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United States of America vs. UBS: A Step Too Far?

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Let's start from the facts: UBS (United Bank of Switzerland) is the world's largest money manager and has naturally developed that business in the United States. Being a Swiss bank, they offer not only US bank accounts but also Swiss bank accounts to their U.S. clients. Most foreign banks offer the same services in the United States. This is not illegal, neither is it tax fraud. Where the fraud starts is when U.S. taxpayers do not disclose the revenues they earn from foreign accounts. The United States is the only country that taxes worldwide revenues. Until June 30 of this year, foreign bank accounts had to be disclosed if they collectively reached $10,000 or more.

There are perfectly legitimate motivations for opening foreign accounts, partly due to the absence of specific international competencies of the U.S. brokerage community. However, for many U.S. foreign account holders, one of the key motivations is to avoid taxation. UBS had gone too far by building sophisticated mechanisms that allowed revenues to be concealed and substantial amounts of taxes to be avoided. For this, UBS paid $780 million in fines to the IRS and was forced to restructure its business on a model that no longer creates incentives for tax fraud. They also communicated the identity and information on about 300 US clients who are currently being sued by the IRS. Two were fined last week and the IRS is pursuing at least 150 more of them, with threats of jail sentences.

As everything seemed to be settled, the IRS sued UBS in Miami to obtain confidential information on 52,000 US account holders. This prompted the Swiss Government to step in because such communication would violate the laws of Switzerland and threatened to seize that information.

Eventually, the US and Swiss Governments came to a settlement whose terms remain secret, but seems to include the disclosure of a few thousand account holders and the case was sent for arbitration to the US regulator, FINRA. UBS and the Swiss Government will communicate information on 4,550 more accounts. Further changes to the Swiss banking secret regulations were agreed, but I would be very surprised if they were approved by the Swiss voters. (Such changes are submitted to the "votation" that takes place at least once a year in Switzerland.)

At the core of this lawsuit lies a much broader issue: the United States has behaved intrusively and has shown little respect for Swiss sovereignty. When I studied law (yes, I am a non-practicing lawyer as well) one of the key principles of international private law was the territoriality of law. The same applies to Governments' taxation powers. In the last few years, the United States has shown a growing tendency to ignore those principles and to exert its authority beyond its borders.

A recent example was the Sarbanes Oxley Act of 2002. While there was no reason to extend its application to foreign stocks, fears that U.S. companies would migrate to offshore centers led lawmakers to violate the principles of international law. I was in charge of the foreign companies listed on the NYSE at that time. It took a year to ensure that the SEC would apply this act in a way that would not create a conflict of law. Companies, even if they are listed in the United States, are first and foremost regulated by their national authorities. However, nothing could be done to prevent a wave of delistings of foreign companies from the United States. The net loser was the United States capital markets themselves. Sarbanes-Oxley gave a huge boost to the City of London, which became the place of choice for foreign listings.

Tax shelters have become a hot topic in international politics. President Sarkozy, Prime Minister Brown and Chancellor Merkel decided to make offshore tax shelters a key issue in the G20. The U.S. reluctantly followed course, not because they are indifferent to tax evasion, but because they know that no international venue can do anything in this matter. The issue merely offered a convenient opportunity for the Europeans to point fingers outside of their borders. The decision was taken to insolate those tax shelters that, according to the OECD, were on the black list. Three months later, it was announced that no country in the world is on that blacklist any longer. They all had "taken measures" to apply the OECD principles.

While I condemn tax fraud as illegal and immoral, I do not believe that the United States has the right to extend its tax arm beyond its borders. This attitude is most unnerving even to our allies. The IRS is empowered and entitled to prosecute U.S. tax frauds and U.S. taxpayers, not to pursue changes in foreign rules and regulations or to threaten foreign financial institutions (unless they commit such frauds).

There are legitimate reasons to limit taxation powers to national borders. Imagine the reverse: taxes would be levied on individuals and companies worldwide in a completely disorderly way. All countries negotiate tax rulings or rebates to attract foreign investors. Taxation is a global competitive weapon. They need to feel confident that international legal norms and national sovereignty will be respected.

It is also not in the interest of the United States to disrupt international tax laws. The fact that New York has lost its global capital market leadership is not favorable to the country. Those activities are taxed and produce substantial IRS revenues. Delistings have hurt U.S. tax revenue. Ask Mayor Bloomberg how he would balance its budget without the taxable revenues of foreign companies and employees in New York.

Last but not least, it is a question of respect: sovereign states are sovereign states. They deserve to see their sovereignty recognized. The Swiss Government candidly admitted today that they accepted this unprecedented move to avoid a sovereignty conflict with the United States.

The IRS statement that it is a "historic agreement" says it all. Diplomacy, not the assertion of tax powers abroad, is the way to address international tax issues. This settlement is a shame for all parties: the US Treasury for having exercised its power rather than its right to force that settlement that does not respect the basic principles of international private law. The Swiss Government for having opened the way for future such investigations and bent its own laws under U.S. pressure. UBS betrayed their customers who trusted their advice to rescue their U.S. knowing that the IRS will seek imprisonment. There is no winner when fundamental rule of law and customer loyalty are not respected. This will have major ramifications outside of Switzerland and the United States.

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