce his income taxable in Spain.

A Belgian resident individual wishing to sell a French vineyard and to avoid French tax on his capital gain, and having imposed a Dutch company between himself and the SCA which owned the vineyard, may best proceed by first transferring the SCA to himself on a sale to him from the Dutch company, operating the vineyard through his Belgian company (making use of its losses) and finally himself disposing of the SCA – being exempt from French tax on his capital gain under the treaty and enjoying a reduced rate of tax in Belgium.

Where are we now with FATF, OECD, etc?
The OECD and the EU seek information for domestic tax but are players and referees in the same game. Switzerland occupies a key position; the agencies – OECD, FATF, FSF and EU have overlapping membership, including all of the world’s rich and powerful countries. The 1998 Report was called “Harmful Tax Competition” – now changed to “Practices”; the FATF exercises a great deal of power, as does the FSF – its members including Japan, whose regulatory record is appalling; the EU has its Taxation of Savings Directive. Offshore centres do not participate in formulating the policies of these agencies.

September 11th stimulated further hostility to offshore centres, though the US had already made a number of information exchange agreements. Jersey and Guernsey have now agreed – under considerable pressure from the UK – to support the EU Savings Directive. The FATF has released a consultation paper on its Forty Recommendations.

In principle, states are not obliged to provide unilateral assistance in the collection of taxes of others: the new demands to provide information are a radical departure from this principle. The onshore countries have power to close down an offshore centre through exclusion from banking and securities markets, and the offshore centre is therefore bound to co-operate. Some states have a “show me your papers” attitude to their citizens. France is a conspicuous example. Privacy is not prized by bureaucrats.

60% of the world’s offshore business is conducted in London, US and Tokyo; 80% in the OECD countries. Offshore centres are a vital lubricant in the world financial system. The effect – if not the ostensible purpose – is to favour the offshore business conducted within the OECD countries. The US position is somewhat different, but similarly favours US business – like the incorporation of Delaware LLC’s. Understandably, the OFC’s are demanding a level playing field.

The OECD Report on Misuse of Corporate Vehicles largely ignores issues posed by structures established in OECD members, and proposes harsher regimes for non-members. This theme is taken up in the FATF Report of 30th May. Switzerland is more concerned about the EU than about the OECD; but all offshore centres need to take steps to protect their position. Greater transparency, however, is inevitable.

Why have a family office?
The problems: Who do you trust? To whom do you report?
Control: Wealth distribution; Investment/business decisions
A solution – Family Governance – an integrated approach
Most trustees expect that the trust fund will be distributed after the death of the founder. They can consult the founder or the Protector. There is often a letter of wishes : it does not always cover the circumstances as they prove to exist at the death of the founder, but often it points the way to the distribution of the fund and the end of the trust.

But other trusts need to continue. A protector can become a “gatekeeper”, whose personal interest may be at variance with the family interests. A mechanism is needed to prevent family conflict, to provide a succession process for the family business and investments, to meet the different tax requirements of different beneficiaries, to provide for the preservation of the family culture and for a family commitment to wealth preservation. Entropy is the process in which wealth, untended, dissipates over three generations. To combat this, a focus on family values is a starting point : this is a kind of family “Mission Statement”, and consensus among members of the family is, in practice, generally obtainable – on tax planning, distribution or preservation, confidentiality, allocation of assets to spouses, and so on. The focus can be embodied in a purpose trust, in contracts with administrators or in a non-binding agreement between the individuals concerned. A tug-of-war between the trustees, the accountants, the lawyers, the bankers, the protector, the investment managers and the family office needs to be avoided. A solution which generally works is to place at the centre a Family Council, which, with the help of the professional advisors, can take strategic decisions, and a Family Committee and Executive to carry these into effect. Clear procedures, regular meetings and a procedure for dealing with disputes are all required. A distribution policy needs to be agreed upon. There may be a formula, merit rewards, a Family Council discretion with guidelines. Family members need learning and discussion ; a way of appointing and replacing members of the Family Council needs to be agreed upon.

The Family Office deals with family administration and the concierge services, but importantly it deals with investment management – the present trend being to outsource this function. The Family Office may also take care of the family database, with yearly reports and discussions. The wealth structure should, ideally, be tax neutral; it should permit retention or variation of investments, permit flexibility and remain intact for at least 100 years. Onerous tax consequences, forced heirship, community of property, recognition of trusts, confidentiality versus transparency – these are all issues which need to be addressed. These various objectives may be achieved in various ways – with a private trustee company (e.g. in New Zealand), with a reserved powers trust a purpose trust embodying the Family Mission Statement.

Switzerland, the trust and private banking
Latin America and the Swiss connection
Italian developments
Pressure from OECD on tax havens has stimulated a flow of new trust business into Switzerland. The country has a private banking tradition, and its confidentiality and personal security attracts clients from other countries – notably those from Latin America. Nowadays clients are making increasing demands – for investment management, for information suitable for their domestic tax returns. The legal status of trusts, and in particular that of irrevocable trusts, as well as their tax treatment, remains uncertain, and changes recommended by a Government report have not been implemented, nor has Switzerland ratified the Hague Convention on the Recognition of Trusts. It may be necessary for Switzerland to introduce separate legal and tax regimes – one for trusts with a Swiss settlor and/or Swiss beneficiaries and a separate regime for trusts with no Swiss settlor or beneficiaries. Having a non-Swiss co-trustee may be a solution to the problem of keeping the trust income outside the scope of Swiss tax, but it is not altogether a satisfactory one. Certain amendments are needed – which could take the form of changes to the Swiss Code on Private International Law – to separate legal and beneficial ownership, for the regulation of trust companies (which is common in the offshore jurisdictions), and for a clear tax regime for “non-Swiss” trusts.

Switzerland has the advantage that it generally does not appear on Latin American lists of low-tax jurisdictions – the so-called “blacklists”, and the freedom from reporting which this accords to taxpayers making use of Switzerland is even more valuable to them than their freedom from tax. Argentina, Brazil, Mexico and Venezuela have changed from a territorial to a world-wide tax basis and introduced “blacklists”, penalising investment in jurisdictions on those blacklists.

A trust in Switzerland may therefore be particularly attractive to a resident of one of these South American countries. Singapore, England, New Zealand and Canada are also not on the blacklists. Singapore, however, can present cultural problems ; the United Kingdom’s reporting requirements create unease ; and clients are sometimes not attracted to New Zealand trustees or to trans-national Canadian trust companies, when they are administered in another country. Mexico appears to be moving away from reliance on a blacklist and towards full CFC rules.

Italy has just had a tax amnesty. It is not the first one, and there was a mixed response from taxpayers: some clients feared a future lack of confidentiality in the treatment of information revealed to government departments, and many preferred to place their assets in trusts outside Italy once advantage had been taken of the amnesty. Some of this business went to Switzerland : if the law relating to trusts had been more certain, more business might have gone there.

Voluntary disclosure – whether or not in consequence of accepting a tax amnesty – brings problems of its own. In the United States, executors of deceased taxpayers have needed to face up to these. Exchange of information agreements can give rise to similar concerns. What is needed is a structure which is lawful, whether or not its details are in the hands of the beneficiaries’ tax authorities; this is the way for professionals to retain their clients, and some clarification is going to be needed of the legal and tax treatment of non-Swiss trusts by Switzerland if trust structures are going to be part of the future of private banking in Switzerland.