The U.S. Deal with Switzerland and UBS -- Good Deal or Bad Deal? (8/19/09)

As revised 8/20/2009 8:00 am. and 8/25/12 (to Include the Annex at the end)

Some pundits are already speculating that the deal the U.S. got was not so good. At the surface, it does not look all that good. The U.S. wanted 52,000 names and is getting 4,450 (approximately) in addition to those it already received (perhaps 250). That's less than 10% in of the claimed UBS account universe.

Now let's scratch the surface. The agreements as released do not state the criteria that will be used to identify the 4,450 (approximate) that UBS will disclose. The criteria are set forth in an annex to the agreement that will be release in 90 days, well after the current voluntary disclosure initiative has closed (on September 23, 2009). Without the criteria, UBS' U.S. account holders will not know whether they have drawn the black bean. Each UBS U.S. depositor who has not already joined in the IRS' voluntary disclosure program will not have certainty that his name and account(s) will not be picked. It is true, that the letter UBS is required to use to notify the account holders who draw the black bean will notify the account holders that they can still get in the program. But, the program only lasts through September 23, 2009, and it appears that the picking of names will extend beyond that date. IRS Commissioner Shulman has confirmed that the voluntary disclosure program will be open only for clients who receive UBS letter notices prior to the September deadline.

Moreover, there will be criteria which probably is designed to get the biggest, most blatant abusers. It has been speculated that the criteria will include accounts with entities as an additional layer of secrecy and threshold dollar amounts. But the IRS press release yesterday cautioned that (IR-2009-75)

The IRS will receive information on accounts of various amounts and types, including bank-only accounts, custody accounts in which securities or other investment assets were held and offshore company nominee accounts through which an individual indirectly held beneficial ownership in the accounts.

Still, you can be sure that the IRS will design the criteria to pick up the big abusers, sort of like its DIF sampling techniques for auditing (except probably much more focused). So, perhaps -- and I too speculate here -- on a dollar tax-evaded weighting, perhaps the IRS will pick up well in excess of 50% of the loot on the table simply by careful selection of the criteria. This careful selection is implied by the indication that some $18 billion is involved under the criteria selecting the 4,450 accounts. The average account, therefore, is over $4 million. This does not indicate that there was a single selection criteria of a threshold dollar amount because there are undoubtedly other criteria (use of entities to further obscure the trail). And, besides criteria designed to identify the worst abusers, the IRS may also want to at least hold out the possibility that there will be some random sampling, so that those with direct accounts below whatever the general dollar threshold is (say $2,000,000) cannot rest easy and will still have an incentive to get into the voluntary disclosure program. In this regard, the criteria will not be released for 90 days, well after the voluntary disclosure program has ended.

Also, an essential part of the voluntary disclosure program and the names that get targeted by this round of UBS turnovers will be to learn the identities of the as many of the U.S. taxpayers' enablers that the U.S. can then bring to justice -- at least the most abusive of the lot. There will be lots of tentacles into U.S. lawyers, financial advisors and others who, like ordinary tax shelter promoters, raked off their share of the taxes that should have been paid to the Government. My gut tells me that many of these enablers are probably not resting easy, particularly because there is no voluntary disclosure for them that will negate criminal prosecution or mitigate any civil penalties that might apply. Moreover, if the U.S. gets to these enablers, the Government might sweep up many more U.S. taxpayers who were assisted by these enablers.

Finally, and perhaps most importantly in the long run, there is a breach in the dam because the Swiss Government has decided that its double tax treaty is more flexible than it had imagined before. The strict definition of tax fraud to permit disclosure under the treaties is being relaxed. And, the agreements contemplate that the U.S. will be able to make similar exchange of information requests on the basis of similar criteria against other Swiss banks involved in UBS-type shenanigans (probably all of them to some degree or another). And, as the Swiss feel similar pressures from other organized and powerful countries, its wall of secrecy is likely to erode even more.

So, bottom line, I think these developments are good for the U.S. Large goals often are achieved in increments. And this particular increment is not just incremental -- it is a big jump.

Addendum:  As mentioned, the criteria for the request are in the annex.  The Annex may be viewed in an official pdf here or in html here.  The entire document is relatively short and a good read, but here are some key excerpts:

2. The agreed-upon criteria for determining “tax fraud or the like” for this request pursuant to the existing Tax Treaty are set forth as follows:

A. For “undisclosed (non-W-9) custody accounts” and “banking deposit accounts” (as described in paragraph 1.A of this Annex) where there is a reasonable suspicion that the US domiciled taxpayers engaged in the following: 

a. Activities presumed to be fraudulent conduct (as described in paragraph 10, subparagraph 2, first sentence of the Protocol) including such activities that led to a concealment of assets and underreporting of income based on a “scheme of lies”[i] or submission of incorrect and false documents.  Where such conduct has been established, persons with accounts of less than CHF 1 million in assets (except those accounts holding assets below CHF 250,000) during the relevant period would also be included in the group of US persons subject to this request; or 

b. Acts of continued and serious tax offense for which the Swiss Confederation may obtain information under its laws and practices (as described in paragraph 10, subparagraph 2, third sentence of the Protocol), which based on the legal interpretation of the Contracting Parties includes cases where (i) the US-domiciled taxpayer has failed to provide a Form W-9[ii] for a period of at least 3 years (including at least 1 year covered by the request) and (ii) the UBS account generated revenues of more than CHF 100,000 on average per annum for any 3-year period that includes at least 1 year covered by the request. For the purpose of this analysis, revenues are defined as gross income (interest and dividends) and capital gains (which for the purpose of assessing the merits of this administrative information request are calculated as 50% of the gross sales proceeds generated by the accounts during the relevant period). 

B. For “offshore company accounts” (as described in paragraph 1.B of this Annex) where there is a reasonable suspicion that the US beneficial owners engaged in the following: 

a. Activities presumed to be fraudulent conduct (as described in paragraph 10, subparagraph 2, first sentence of the Protocol) including such activities that led to a concealment of assets and underreporting of income based on a “scheme of lies”[iii] or submission of incorrect or false documents, other than US beneficial owners of offshore company accounts holding assets below CHF 250,000 during the relevant period; or 

b. Acts of continued and serious tax offense for which the Swiss Confederation may obtain information under its laws and practices (as described in paragraph 10, subparagraph 2, third sentence of the Protocol), which based on the legal interpretation of the Contracting Parties includes cases where the US person failed to prove upon notification by the Swiss Federal Tax Administration that the person has met his or her statutory tax reporting requirements in respect of their interests in such offshore company accounts (i.e., by providing consent to the SFTA to request copies of the taxpayer’s FBAR returns from the IRS for the relevant years).  Absent such confirmation, the Swiss Federal Tax Administration would grant information exchange where (i) the offshore company account has been in existence over a prolonged period of time (i.e., at least 3 years including one year covered by the request), and (ii) generated revenues of more than CHF 100’000 on average per annum for any 3-year period that includes at least 1 year covered by the request. For the purpose of this analysis, revenues are defined as gross income (interest and dividends) and capital gains (which for the purpose of assessing the merits of this administrative information request are calculated as 50% of the gross sales proceeds generated by the accounts during the relevant period). 

[i] Such “scheme of lies” may exist where, based on the Bank’s records, beneficial owners (i) used false documents; (ii) engaged in a fact pattern that has been set out in the “hypothetical case studies” in the appendix to the Mutual Agreement concerning Art. 26 of the Tax Treaty (for example, by using related entities or persons as conduits or nominees to repatriate or otherwise transfer funds in the offshore accounts); or (iii) used calling cards to disguise the source of trading. These examples are not exhaustive, and depending on the applicable facts and circumstances, certain further activities may be considered by the SFTA as a “scheme of lies”. 

[ii] For “banking deposit accounts” based on the Contracting Parties’ legal interpretation a reasonable suspicion for such tax offence would be met if the US persons failed to prove upon notification by the Swiss Federal Tax Administration that they have met their statutory tax reporting requirements in respect of their interests in such accounts (i.e., by providing consent to the SFTA to request copies of the taxpayer’s FBAR returns from the IRS for the relevant years). 

[iii] Such “scheme of lies“ may exist where the Bank’s records show that beneficial owners continued to direct and control, in full or in part, the management and disposition of the assets held in the offshore company account or otherwise disregarded the formalities or substance of the purported corporate ownership (i.e., the offshore corporation functioned  as nominee, sham entity or alter ego of the US beneficial owner) by: (i) making investment decisions contrary to the representations made in the account documentation or in respect to the tax forms submitted to the IRS and the Bank; (ii) using calling cards / special mobile phones to disguise the source of trading; (iii) using debit or credit cards to enable them to deceptively repatriate or otherwise transfer funds for the payment of personal expenses or for making routine payments of credit card invoices for personal expenses using assets in the offshore company account; (iv) conducting wire transfer activity or other payments from the offshore company’s account to accounts in the United States or elsewhere that were held or controlled by the US beneficial owner or a related  party with a view to disguising the true source of the person originating such wire transfer payments; (v) using related entities or persons as conduits or nominees to repatriate or otherwise transfer funds in the offshore company’s account; or (vi) obtaining “loans” to the US beneficial owner or a related party directly from, secured by, or paid by assets in the offshore company’s account. These examples are not exhaustive, and depending on the applicable facts and circumstances, certain further activities may be considered by the SFTA as a “scheme of lies”.