The global crackdown on tax havens

Michelle Perry considers whether euro ministers have a realistic chance of achieving implementation of measures intended to combat tax evasion

The monthly meeting of Europe's economic and finance ministers scheduled for early June could turn out to be a less than comfortable affair. Ministers are due to gather to endorse new legislation aimed at combating tax evasion within the European Union and determine whether all the countries nominally signed up are ready to deal with the changes.

But with less than a month to go, it is uncertain whether the goal will be achieved.

Under the new laws, EU countries, their dependencies and so-called third countries, such as Switzerland, have the option of complying with either the exchange of information model or a withholding tax model as a transitional measure.

The new rules require these territories to exchange information on savings held by non-residents, so that they can be taxed in their country of origin.

In January 2003 a landmark agreement was reached on the saving directive under which a number of non-EU jurisdictions including, crucially Switzerland, agreed to adopt the directive on the basis of a negotiated withholding tax model.

The agreement removed one of the last remaining obstacles to implementation of the directive planned for 1 January 2005.

But April's meeting of Ecofin ministers made no headway in ending the impassé with Switzerland. The meeting concluded with a stark warning from internal markets commissioner, Frits Bolkestein.

'The Swiss Government is maintaining the position of trying to link the savings tax agreement to other issues. The Commission and the Council should stick to their guns and ask Switzerland to sign an agreement without any further delay,' said Bolkestein.

Switzerland has been throwing its weight around by using the directive as a stick with which to beat the Commission into agreeing to other conditions to minimise what it perceives as a potential loss to its coveted status as one of the world's leading banking centres.

The country's continued refusal to implement the law without caveats raises further complications. The endorsement of the directive by some EU and non-EU countries and dependencies hinges on what Switzerland decides.

EU members Austria, Belgium and Luxembourg have all retained their right to banking secrecy in exchange for a withholding tax applied at source.

The remaining EU countries have all agreed to exchange information with the respective tax authorities. And all eight Crown dependent territories have finally agreed, after much pressure from governments and a few token rewards in return, to adhere to the laws by applying the withholding tax.

But none of the offshore centres or microstates in Europe, such as Liechtenstein, Andorra, San Marino or Monaco, will endorse to the rules unless Switzerland does.

The withholding tax model, however, is seen by many as a pyrrhic victory.

All withholding countries must also offer their customers the option of reporting their details to the respective tax authorities instead of applying the withholding tax. This means that institutions in those countries have to set up two different types of systems.

'Another thing that will be expensive for withholding countries is the fact that they have got to give their customers an alternative to withholding, such as the choice of reporting,' says David Frood, tax director in the banking and capital markets group at PricewaterhouseCoopers.

Stephen Holden, partner at BDO, says: 'I'm not sure if Austria and the others have thought this through. They are making themselves less attractive. There's no real downside to the exchange of information model for those who have their tax affairs dealt with on the correct basis.'

Observers say these countries have opted for the withholding model as a political stance and because their traditions are steeped in banking secrecy.

Graham Parrot, partner at Ernst & Young in Guernsey, says: 'Guernsey gets to keep about 25% but it will be swallowed up by the cost of having to run this retention approach.'

According to Parrot, an estimated 10% of deposits in Guernsey will be affected by the changes. 'On one level it's more about reputational issues and systems,' he says.

This is the general mood in the banking world; that the new laws are a necessary evil that will bring little benefit.

'It's more a case of managing the downside than exploiting the upside,' says Parrot.

Ian Harrison, director of the London Investment Banking Association and secretary of the business group co-ordinating City views on the new directive, says: 'Obviously it means a lot of additional systems working for paying agents. But most are coping with it well.'

The UK's Inland Revenue, however, says the benefits will be many. The directive, says the Revenue, will ensure fairness to taxpayers, ensure the right amount of tax on savings income is paid in the right country at the right time, and provide a reduction in the resource cost of ensuring compliance.

Enormous cost

But the expense to the banking world is expected to be massive. The fund management industry will also be greatly affected by the changes, say experts.

Michael Barnett, tax director at Ernst & Young London, says: 'The cost will be enormous for financial institutions, if only because of the systems implications. All sorts of products and business streams will be affected in different ways.'

Some experts have put the cost at up to £20m for the largest banks to meet their new obligations.

David Frood says: 'There are significant systems spend implications for those institutions in withholding countries. But there's also significant spend impact for banks and other financial institutions in reporting countries.'

He adds: 'In withholding countries there's the added burden of calculating the tax accurately. If it's too big then the customer gets upset. If it's too small then the tax authorities will get cross. The risk of getting it wrong is quite high.'

Despite initial resistance, offshore centres are resigned to the new laws and don't believe it will greatly impact on their attractiveness as a place to do business.

Industry advisers predict that banking centres such as Singapore and Panama will pick up some business, but few believe there will be an exodus from those countries signed up to the directive.

Barnett says: 'There will be customer behaviour changes. Financial institutions will be looking at their business structures and product ranges, but they will be mindful of reputational issues. The directive will have a huge impact if only because of the systems implications.'

But if Switzerland doesn't back down, it could derail the whole process.

Politicians are, however, in a very good position to engage the banking sector and reticent governments. The last few years' terrorist attacks around the globe, and the continued threat of terrorism, has partly aided their bid to encourage the exchange of information across borders.

When it comes to sharing information on financial matters, few arguments can beat that of transparency, given the will to stop money being channelled into terrorism.

At best, June's meeting will result in full endorsement by the countries involved, meaning the law will take effect on 1 January 2005.

Paul Tipping, director at the British Bankers' Association, says: 'I can't imagine that the finance ministers would want to postpone it but one possible reason could be Switzerland.'

At worst, it will be delayed by one or two years for those dragging their feet to prepare for the changes. But if this is the case, it throws up concerns that the extra time will permit those governments delaying implementation to tinker with the directive's content, resulting in a diluted form of the original, which would defeat its entire purpose.

Michelle Perry is a freelance journalist specialising in financial and business issues.