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In July 2005 if a German resident, Heinrich earned interest on his French bank account, the French bank was obliged to notify the German tax authorities under the Savings Directive that Heinrich had a bank account in France. Why then if the Savings Directive is already in place has it been necessary to implement the automatic exchange of information? Surely this Directive was sufficient for all Governments to get the information they needed to stamp out the tax evasion of their residents?

The Directive however, failed to live up to its ambitious plans, for a number of reasons.  For example; Austria and Luxembourg were granted exemptions. Instead of exchanging information on the identity of account holders both countries were allowed to preserve the anonymity of their clients and apply a withholding tax of 35% on all interest earned on the account of non- EU residents. But, it backfired.

Francois, for example is French, but has a bank account in Austria. Austria deducted 35% against interest earned by Francois and paid three quarters to the French tax authorities. Francois pays the top rate of tax in France which is 45% which is 10% higher than the amount deducted in Austria. Francois is liable to pay an extra 10% tax in France and should declare it. However, if he does not, the French tax authorities do not know that Francois has a bank account in Austria, so they cannot they cannot check that he has paid the right amount of tax.

Exemptions from the general rule are already beginning to creep into the Common Reporting Standard for the automatic exchange of information.

Some countries such as the Bahamas and Switzerland have seized on the legitimate concern recognised by the OECD that some countries in which wealthy individuals live do not have the necessary security and confidentiality measures in place to protect the privacy of the information exchanged. In situations such as this the jurisdiction collating the information need not exchange it.  

Bahamas has refused to sign the multi-lateral convention for this reason and will only sign bi-lateral agreements with countries it considers to be safe. It has not for example signed many agreements with S American countries in which it has a significant number of account holders. Switzerland has adopted a similar approach, and has identified only a handful of jurisdictions which it considers to have adequate security measures in place. As a result, both the Bahamas and Switzerland have a competitive advantage over other financial centres.

The second loophole in the Savings Directive, was the fact that the Directive only applied to accounts owned by individuals, not accounts held by entities such as a company, trust or foundation. If Francois did not wish to pay the 35% on his Austrian bank account, all he had to do is to transfer his account to a British Virgin Island company. Austria would not then look behind this company and declare Francois as the shareholder and disclose these details to the French government. In the UK, if there are five or fewer shareholder which control a company the tax authorities can tax the shareholder on the income of the company and I am sure France has similar anti avoidance rules. Therefore is Francois doesnot declare the income arising in his offshore company which holds the Austrian account, he is evading tax.

In 2004 before the Directive was implemented 50% of accounts in Switzerland were held by offshore companies, whereas by the end of the 2005 60% were owned by offshore companies – an increase of 10%.

The possible reason why this percentage was not higher was the example made by the US of Credit Suisse, UBS and other Swiss banks in response to legislation which proceeded FATCA, known as the qualified intermediary rules. Banks were obliged under these rules to provide data to the US IRS only if their clients held American securities. To avoid this rule, the American Securities were transferred to an offshore company. The Swiss banks keen to assist their clients promoted the ownership of their accounts through offshore companies. The IRS did not like this conspiracy to evade its rules and sued the Swiss banks for defrauding the US IRS. Credit Suisse was fined $2.6billion.

The CRS automatic exchange of information has similar loopholes. Income on investments held in a discretionary trust do not need to be reported until such time as paid out to a beneficiary. Discretionary trusts do not have similar anti avoidance rules as companies an are therefore much more useful. Income can therefore be accumulated without any reporting to the country where the beneficiaries reside, until such time as they receive the income. Furthermore, there are ways in which distributions can be made without the need to report as income.

However, it is now unlikely that a financial institution with reporting obligations will advise their clients on what they can do to plan for fear of being sued.

Wealthy families are beginning to realise this and are now looking for planning from independent advisers; whether on the structuring to preserve privacy, protect their assets from spurious litigious claims, provide for their heirs or legally mitigate their tax obligations.

There are numerous ways in which people can plan, mainly because there is nothing to stop wealthy families taking advantage of companies and trusts in jurisdictions which want to attract business to their shores.

If you would like to find out more, or you would like to book a meeting with Caroline or one of her team, please email or phone 020 3740 7423.

You can buy Caroline’s book ‘Who can you trust when you are super rich?’ from Amazon or direct from Svetlana.