Bob Reynolds is consultant editor of Offshore Red.
As the European savings directive alters wealth management strategy in family offices, canny Swiss banks are introducing new products to keep a firm grip on their money, says Bob Reynolds
For Switzerland's wealth management industry, the loopholes could generate a healthy windfall. With wealthy customers shifting their savings into specialised financial products, banks should be in a position to harvest a new range of management fees.
New Year's Day 2005 is the target date for the introduction of the EU's highly controversial savings tax directive. This is the hotly disputed rule which obliges members of the EU to exchange information on savings of taxpayers from other member states of the Union.
The savings directive is the most visible of a series of measures which are shifting the strategies of managers of family offices and individual personal wealth. During the past decade, the world's low tax and no tax jurisdictions have been under increasing pressure to comply with a series of initiatives to promote increased transparency.
The OECD also created a blacklist of countries which were deemed to promote harmful tax practices. In its document 'Behind the corporate veil', the OECD castigated the offshore centres and was particularly exercised by bearer shares, international business companies (IBCs) beneficial ownership.
The blacklist was hugely damaging for various island economies despite the fact that the report was widely considered as partisan. At the outset the OECD contended that the report would deal with OECD members and OFCs equally but, in fact, the document is a largely anecdotal sideswipe at offshore centres.
It prompted the Society of Trust and Estate Practitioners and the International Trade and Investment Organisation, which represents some of the smaller OFCs, to engage lawyers Stikeman Elliott to produce the far more balanced document, 'Beyond a level playing field'.
The initiative of the OECD sibling, the Financial Action Task Force on money laundering, delivered a similar blacklist which although not identical had a comparable effect. The FATF blacklist is now down to seven names – some of which are ultimately expected to be removed and the remainder which will not.
Effect on financial centres
The offshore centres were struck by the inequality of the campaigns. Offshore centres were being obliged to adopt exemplary standards of business, while OECD members including Switzerland could exempt themselves from the provisions.
The OECD and the FATF programmes have forced jurisdictions along a certain path of compliance. In some cases, particularly specific Caribbean and Pacific jurisdictions, these new rules have forced some centres out of the financial services business entirely.
The European Commission, the most stringent agency in demanding compliance, devised the EU tax package and the Code of Conduct which demanded that offshore centres improve transparency and end client anonymity. Some of the better managed centres did not mind improving the efficiency of their regulation but they did object to competing with the Swiss with one hand tied behind their back.
The aim of the savings tax directive is to repatriate savings held outside the usual jurisdiction of residence of the taxpayer – and furthermore to pay taxes on any interest earned. The larger powers of the EU hope that significant sums will be returned to national tax authorities rather than remaining hidden offshore.
Some EU states – Luxembourg, Austria and Belgium in particular – objected to the measure. To a greater or lesser degree, each of these countries offers incentives for investment from outside and believed that the adoption of the directive would hinder this process.
Equally, they and the dependent territories of the UK (Jersey, Guernsey, Isle of Man and some Caribbean islands) were convinced that the directive would deal a major blow to their financial services industries. And it would directly benefit their biggest competitor – Switzerland.
Switzerland is the number one destination for the savings of EU taxpayers. Around 39% of all personal or family wealth deposited offshore goes there. The total sum is anyone's guess and some have assessed the aggregated totals to be in the trillions of dollars.
Since the Swiss – until now – have refused to say a word about their clients, it is hard to fix on a definitive figure.
For years Switzerland has maintained that banking secrecy is an indelible facet of the Swiss federation. Client confidentiality is central to the package which the Swiss offer to their private banking customers.
The banks and their political compatriots are unshakeable in their conviction that Swiss banking derives its unique nature from its track record of reliability and continuity over many decades. Discretion is essential to the mix, they argue.
Nevertheless, the Swiss have other economic needs and finally in May 2004 agreed nine treaties which include closer cooperation with the EU on security and asylum and the fight against international smuggling and customs fraud. Contrary to the expectations of many observers, the Swiss also supported the introduction of a withholding tax.
A withholding tax on the savings accounts of EU citizens will start at 15% and gradually increase to 35% by 2010. This concession was at the heart of a complex set of agreements which will allow Swiss citizens access to the markets of eastern Europe nearly absorbed into the EU.
For all practical purposes, Brussels needed the compliance of the Swiss to make its EU savings tax directive work. Three of the EU members prior to its massive expansion on 1 May – Luxembourg, Austria and Belgium – refused to back automatic exchange of information.
In the end the European Commission had to make concessions to Switzerland's major competitor in central Europe – Luxembourg. Brussels gave Luxembourg similar safeguards to the Swiss to protect its culture of banking secrecy.
The revenue identified by the Swiss tax authorities will be transferred in lump sums to the EU depositors' nations of origin - while preserving the anonymity of the depositors. But Swiss opposition leaders are putting pressure on the government to slow the implementation process.
President Joseph Deiss told EU president Romano Prodi at the end of May that Switzerland could not adopt the measures before the 1 January 2005 deadline. And without the Swiss the measure is effectively dead. Deiss said that the Swiss parliament would need to debate the proposals which are not scheduled to be tabled before the end of this year. If they are accepted by the politicians, then the final draft will be put to the Swiss people in the form of a referendum. Allowing for the good grace of federal politicians and the usually unhurried pace of the process, it could go before the electorate in the middle of next year.
What difference will it make to Switzerland?
In the short term, there will be little movement. It has taken years to reach this stage. And so far there is no firm date for implementation.
The Swiss have refused – point blank – to move on client anonymity. They will provide no information on the personal details of the clients of Swiss banks. The withholding tax will provide only an aggregate sum for each jurisdiction.
Swiss officials expect any referendum on the treaty to pass, but only because Swiss banks were allowed to retain banking secrecy, a key attraction for savers throughout the EU. Swiss authorities have promised to co-operate on tax fraud but not tax evasion, which isn't a crime in Switzerland.
Swiss financial institutions could see which way the wind was blowing and have spent the past few months devising new products to sidestep the new rules.
"There are a lot of loopholes in the EU's taxation directive, which underpins the agreement between the EU and Switzerland," says Thomas Jaussi, a Basel-based tax specialist with accounting firm KPMG. "In my personal opinion, if you have a lot of money, you will be able to find a way of avoiding this tax," he said.
The bilateral accords, agreed after Switzerland received guarantees that the deal would not compromise banking secrecy, include the introduction of a withholding tax on interest. It will not apply to income from dividends, share funds, insurance policies, derivatives and gold. Government bonds issued before March 2002 are also exempt, providing a loophole that at least one bank has openly sought to exploit.
In April Bank Leu launched a new fund that will invest in Euro bonds allowing customers to sidestep the new levy. Product development teams at other banks have also reportedly been working on individual solutions for clients.
For Switzerland's wealth management industry, the loopholes could generate a healthy windfall. With wealthy customers shifting their savings into specialised financial products, banks should be in a position to harvest a new range of management fees. One Swiss newspaper recently estimated that at least SFr200bn could be "re-allocated" in this way. A management fee of just 1% would generate significant earnings.
A second source of weakness is the fact that the EU levy is not 'withheld' at the source, but by the 'paying agent'. "Normally, this will be a bank," said Jaussi. But if the paying agent is outside Switzerland or the EU, the tax will not be levied.
Related to this is the treatment of trusts and foundations, which fall into a grey area. For example, an individual could bundle ownership of a portfolio of securities into an offshore entity.
"This is not subject to the tax because the beneficial owner – an individual domiciled in the EU – doesn't receive direct interest income, but indirect income via the legal entity," Jaussi said.
According to Jaussi, an added allure of such vehicles is the fact that the EU's taxation directive – a document designed to create a pan-European taxation system – contains no express penalties for abuse.
Some analysts predict that only those who are not wealthy enough to afford good advice or set up a foundation will be hit with the new levy.