Tax Analysts Blog

How Tax Collectors Learned to Love Bank Secrecy

Posted on Aug 29, 2011

Germany and Switzerland recently signed a landmark tax agreement that resolves years of squabbling over secret bank accounts. Fascinatingly, the agreement ends one form of blatant offshore tax evasion while preserving Swiss bank secrecy. How can that be? The answer is simple: tax collectors have been promised a piece of the action.

The accord serves as a blueprint for how Switzerland plans to deal with other countries that share concerns about offshore tax evasion. This could be the next big trend in global tax administration: withholding in lieu of information exchange.

Here are the details in brief.

For generations, wealthy Germans have been stashing money in Swiss bank accounts and not reporting the income for tax purposes. The existence of the foreign bank accounts is not illegal, but the tax evasion certainly is. This scenario should sound familiar. Substitute U.S. taxpayers for German taxpayers and you have the recent UBS scandal.

Under the new agreement, however, the Swiss will enforce a 26% withholding tax on the bank deposit income earned by German account holders. Once the Swiss collect the tax, the proceeds will be remitted directly to the authorities in Berlin. Germany will receive tax revenue, but they won't know from whom? And they'll never know -- that's an essential part of the deal. The identities of the offshore investors remain intentionally obscured.

The key here is that the withholding at source is "final" and therefore substantially different from the conventional wage withholding we Americans are familiar with. Because the withholding tax is final, the account holders are under no legal obligation to pay further taxes on the income in question. They don't need to report the earnings on their tax returns or otherwise acknowledge the offshore account.

What's in the deal for Germany?

The short answer is cash. The country is guaranteed a steady flow of tax revenue that was previously unobtainable (a minimum of 2 billion Swiss francs per year). From a practical standpoint, this is easy money. Tax revenue falls into Germany's lap without the considerable burden of chasing down many thousands of individual tax cheaters. There's no mountain of computer records to sift through, no assessments, and no protracted litigation. The beauty of the withholding tax is that it dispenses with all that.

Is there a downside? Absolutely; the German government won't know which of its citizens are involved in the offshore sector. The price for this reliable new revenue source is a step backward for transparency. By signing on the dotted line, German tax collectors are effectively saying "To heck with transparency, show me the money!"

How does the deal play out for the Swiss?

The hefty withholding tax certainly erodes the alpine country's image as a leading tax haven. But the fact that bank secrecy is preserved may outweigh the collateral damage. The Swiss Bankers Association supports the arrangement with Germany and is encouraging similar agreements with other European neighbors. (In case you're wondering, the U.S. government wants nothing to do with this kind of final withholding deal, preferring to opt for information exchange so the IRS can pursue tax evaders one by one.)

Why would Swiss banks go along with a tax on their own offshore sector? Excellent question. The answer is that many offshore investors place a greater value on preserving their anonymity than on dodging taxes. And under the new withholding tax deal these account holders will still be able to conceal their personal wealth from prying third parties (think litigious ex-wives and business creditors). In many cases it's this intense desire for financial privacy that serves as the primary motivation for entering the offshore sector. Swiss bankers expect any capital flight to be minimal.

Thus Switzerland is re-branding itself as a privacy haven rather than a tax haven.

So, how does this deal strike you? It seems that cash-in-hand has trumped our idyllic notions of financial transparency. Are we cool with that? Does it matter that we don't know whose income is being taxed so long as the tax is collected and paid to the appropriate government?

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