Liability of the Banker and Automatic Exchange
The forthcoming entry into force of the Standard for Automatic Exchange of Financial Account Information (denoted CRS) raises the question of the possible liability of banks if the data transmitted by the bank to the recipient State were to be inaccurate. In fact, the foundation of the system consists of an enormous classification system at the expense of the banks. They will assign each account number with one or more countries for receiving information. The assignment of an account to a recipient country depends on the tax domicile of the account holder. For this system of exchange to work, it is essential that all banks of each member country of the trading system are capable of making such identification.
At first glance, the process appears simple. It is important to note, however, that the bureaucrats of the OECD, that are behind this administrative whim, had to concoct several hundred pages of regulations to handle this issue. This big construction included three international conventions: the CRS Multilateral Competent Authority Agreement (M-CAA), the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (CAAMF), and its Annex NCD (the common standard on reporting and due diligence for financial account information). All these texts are supplemented by their abundant administrative commentaries, which bind Switzerland. Additionally, they are augmented by Swiss legislation including, law on the automatic exchange of information and its ordinance, as well as law on administrative assistance on tax and its ordinance, the money laundering ordinance issued by FINMA and the Swiss Bank’s Code of Conduct 16 and its commentary.
In light of this regulatory abundance, banks might think that scrupulously running all instructions within this legislative framework constitutes correct practice. In an ideal world, banks would proceed with the specification of the accounts on the basis of a unique and universal document; that would be the absolute goal of the CRS. When opening an account, the banker would fill out a suitable form, based on proof of identity that would attest the tax residence of its holder. In the real world, such a document does not exist. More generally, the ability of a banker to know at any time and with absolute certainty where the account holders are in fact residing is of its very nature an extremely difficult task. Yet only this knowledge would allow the CRS to function effectively.
To try to achieve this goal, OECD officials devised a vast sequence of procedures to resolve various practical questions they identified as obstructing the effectiveness of the CRS. Since the exchange takes place annually, does that mean that every year a new proof of residence should be requested from each account holder? If the account holder lives in a country that does not have any form of universal tax identification number (TIN), what evidence of taxation should be demanded? If the account holder proclaims a tax address in a country where he does not live, how is the deception to be discovered? What country should data be sent to if the account holder is a Panamanian company with four shareholders, each living in a different country? Is a self-certification attesting the account holder’s residence enough? How is an address to be determined if it does not appear on the passport of the account holder, as is the case in Switzerland?
OECD officials identified this problem. For this reason, the exact title of the CRS contains firstly the term « common reporting, » but also « due diligence ». Due diligence here, refers to the bankers’ duty to collect the relevant information necessary for the operation of the CRS. Therefore, the task of the banker is to collect and report the relevant data, but also to apply to this process reasonable diligence in ensuring the accurateness of the data.
What amount of care must be taken by the banker in checking the account holder’s tax residence in order to satisfy the requirements of due diligence? Do the authorities expect bankers to adopt a more proactive attitude in order to determine, beyond the appearance created by the paperwork, what is the actual tax domicile of each of its clients, or is the formal procedure described above satisfactory? If formalism is enough, the attitude of the banker will be perfect as long as he has scrupulously gathered the documents prescribed by the provisions of the CRS. If the actual fiscal domicile of the customers is to be required the burden on the banker will be heavier. Hence, it will be more critical to assess the quality of information collected during the account opening process. The banks will be required to make further inquiries into their customers’ lives necessitating further questions to be answered by the account holders. Otherwise, they would run the risk of transmitting incorrect information, which could potentially cause harm to the recipient states. These states could then turn against the banks to try to recover the amount of taxes evaded by the clients, as was the case against the US IRS . The problem with the system that is due to come into force is that it does not take a clear position on this alternative.
We believe, however, that the banker’s liability should be limited and the CRS should not impose excessive diligence from the banks that is outside the scope of the individual bankers’ jobs. Otherwise, the system in place would implode. A prudent banker, who is not aware of his potential liability must assess his financial risk and cover it by making accounting provisions for potential tax liability. If we take the (imaginary) example of a local bank, which manages 440 billion in assets, it could be guessed that 10% of its accounts would be miscategorized. This would mean than 44 billion are not reported in the right country, and therefore not taxed correctly. This amount could generate an average wealth tax rate of 0.5%, approximately CHF 220 million in taxes. In terms of income tax, these CHF 44 billion could generate a return of 5% taxed at an average rate of 20%, equating to CHF 440 million evaded in income tax. On the basis of this calculation, this prudent banker, remembering recent experiences overseas, would annually set aside a sum of CHF 660 million. Additionally, it could be estimated that the average statute of limitation term of tax claims is five year. Taking this into account, the banker would have to set aside further reserves of CHF 3.3 billion, caused solely by the CRS. If this (not so) imaginary local bank had 2.6 billion of equity, it would have to file for bankruptcy four years after the entry into force of the law…
A somewhat cynical reasoning, however, leads me to think that the States, except FINMA who dreams of a country without banks because it is easier to monitor, does not desire the death of the banks. Indeed, the purpose of the CRS is to improve the efficiency of tax collection. However, tax collection is also a means by the state to pocket citizens’ money on a yearly basis. However it is easier for tax authorities to knock on the doors of 250 banks in Switzerland to ask them to do the work instead of the state agents. The bank will submit easily to the prompt that the legislation has constrained them, limiting them to the point at which they lose their freedom and the banker would not give an excuse not to comply. In these circumstances, the interest of the state is not to structurally cause the bankruptcy of banks, because they are so convenient to finance the State, as the banks concentrate the wealth of citizens in their vaults. The state holds the bankers to account by the criminal law, so that it can force them to pay taxes with the money of their depositors.
In conclusion, the State may not want to cut the branch on which it sits by excessively increasing the potential liability of the banks so as to weaken them financially and cause them to go into liquidation. It cannot therefore seek to overstretch the banker’s liability. His responsibility will be limited to a formal obligation to collect the information prescribed for by the CRS.