Where US Law Ends

Will the US attack on UBS break the Swiss banking system...?

WILL THEY SUCCEED? asks Julian Phillips of the GoldForecaster.com. After whacking Swiss banking giant with a $780 million fine, the US authorities are now coming in for another attack, demanding the exposure of US Swiss account holders in the bank.

UBS had already agreed to disclose the names of 300 US-based clients with unreported accounts at UBS in the States. So far, they will not agree to disclose the names of US citizens who hold accounts in Switzerland. But the entire body of US citizens holding Swiss bank accounts are worried about this prospect. And on top of that, all other foreign Swiss bank account holders are worried too.

The entire Swiss banking system holds countless "secret" bank accounts, not just for investors around the globe but also going back through many, many decades. Banking for foreigners is so important to the Swiss that they passed the Banking Secrecy Act, imposing serious prison time on those who disclose such secrets. So this is not just a battle between UBS – the multinational Swiss Bank – but between the Swiss government and the US tax authorities.

When the South African Reserve Bank decided to prevent Swiss bank investment from a popular equity issue in the country – demanding that the beneficial owners of any such funds disclosed themselves first – Fritz Leutweiler, then president of the Swiss National Bank (SNB) flew to see the South African Reserve Bank governor and warned him: Unless these funds were released to the investment, or allowed to be repatriated, there would be no more Swiss investment in South Africa whatsoever.

The funds were released that day.

Now in the United States, the tax authorities think they have the Swiss on the run instead. They know that UBS bank executives are in an invidious position. But these executives know full well that they are within the laws of both countries, provided they maintain the secrecy of their clients with accounts in Switzerland but NOT in the United States, where the Swiss laws hold no jurisdiction.

Adding to the political row, US newspapers are now claiming that the Swiss will be broken and that Swiss banking secrecy is tantamount to a crime for US taxpayers. Indeed, the charges being leveled against both the bank and US citizens that hold accounts there are that they are evading US taxes.

It is sad to see such reports and charges take such emotional lines, far departed from the realities of international law.

In short, you see, the authority of the US tax authority is limited to the borders of the United States and those tax payers living there. Yes, it is true that even US citizens living overseas are required to submit a report of their worldwide assets annually to the tax authorities, but the power of the US remains limited – even in these cases – because these citizens cannot be forced to pay US taxes until they return to the States, except on those assets held within the United States.

No nation outside the United States will impose US tax laws in their country. The will of Washington is limited to its domestic shores. And so two obstacles stand in the way of US tax officials trying to impose their rules on US citizens and assets held overseas. The first is jurisdiction; the second is the reality of a legal entity.

Jurisdiction Rules O.K.

It is my experience, and not academic theory, that jurisdiction is paramount in these matters. Some real examples will illustrate this.

Should a citizen of the United States be charged with tax evasion (not simply suspicion of tax evasion) in a foreign land, it is incumbent on every court to establish the correct jurisdiction before proceeding with any such charges. And should it be found that the court does not have the jurisdiction to impose any finding in a foreign jurisdiction, the case will be dismissed.

For instance, a German suing an Englishman in Sweden for a matter taking place in Germany would have the case referred to the German courts. The Swedish court does not have the power to adjudicate on the matter. Taking this to an extreme, the president of Zimbabwe can starve his own people and no court other than the Zimbabwean courts can try him except the International Court of the Hague.

So in the UBS case, the laws of Switzerland alone govern the activities of UBS in Switzerland. Yes, UBS activities in the United States are governed by US law, but should those activities be Swiss-based then the US has no power to impose its law in Switzerland. The US tax authorities can accuse Swiss officials as much as they like, but their jurisdiction applies only to activities inside the States.

Any US citizen that has donated assets to a Swiss legal entity must of course report it to the US tax authorities (and perhaps "Donation Tax" will apply?). But any money then made thereafter on the entity in Switzerland – inside a foreign legal entity – will sit outside the scope of US tax jurisdiction. This fact, we believe here at the GoldForecaster.com (and with almost four decades of experience in advising on exchange-control and offshore trust management) will come out in the present attack on the UBS.

Under Swiss law, any US citizens against whom there is substantive evidence of a crime involving money invested in Switzerland should expect the Swiss Authorities to cooperate fully with the US authorities in their criminal investigation. However, Switzerland does not regard simple tax evasion as a crime.

Moreover, in the 1970s the Bank of England wanted to explore the Swiss-based activities of certain British citizens. So it sent a detective to Switzerland to investigate. But this official was promptly locked up for breaching Swiss banking secrecy laws. Might the same happen to a US tax official in 2009...?

Taken further, any UBS official who passes to the US tax authorities the bank account details of US citizens against whom there is no Swiss-agreed tax evasion evidence would likely be imprisoned on his return to Switzerland. And it's also signal to note that for some reason, President Sarkozy of France has cast his stone at the Swiss (the man appears to like the stage), suggested that Switzerland be added to a blacklist of "Tax Havens" worldwide.

But he would not do this if he believed that the Swiss could be broken by the US tax authorities.

Legal Entities: Ruled Where They Live

Any legal entity exists under the jurisdiction of the country in which it is formed. No outside tax authority can impose taxes on it.

If the entity carries on legal business overseas, what should happen is that the local authorities have the right to impose taxes on the repatriation of that cash flow. What also happens in some countries is that where a tax authority deems the entity to be placed in the foreign location solely to avoid taxes, it can impose anti-avoidance taxes on the flow of cash, taxing it as though there were no legal entity there in the first place.

But the cash flow has to come home first! Taxation is then imposed on the individual or entity originating the foreign entity, but only in the country of origin. The tax authorities cannot step over into the foreign jurisdiction – striding across international boundaries – and impose their laws there.

Many individuals and corporate structures are set up in a way so as to avoid taxes. This is vastly different to evading taxes. Avoidance is ensuring that taxes are not due, whereas evading (in most countries) means criminally ducking taxes that are due. One is within the laws of the US; the other is outside it. The chest-beating of the US taxman seems to be obscuring that difference. But nevertheless the difference is clear.

The United States has often barked about "Dummy Corporations" in foreign jurisdictions, but a corporation is either a legal entity or it is not. It is governed by the laws of the jurisdiction it is in. Whereas the concept of a "Dummy Corporation" implies tax evasion in the US, but not elsewhere. Its existence, in reality, may well facilitate tax avoidance only.

Even there, the US tax authorities must establish grounds for charging with tax evasion (which differs from avoidance, remember), and gather evidence to confirm it. Where it is legally permissible, corporations set up primarily to minimize tax can be simply a re-routing of cash flow in such a way as to avoid or postpone taxes.

The important feature of this is that the letter of the law is obeyed. In many cases today, the taxman is shouting about the "spirit of the law" – which may be different. So it is comforting to realize that even the US taxman has to obey the letter of the law as it is written.

It appears that UBS paid that huge $780m fine primarily to pacify the US authorities so it could continue doing business within the United States. The bank did not admit to tax evasion support, and if it did support such activities inside the United States, then we are sure the executives concerned would be hung out to dry by their own people. Swiss bankers are extremely precise, and in the US they would also obey the laws of the US government. What is tragic is that at the end of the day, UBS may well depart the shores of the US battered and bruised but with its Swiss secrets intact.

Switzerland has been a haven for money by all types of individuals for the last 400 years. It is perhaps the main commercial activity in Switzerland. This service has gone hand in hand with the neutrality of Switzerland – a policy guarded by nearly all Swiss citizens. They are unlikely to change these laws because of the huffing and puffing of US tax officials.

And just now we receive news that the Obama administration is not interested in escalating a dispute between the United States and Switzerland over bank secrecy laws. The tensions have risen far enough, leading to a meeting between Switzerland's top justice official and her counterparts from the US Justice Department.

Why? Because jurisdiction rules!