The Swiss–UK Bilateral Tax Agreement: Decision Time

On 6 October 2011 the UK and Swiss Governments signed an historic tax agreement (the ‘Agreement’) which, when it comes into effect, will provide a mechanism by which UK resident individuals holding Swiss bankable assets may regularise certain historic undeclared UK tax liabilities in relation to those assets through a one-off deduction from those assets.  The Agreement will also provide for a withholding tax on future income and gains arising from those assets.

Both the one-off deduction and the withholding tax will be paid anonymously to the UK’s HM Revenue & Customs (HMRC) through the Swiss Federal Tax Authority (SFTA).  Modified rules will apply to non-domiciled UK resident individuals.  At the date of writing this article, the Agreement has yet to be ratified by each country, but it is expected to come into force on 1 January 2013.  This article is based on the form of the Agreement signed on 6 October. 

The industry has now started to digest the terms of the Agreement and inevitably there are a number of areas that need clarification.  HMRC is expected to provide guidance shortly in the form of ‘frequently asked questions’.  What is crystal clear, however, is that the way Swiss banks conduct their UK business will be substantially and irreversibly affected. 

When considering the Agreement one should remember that it is not a disclosure facility as such.  Its terms have been negotiated by two Governments in relation to assets in those countries only.  It will achieve an effect equivalent to the automatic exchange of information between those two countries. 

The Agreement has been criticised for its failure to recover fully all unpaid taxes due from the affected individuals.  However, HMRC has taken the pragmatic view that, given that Swiss banking secrecy was unlikely to be broken down within the next five years, some sacrifice of taxes is justified in order to draw in a large amount of Revenue in the short term, which it might not otherwise have seen.  The Swiss for their part are keen to focus their attention on declared funds going forwards, but without sacrificing banking confidentiality.  An upfront payment of CHF500m will be paid by the Swiss banks as part of their commitment to the Agreement.

Who Falls Within the Agreement?

The Agreement will apply to UK resident ‘relevant persons’ who directly own ‘bankable assets’ in Switzerland (which includes cash, bank accounts, precious metal accounts, shares, securities and various structured products) or who are the ‘beneficial owners’ of such assets held by companies, trusts, foundations and partnerships.  Irrevocable discretionary trusts are thought not to be caught by the Agreement (because there is no ‘beneficial owner’), although revocable discretionary trusts might be.  It is therefore important that trustees confirm each trust’s status with their Swiss bank.

Individuals who are resident outside both the UK and Switzerland that provide a British passport when opening their account will be required in some circumstances to provide formal documentation from their country of residence to confirm that they are not UK resident.  Failing this they will be deemed to be UK resident.  In addition, an individual who has provided a primary correspondence address in the UK will be deemed to be UK resident, and at the moment it is not clear whether this can be overridden by proof (such as a Legal Opinion) that he/she was not in fact UK resident. 

More beneficial rules apply to UK resident non-domiciled individuals.  A Swiss institution will only accept an individual as non-domiciled if this is certified by an appropriate professional and the individual has elected for the remittance basis of taxation to apply for the relevant tax year (and the relevant remittance basis charge has been paid if necessary). 

Regularising the Past

Once the Agreement comes into effect a UK resident and domiciled individual with undeclared Swiss assets will have the following options:

• an anonymous one-off deduction from their Swiss assets of between 19 per cent and 34 per cent of their value on 31 December 2010;
• a voluntary disclosure of their Swiss assets to HMRC, either through the mechanism in the Agreement or (more likely) through the Liechtenstein Disclosure Facility;
• to remove their assets from Switzerland before 31 May 2013.

The effect of the one-off deduction is to regularise all income tax, capital gains tax, inheritance tax and VAT liabilities which arose prior to 1 January 2013 on the funds in respect of which the deduction is made.  The clearance only applies to those funds still situated in Switzerland and not to those which have already been withdrawn (although it might be possible to transfer those funds back to Switzerland now so that they too can be regularised).  The one-off deduction route is not available to individuals who are already under investigation, who have previously been subject to a serious criminal or civil investigation, who have been contacted in relation to a previous disclosure facility or whose Swiss assets represent the proceeds of non-tax related crime. 

Although HMRC have confirmed that historic liabilities (including interest and penalties) will be treated as having been met, compliance with the Agreement will not guarantee protection from prosecution.

Even if the Swiss assets are fully declared, details must still be reported to HMRC (via the SFTA) by a relevant institution to avoid the one-off deduction.

A UK resident non-domiciliary has similar options to those described above, but also has the option of electing for a one-off anonymous payment to be made, calculated by reference to any undeclared UK source income or remittances of income and gains to the UK since 2002, or alternatively to opt out of the Agreement altogether if there are no outstanding liabilities in relation to the Swiss assets.

A UK resident non-domiciliary with an un-segregated bank account who wishes to remit funds in the future to the UK might benefit from allowing the full 19 per cent to 34 per cent deduction to be made.  Providing the account was then properly segregated, tax-free remittances could be made in the future from the ‘clean’ capital account.  It is not clear from the Agreement, though, whether the payment of the one-off deduction would itself constitute a remittance.

Future Investment Income and Gains

Future investment income and gains of UK resident and UK domiciled individuals from Swiss assets will be taxed under the Agreement in one of two ways:

• by the institution applying a withholding tax and paying it through the SFTA to HMRC anonymously on behalf of their client.  The rates are based on the UK’s highest rates of tax, and will mirror future UK tax rate changes (although at 48 per cent for interest, 40 per cent for dividends and 27 per cent for capital gains the current rates are slightly lower than the corresponding UK tax rates due to the earlier receipt of tax by HMRC); or
• by the individual authorising their bank to disclose his/her details to HMRC (and of course declaring the income and gains in his/her own tax return). 

The withholding tax will apply to income arising and gains realised from the Swiss assets after 1 January 2013 and will satisfy all UK tax liabilities in relation to those income and gains. 

Similar options are available to UK resident non-domiciliaries, except that the withholding and disclosure options relate only to post-2013 UK source income or gains, and to taxable remittances of post-2013 income or gains.  These individuals have the additional administrative burden of confirming to the institution in advance their intention to claim the remittance basis, so that the institution can withhold tax as appropriate. 

Decision Time

So what should an individual with a Swiss account do?  This will depend upon his/her circumstances and primary objectives. 

For an individual whose paramount concern is confidentiality, the Agreement is useful because it should allow his/her liabilities in relation to the Swiss assets to be regularised anonymously in 2013. There is of course the danger that HMRC will investigate his/her affairs before the Agreement takes effect, which would prevent him/her from being able to use the Agreement. Those who do not wish to risk waiting, or for whom a deduction of 19 per cent to 34 per cent of their assets is not acceptable, will need to consider whether to regularise their tax affairs by making a voluntary disclosure or to move their assets to another jurisdiction.  The LDF is one way of making a voluntary disclosure and the typical overall cost (including tax, interest, penalties and professional fees) is normally significantly less than 19 per cent of the value of the assets. Although these individuals will not enjoy anonymity, the LDF does have several other benefits including guaranteed immunity from prosecution, the ability to regularise worldwide assets and confirmation that all liabilities have been met.  The period of liability is also limited to be from 6 April 1999.

The one-off deduction method of regularising the past will be financially better than the LDF only in a limited number of circumstances.  These might include where an inheritance tax charge has arisen between 6 April 2009 and 1 January 2013 or where a fund is almost entirely made up of post-1999 untaxed employment income. 

Where the one-off deduction is chosen, there are certain issues of which individuals should be made aware.  The deduction is intended to meet liabilities arising prior to 1 January 2013, but will only be paid on 31 May 2013.  The anonymous withholding tax rates will apply to all income arising and gains realised after 1 January 2013.  Individuals should take early advice to decide when assets should be sold to fund the payment; normally disposals before 1 January 2013 will be preferable.  Depending on whether the proposals to make foreign exchange gains non-taxable are introduced from 6 April 2012, it may also be important to ensure that these funds are converted into sterling before 1 January 2013 to avoid any taxable currency exchange gains (should exchange gains still be taxable).

Further clarification in relation to inheritance tax is required.  It is clear that an inheritance tax liability, which arose before 1 January 2010 can usually be met by the one-off deduction, although the position in relation to a death between 1 January 2010 and 1 January 2013 is currently unclear.  In future, the assets will form part of an individual’s taxable estate if UK domiciled (or deemed domiciled).  If an account holder elects to remain anonymous and his/her heirs make the same election, there appears to be no mechanism under the Agreement to meet anonymously any future inheritance tax liability arising, so at that point the assets should be declared by the executors.

There are also practical considerations as to how the Agreement will be implemented.  It is estimated that the costs of implementation by the Swiss financial sector (in terms of new IT systems, additionally staff, training, etc) will be approximately CHF500m.  Every institution wishing to have UK resident clients after 2013 will need to put suitable arrangements in place.

Although most discretionary trusts ought not to be caught by the Agreement, whether this will be the case in practice may depend upon what due diligence records the financial institutions have and their accuracy.  This may pose problems because many trustees have not updated their due diligence records from the old fashioned Form A to the newer Form T, which was introduced more recently for discretionary trusts.

There are several monitoring and anti-abuse provisions included in the Agreement.  One of these is that Switzerland needs to provide the names of the 10 most popular destination countries for ‘fleeing capital’.  It seems likely that these countries will then be targeted by HMRC.  Penalties for those caught by HMRC after having moved their funds from Switzerland will be significantly higher (up to 200 per cent of tax due).  Moving funds to less stable destinations than Switzerland is therefore a short term and potentially very risky option.

If the Agreement is ratified by both countries, HMRC will receive significant funds (£4 - £7 billion is estimated) with a minimum of effort because the primary administrative burden is on the Swiss institutions and the SFTA.  Confidentiality is still available for those who would like it, but at a cost.  Individuals with accounts should take early advice to ensure that they make the right decision for their circumstances.