Does Switzerland s Tax Haven for Offshore Accounts Violate Internationally Recognized Human Rights? Stephen B. Cohen, Georgetown, copyright 2013 Developing countries experience a large tax gap a gap between revenues actually collected and revenues that would be collected if there were full compliance with each country s tax laws. Some reasons for the tax gap are purely domestic. A government may, for example, lack the administrative capacity to collect taxes within its own jurisdiction. Our subject, however, is tax abuse that is the product of international transactions. There are two practices in particular that account for a significant tax gap in the developing world. One is the use of offshore investment accounts by wealthy individuals to conceal their income. The other is the shifting of income from high to low tax jurisdictions by multinational corporations through transfer mispricing, thin capitalization, and the relocation of intangible assets. I m going to concentrate on the first practice, offshore investment accounts. My talk is divided into four parts: First, I ll provide estimates of the magnitude of the tax gap for the developing world created by offshore investment accounts. Second, I ll explain one possible solution, multilateral automatic information exchange, which would require that income earned by and assets deposited in offshore accounts be reported to the governments of the owners of those accounts. I ll also describe the threat to this solution posed by Switzerland s promotion of bilateral anonymous withholding agreements as a substitute for automatic information exchange. In these first two parts of my presentation, I rely heavily on, and quote from, a recent article in the UCLA Law Review, The Battle Over Offshore Accounts by former US Treasury official and now one of my colleagues, Prof. Itai Grinberg. Third, I will go on to discuss whether states like Switzerland that provide a tax haven for offshore accounts violate internationally recognized human rights. Fourth, I ll end by indicating a possible human rights problem that multilateral automatic information exchange might create. 1
First, what s the magnitude of the tax gap created for developing countries by offshore accounts? Taxpayers use offshore accounts to evade taxation in two distinct ways. Taxpayers may conceal from their governments the income earned on investments placed in offshore accounts. In addition, taxpayers may covertly siphon profits from closely held businesses to investment in offshore accounts so that such business income entirely escapes domestic taxation. Information about the income and assets in most offshore accounts is subject to laws that require confidentiality and make disclosure of such information a crime. Thus, estimates of the tax gap caused by offshore accounts are difficult to produce and may be unreliable. According to one estimate, produced by the OECD for 2009, tax revenues lost each year by offshore tax evasion, including offshore accounts, may approximate all official worldwide development assistance, on the order of $120 billion a year. More recent estimates by the Tax Justice Network suggest that the total offshore wealth held by citizens or residents of the developing world is two or three times more than previously thought and that the lost tax revenue may consequently be much greater. What is certain is that the magnitude is growing. According to Professor Grinberg: The capacity to make, hold, and manage investments through offshore financial institutions has increased dramatically in recent years, while the cost of such services has plummeted. Individuals now find it substantially easier to underreport or fail to report investment earnings through the use of offshore accounts, and experience suggests that such accounts may also be used to help evade tax on income earned domestically by closely held businesses. Consequently, the principal held in offshore accounts, as well as the investment earnings generated through such accounts, may go untaxed. Moreover, for the developing world, the tax gap created by offshore accounts is a much larger problem than for already developed, industrialized economies. Only about 2% of North American private wealth and 8% of European wealth is invested offshore, compared with more than 25% of Latin American and 33% of Middle Eastern and African private wealth. Again, to quote Prof. Grinberg: In many such economies, the bulk of the individual income tax base is often comprised of a concentrated group of well-off individuals. Domestic financial institutions are also often relatively undeveloped. [i]t is commonplace for the wealthy to hold investments through offshore accounts.... Thus, the taxation of offshore wealth should be of greater relative 2
importance to Latin America, the Middle East, and Africa, than to the United States and Canada or the major European economies. Second, what is multilateral automatic information exchange and how would it solve the problem? Automatic information exchange would work basically the same way as tax reporting for domestic financial institutions and domestic taxpayers in the United States. When a US taxpayer establishes an investment account with a domestic financial institution, U.S. law requires that the taxpayer provide identification in the form of a social security or taxpayer number. Using this identifying information, the financial institution is then obligated to report to the U.S. government the investment income earned by the account each year, as well as any usually large deposits to the account. Under automatic information exchange, this kind of system would extend internationally. The account owner would be obligated to provide the financial institution with identifying information, including the owner s country of citizenship and/or residence. The financial institution would then be obligated to report to the relevant government the income and assets in the account on an annual basis, along with the account owner s identity. Automatic information exchange would require implementation of multilateral tax treaties, and for that reason the quest for such a system may seem quixotic. In order for the system to be effective, virtually all countries would have to agree to obligate their domestic financial institutions to make offshore account information available to other countries. However, according to Prof. Grinberg: In April 2009, leaders of the G20 countries... emphasized the importance of including developing countries in what they said would be a new cooperative international tax environment. Since that time, a growing number of governments and NGOs have called for automatic exchange of tax information to address the taxation of offshore accounts. The European Union s Savings Directive resulted in a limited form of automatic information exchange among most EU countries, and proposals of the last few years would expand its scope. Moreover, last year the governments of six large developed economies, including the United States, announced a commitment to develop the automatic exchange of tax information. In addition, the coming into force of FATCA the Foreign Assets Tax Compliance Act, a U.S. statute, which penalizes foreign banks that fail to report to the IRS the investment 3
income of US taxpayers although only affecting US citizens with offshore accounts provides a first step toward true multilateral automatic information exchange. There is, however, a significant threat to automatic information exchange posed by bilateral anonymous withholding, which is being actively promoted by Switzerland with the acquiescence of authorities in Germany and the United Kingdom. Switzerland has negotiated bilateral treaties with both Germany and the UK that provide for anonymous withholding. Under these agreements, Switzerland will withhold taxes at a specified rate from the future investment income generated by offshore accounts of German and UK taxpayers and remit the withheld taxes to their respective governments. A one-time penalty tax will also be imposed to make up for the failure to tax past investment income. The identity of the offshore account holders, however, will remain hidden, therefore the label anonymous. In addition, the account holder receives immunity from the assessment of further taxes with respect to the offshore account. Thus, Prof. Grinberg observes: The agreements both specify that once the withholding tax is imposed by Swiss financial institutions, the investor s tax obligation to Germany or the UK will be fulfilled. German and UK residents with Swiss bank accounts will not be required to declare those accounts to the German or UK government, respectively. The relevant persons do not have any tax liability or information reporting obligation to Germany or the United Kingdom on income... with respect to which the anonymous withholding tax is imposed. The tax rates specified for withholding in the agreements may be lower than the rates that would apply if the income were taxed directly. Moreover, anonymous withholding is restricted to income earned offshore and does not track additional deposits to offshore accounts. Thus, it will not combat the problem of wealthy individuals siphoning off the domestic profits of small businesses and concealing those profits in offshore investments. Finally, holders of offshore accounts are offered a wide escape hatch. Under the agreements, German and UK investors are permitted to move their Swiss accounts out of Switzerland prior to May 31 of the year when the withholding agreement enters into force, without being subject to withholding of any kind or the one-time penalty tax. Reportedly, with the negotiation of the anonymous withholding treaties, there have been huge outflows from Switzerland to Singapore branches of Swiss banks. Singapore, like Switzerland, has stringent banking secrecy laws, which criminalize the disclosure of information about offshore accounts. 4
Thus, the escape hatch may have reduced the number of offshore accounts under direct Swiss jurisdiction without imposing much of a penalty on Swiss banks. Prof. Grinberg concludes: The Swiss agreements represent a major blow to multilateral automatic information reporting. Bilateral anonymous withholding agreements are incompatible with a broadly multilateral automatic information exchange system. A comprehensive, multilateral automatic information exchange system is less likely to emerge if anonymous withholding is accepted.... Bilateral anonymous withholding agreements are... incompatible with a comprehensive multilateral automatic information exchange system. Third, do states like Switzerland, providing a tax haven for offshore accounts, commit a violation of internationally recognized human rights? To answer this question, we need to specify the relevant internationally recognized human rights. No international human rights agreement mentions tax evasion. Moreover, no international tax treaty mentions human rights. Nevertheless, tax abuse has a significant human rights impact if governments are deprived of resources needed to meet basic economic rights guaranteed by the United Nations Covenant on Economic, Social, and Cultural Rights. The Covenant came into force in 1966 and currently has 160 member state parties. Among states that are parties to the Treaty are even several notorious offshore account jurisdictions, including Switzerland and Luxembourg (but not Singapore). The Covenant explicitly recognizes individual rights to adequate food, clothing, and housing (Article 11); health care, clean water, and sanitation (Article 12); and education (Article 13). The Covenant also imposes obligations on member states to implement these rights. Article 2 states: Each State Party to the present Covenant undertakes to take steps..., to the maximum of its available resources, with a view to achieving progressively the full realization of the rights recognized in the present Covenant.... The Covenant acknowledges constraints on government ability to meet these obligations due to limits of available resources but also imposes an obligation to progressively improve, that is, to take steps to realize the rights enumerated in the Covenant. Thus, under the Covenant, states have the obligation of progressive realization. 5
One issue is whether obligations under the Covenant extend extraterritorially. Do parties have an obligation to progressively improve the enumerated rights, not only in those territories over which they have jurisdiction, but also in territories over which they do not? Although there is no explicit language restricting the obligations to a state s own territory, one has the sense in reading the Covenant that extraterritorial obligations were not considered and perhaps not intended. When referring generally to rights to food, clothing, health care, clean, water, sanitation, housing and education in Articles 11, 12, and 13, the Covenant appears to mean the obligations of a government with respect to individuals within its territorial jurisdiction. Moreover, Article 14 refers specifically to the obligation of a state to provide primary education in its metropolitan territory or other territories under its jurisdiction [emphasis added].... Nevertheless, at least one committee of legal experts, convened by Maastricht University and the International Commission of Jurists, interprets the Covenant to impose extraterritorial obligations. In February 2012, this committee proposed the so-called Maastricht Principles, under which: A State has obligations to respect, protect and fulfill economic... rights recognized by the ESC Covenant in... situations over which State acts or omissions bring about foreseeable effects on the enjoyment of economic, social and cultural rights, whether within or outside its territory and in situations in which the State... is in a position to exercise decisive influence or to take measures to realize economic, social and cultural rights extraterritorially, in accordance with international law. More specifically, Articles 19 and 20 of The Maastricht Principles call on states to refrain from conduct which nullifies or impairs the enjoyment and exercise of economic... rights of persons outside their territories... or which impairs the ability of another State to comply with that State s... obligations as regards economic rights. There are two further possible objections to concluding that a state providing a tax haven for offshore accounts violates human rights recognized by the Covenant. Even if the government of the account holder receives information about the offshore account, it may lack the capacity to collect the revenue that is legally owed. Even if the revenue is collected, there is no assurance that it will be used to progressively realize the rights recognized by the Covenant. Thus, there is no certainty of an actual connection between one country providing a tax haven for investment accounts of the taxpayers of another country and the resulting failure of the second country to 6
progressively realize Covenant rights. There are also varying degrees of state responsibility for the offshore accounts within its jurisdiction. The degree of responsibility may depend on whether a state enacts bank secrecy laws that criminalize the disclosure of financial information, fails to apply a withholding tax on offshore accounts at a rate sufficient to deter their use for tax evasion, or evades requests for information about offshore accounts from other governments conducting taxpayer investigations. The responsibility is particularly great in the case of Switzerland, which is working actively to prevent the adoption of automatic information exchange, has a legal regime that criminalizes the disclosure of financial information, enshrines in its constitution the principle of bank secrecy, and fails to withhold tax on offshore account income or provide financial information about offshore accounts, even on a bilateral basis, except when under enormous pressure from powerful governments, such as Germany, the UK, and the United States. No international mechanism exists for actually enforcing the Covenant, even when a clear violation is established. Parties to the covenant are required to submit regular reports to a UN Committee on implementation and an optional protocol, not yet in force, would permit individuals to submit complaints of violations. Thus, it may not be crucial to definitively determine whether, as a technical matter, the maintenance of a tax haven for offshore accounts constitutes a violation of internationally recognized human rights. Whether state obligations under the Covenant are extraterritorial, whether revenues owed would actually be collected, and, whether, if collected, revenues would be appropriately used is less important than recognizing the fact that tax havens for offshore accounts make it difficult for developing countries to implement Covenant obligations. It therefore seems indisputable that offshore accounts impede the fulfillment of internationally recognized human rights. Recognition of this fact could accelerate the adoption of multilateral automatic information exchange. Fourth, if multilateral automatic information exchange were generally adopted, there would be a human rights issue of a different sort. Requiring that financial information regarding offshore accounts be provided to the government of the account holder could be problematic when that government is oppressive, brutal, and a systematic violator of basic human rights. Would we want, for example, to require financial institutions in Switzerland to report to the Assad regime the income and assets of offshore accounts of Syrian citizens? 7
We might reasonably not want to provide such a regime with the ability to collect additional revenue to finance oppressive practices. Moreover, the regime might use information about offshore accounts to target its critics. The implementation of automatic information exchange on a multilateral basis, if and when it occurs, should be structured to provide for appropriate exceptions. One solution would be to create an international body, perhaps on the model of the WTO, with authority to suspend the requirement of automatic information exchange in the case of offshore account holders from a country with a highly repressive government. 8