A surprising Swiss federal court ruling is forcing the government to gear up for a new battle against the US Internal Revenue Service, which is trying to punish rich Americans hiding their wealth abroad to avoid taxes. If it occurs, the Swiss resistance could derail a main plank of the Obama administration’s drive to choke foreign tax havens. The ruling also heaped trouble upon a former Swiss President who helped conduct tax negotiations last year.
After Obama’s arrival, the IRS started a very robust campaign against Switzerland’s traditional tax haven status. In particular, it accused the giant Union Bank of Switzerland (UBS) with helping rich Americans to hide money abroad and threatened to force closure of its very large operations in the US.
Running scared, UBS with extensive political help from the Swiss government reached a deal in August 2009 paying over $780 million in fines. It also pledged to disclose the names of several thousand American clients to the IRS opening them to potentially severe punitive action in the US.
The decision to reveal the names and accounts of American clients sent the usually discreet and velvet-lined world of Swiss banks into uproar with cries against the government of “foul” and “spineless submission to America”. The decision was very controversial because it could violate Swiss banking secrecy laws that guarantee confidentiality to clients except when the money comes from very few special circumstances, such as gains from crime or funding terrorism.
The Swiss government was deeply involved in the deal with the IRS and US authorities because UBS was the country’s largest bank with tentacles in all parts of its economy. It also suffered very heavily from its huge exposure to the dodgy financial and mortgage instruments that triggered the financial tsunami of final quarter 2008.
According to some experts, UBS was on the edge of collapse so the government helped by bending the banking secrecy laws to prevent punitive legal action by the IRS against the bank in America. Aggressive prosecution seemed inevitable because the IRS had a paper trail showing that UBS employees actively encouraged and assisted rich Americans to hide wealth in Switzerland.
A few days ago, the Swiss Federal Administrative Court, which is the high court of appeal against Federal government decisions, ruled that key aspects of the deal with the IRS violate Swiss banking secrecy laws. In particular, the government should not have approved future disclosure by UBS of about 300 names of American clients and their account details.
Then the Court struck again. It said the revelations also violated the double taxation agreement with the US. The rulings have caused political uproar in Switzerland with calls for a parliamentary committee investigation into how the government reached it decisions last year. Former President Hans-Rudolf Merz is stoutly defending the government but critics are lining up for onslaught.
The Court’s rulings are narrowly worded and address very specific issues but a growing feeling in political and banking circles that the IRS is trying to apply American laws in little Switzerland continues to fuel anti-American anger.
But there is palpable fear that the IRS could attack UBS in America if the Swiss government reverses its previous decisions under pressure from the Court rulings. That would prevent UBS from honoring its disclosure commitments to the IRS. Several experts think that the bank will collapse if it can no longer operate in the US or gets involved in long litigation ending up in huge new fines. There is little doubt that the IRS will win.
But the Court ruling is gradually pushing the Swiss into a constitutional crisis. The key question is whether the Swiss government can resist the American Goliath by insisting on its laws or will banking secrecy, which has helped to make Swiss banks among the world’s richest, start to die.
The current form of banking secrecy was created to hide the wealth of Jews being marched into the holocaust. Is the world so free of persecution that Swiss lawmakers should sacrifice this kind of protection to the IRS’s ire against American tax evaders?
Some UBS employees and the bank may be found guilty of violating tax laws in America and be punished appropriately within the US. But, should Switzerland be forced to disregard its laws to allow transfer of secret banking information from its sovereign territory in subservience to authorities of a foreign power? The future health of UBS will depend on how the Swiss government and courts answer these questions.