The Mark 2010

Proposed U.S. legislation against tax havens would force the hands of foreign asset holders worldwide – Canadians should take note.

The Union Bank of Switzerland tax evasion saga is the dawn of a new era in international tax compliance and enforcement. Following the lead of the United States, the Canada Revenue Agency has asked UBS to disclose the names of its Canadian clients. No response to date.

The saga started off routinely: Some Americans and Canadians wanted to hide their income from the tax authorities. The UBS obliged by offering to hide money behind Swiss banking secrecy laws that strictly prohibit – under threat of criminal sanctions – the disclosure of banking information. If everything went accordingly to plan, no one would be the wiser. The clients would become wealthier, UBS would make more profits, and the Swiss government would collect more in taxes.

Everyone’s happy until the U.S. Internal Revenue Service pops the party balloon by invoking the information exchange requirements of the U.S.-Swiss Income Tax Treaty. The IRS asked UBS, whose net assets are four times Switzerland’s GDP, to release the names of 52,000 of its American clients.

UBS initially rejected the request, citing Swiss domestic laws that prohibit the disclosure of banking information. The Swiss government claimed that income tax evasion is not fraud under Swiss law and, therefore, the request for information pursuant to the treaty was outside the scope of its disclosure requirements. A clever argument, to be sure, but it underestimated the economic clout of the U.S.

UBS has significant assets in the U.S.; it would have been economically exposed if the IRS proceeded with full-scale criminal prosecutions and sanctions against it. The Swiss government understood the stakes and capitulated. They revealed the names of 4,450 wealthy Americans with offshore bank accounts at UBS.

What of the remaining 47,550 names? Brilliantly, the deal was orchestrated to avoid disclosing the methodology of selecting the potential offenders from the list of 52,000 Americans until some time in November 2009 – after the deadline of the U.S. amnesty for tax evaders, which expires October 15. Americans with undisclosed offshore accounts are caught in a reverse lottery – guessing as to whether their names will be called up. Faced with the threat of criminal prosecution and severe sanctions (including jail time), this gamble has been a powerful incentive to voluntarily confess. By mid-September, more than 3,000 taxpayers had come forward and confessed.

The pressure is building. The Americans convicted Bradley Birkenfeld – a former UBS private banker – and sentenced him to 40 months in prison even though he helped and cooperated with the U.S. prosecutors. Indeed, the judge imposed a penalty even higher than the prosecution recommended.

Will there be spillover in Canada? Lichtenstein, another haven for tax evaders, is also under close scrutiny after a bank employee stole an electronic list of depositors and sold it to various governments. Canada has the names of about 100 Canadians with Lichtenstein bank accounts, which the government obtained from the stolen disk. An interesting aspect of the Lichtenstein probe is that the Canadian government is in possession of stolen property. It remains to be seen how the courts will deal with evidence arising from the stolen property.

As in the U.S., Canadian taxpayers are required to annually file a statement of their foreign assets holdings if they exceed $100,000. Failure to do so can result in penalties and sanctions. Canada, however, has a perpetual amnesty. Canadians can disclose offshore income through an anonymous voluntary disclosure process and avoid penalties and prosecution. Timing is the key to amnesty. The remedy is not available after the CRA commences its audit.

Perhaps the most draconian long-term effect of the UBS saga is proposed U.S. legislation that would reverse the onus of proof for taxpayers who have money in accounts in “offshore secrecy jurisdictions.” Taxpayers with such accounts would have to prove that they are not subject to U.S. tax. The proposal lists 34 countries, including the Cayman Islands, Lichtenstein, the Bahamas, and Antigua as secrecy jurisdictions. How far behind can Canada be with copycat legislation?

To be sure, UBS capitulated to the Americans because of their economic clout. It remains to be seen if they will respond similarly to Canadians.

Warren Buffett once said, “You don’t know who is swimming naked until the tide goes out.” In the meantime, potential evaders in Canada should seriously consider voluntary disclosure while the tide is still in.