Switzerland and tax evasion from the South

Article as analysis
International pressure on tax havens keeps growing. Switzerland is reacting with the usual evasive manoeuvres. In so doing it is also harming developing countries.

Every year developing countries lose billions that they urgently need to fight poverty and the consequences of climate change. The reasons for these massive losses are tax evasion manoeuvres by members of the wealthy elites and tax avoidance practices by multinational corporations. This recently prompted former UN Secretary-General Kofi Annan to write an untypically outspoken piece on the subject. In an article in the New York Times he underscored that no continent was suffering as badly from the consequences of illicit financial outflows into the wealthy industrialized countries as Africa [New York Times, Stop the Plunder of Africa, May 9, 2013]. A call was made expressly on Switzerland, the United Kingdom and the USA to finally take countermeasures and ensure greater transparency in the financial sector.

Almost no tax revenues

Tax revenues in developing countries indeed make up an average of just 17% of their gross national product. In the wealthy industrialized countries it is 35%, whereas in many poor African developing countries the figure falls short of 15%. In the unanimous opinion of many development experts and the International Monetary Fund, that is insufficient to finance a government apparatus that is functional even in principle. The good news is that there is still enormous potential for catching up.

The main reasons for the extremely low tax revenues in developing countries include inadequate tax systems and administrative shortcomings on the part of tax authorities. Huge swathes of the economy, and of the informal sector in particular are hardly taxed or not taxed at all. International organizations such as the International Monetary Fund and the OECD are therefore providing financial assistance and technical advice to developing countries carrying out tax reforms. Various development programmes of Switzerland's State Secretariat for the Economy (SECO) are pursuing the same goal. Often enough, however, such tax reforms also entail introducing consumption taxes which hit poor households the hardest.

The tax evasion problem

At the same time, developing countries are confronting a problem that also affects rich industrialized countries with functioning tax systems and well-equipped tax authorities – namely, tax evasion by well-to-do individuals who shift their undeclared assets abroad. Added to this are the tax avoidance practices of multinational corporations, which often use legal channels to transfer their profits to low-tax areas such as Switzerland. This calls for countermeasures not only in the affected countries, but above all in the foreign tax havens that are seeking a profit from the influx of untaxed foreign monies.

Shortly after the onset of the global financial and economic crisis in 2008, the international community declared «war» on the numerous tax havens across the world. To date, however, developing countries have derived virtually no benefits from the progress made towards greater tax transparency. The example of Switzerland illustrates this: under OECD pressure Switzerland has concluded new or revised double taxation agreements with almost 40 countries. These agreements allow for the sharing of relevant banking information in the event of a well-founded suspicion of tax avoidance and at the request of the partner country. One would be looking in vain however for poor developing countries in the list of new Swiss tax agreements.

Mounting pressure

International pressure on tax havens like Switzerland has again been ramped up considerably since the start of this year. Ever more countries, and chiefly the European Union, wish to make the automatic exchange of information in tax matters into a worldwide standard. This would act as a powerful deterrent to potential tax dodgers and would therefore be extremely useful to developing countries as well – quite independently of how much use is actually made of the information received by their tax authorities.
In parallel, the European Commission is now working on an action plan that will allow the EU to impose sanctions on insufficiently transparent financial centres. Possible sanctions will also be aimed at countries that engage in harmful tax competition. This refers to countries which tax corporate revenues from abroad at a lower rate than domestic profits. Switzerland is also amongst that number, with its special cantonal tax regimes for holding companies and the like. These provide a substantial incentive for multinational corporations to use interest payments or high service costs to transfer profits from countries of production to their Swiss headquarters.
In the meantime, it is not just the EU that is keen to move against such tax regimes, but also the OECD. Under its Base Erosion and Profit Shifting (BEPS) programme, the OECD is considering measures designed to combat unfair tax competition between the possible headquarters countries of multinational corporations.

Switzerland’s evasive tactics

Switzerland is continuing to react to the growing pressure with evasive manoeuvres. Whereas the Federal Council is already thinking out loud about automatic information exchange, it officially continues to push for a half-baked clean money strategy: amongst other things, banks should ensure by means of self-declarations by clients that they no longer accept any untaxed funds. However, such self-declarations, which have already been introduced voluntarily by several banks, are hardly adequate. This is illustrated of all things by an article by the Neue Zürcher Zeitung [NZZ, Der steinige Weg zum «weissen» Geld (The rocky road to «clean» money), 18 May 2013]. In it a bank employee bluntly admits that assets from developing countries were indeed «traditionally untaxed», and that the truthfulness of forms completed by the clients was often doubted. Yet nothing was being done about this.

The planned clean money strategy will therefore hardly be able to prevail as an alternative to the automatic exchange of tax information. The Swiss Private Bankers Association too has understood this. Its President Nicolas Pictet now openly favours automatic information exchange. Ironically, however, he wants to withhold it from all developing and emerging countries – under the blanket pretext that in any case, legal certainty is totally inadequate in those places. What Pictet's position boils down to is that Swiss banks should happily continue their flourishing business with untaxed money from the South without hindrance.

But Switzerland is also relying on a backdoor when it comes to corporate taxation. The Federal Council proposes that the cantonal special regimes for holding companies and similar constructs should be replaced by what are called license boxes, which would afford multinational corporations the possibility to avoid profit taxes in developing countries by transferring the highest possible amounts of license payments to Switzerland.