In the wake of the allegations that the world’s largest private bank, the Swiss UBS, assisted an unknown number of their American account holders to evade U.S. taxes, last week U.S. Internal Revenue Service officials revealed plans to tighten the rules of their so-called "Qualified Intermediary" (QI) program.
The little-noticed program has come under greater scrutiny amid a widening investigation into whether UBS misused the program to help American clients evade federal income taxes by non-reporting or using legal offshore entities such as trusts or family foundations.
Under the QI program foreign banks have held billions of dollars offshore for American clients without legally having to disclose their names to the IRS. In exchange, the banks promised to know who their clients are, withhold any taxes due on U.S. securities in their accounts and send that money to the IRS. More than 7,000 foreign banks are enrolled in the program and paid about $2 billion to the IRS last year.
Bankers as IRS Spies
In effect, the IRS, beginning in 2001, forced foreign banks and financial institutions into the unwelcome role of IRS informants, a.k.a. "qualified intermediaries" (QI). To put it plainly, just as American bankers were forced to spy on their customers under the terms of the Bank Secrecy Act and the PATRIOT Act, the QI program turned offshore bankers into spies on their U.S. clients, at least in certain defined situations.
Since the imposition of the QI rules U.S. persons holding U.S.-based investments purchased through their offshore banks did have a choice: 1) they could either have offshore banks report the American holdings to the IRS, or; 2) they could have the bank withhold a 30% tax on all interest and dividends paid to them. To avoid either event, the U.S. offshore account holder investor could (and we have recommended) not hold any U.S.-based investments through an offshore bank or financial institution. No U.S. investments -- no required reporting under the 2001 QI rules.
By comparison, foreign, non-U.S. investments held offshore by U.S. persons through an offshore financial institution until now have been exempt both from the QI reporting and the QI tax withholding rules.
Under the IRS Gun
The clear threat to offshore banks that underpinned the QI rules was the real possibility that an uncooperative foreign bank would be denied access to the entire American banking system, meaning they and their clients could not to do business with the major banking system of the world.
Barry Shott, a deputy commissioner of the IRS, claims that the agency since 2001 has halted the participation in the program by about 100 foreign banks that were accused of violating QI rules. But in my observation, far fewer banks were embargoed and those that were tended to be banks located in backwater places such as Vanuatu and the Solomon Islands where Russian criminal elements had established a financial presence.
U.S. Rule Imposed Worldwide
Bent on crushing possible offshore tax evasion, in effect the IRS imposed extraterritorial tax enforcement burdens on foreign nations and their banks. Banks were forced to meet IRS established anti-money laundering and "know your customer" standards in order to get the "QI" stamp of approval. Offshore banks that qualified in the eyes of the IRS received "approved status," meaning the 30% tax on U.S. source income did not need not be withheld on non-U.S. investments, plus reduced tax rates could be applied under terms of mutual double tax avoidance treaties with the U.S.
But IRS QI approval came loaded with onerous conditions that could end customer confidentiality for American offshore investors who didn't know how to apply the rules. It also gave the IRS leverage over foreign nations when demanding exchange of tax and other financial information, although those nations, such as Switzerland, Liechtenstein and Panama, that have strict financial privacy laws, legally were able to escape the worst anti-privacy parts of the QI rules.
Understand what happened. Under the high handed QI rules, cloaked in the guise of enforcement of U.S. tax laws and threatening to deny access to the U.S. financial system, the IRS demanded and got imperial approval of all foreign nations’ banking rules and reporting requirements.
Stop for a moment and think what the reaction of American banks (and of the IRS) might be if a foreign nation ordered them to follow strict rules imposed from abroad. It is to laugh!
Tough New IQ Rules?
IRS officials now say foreign banks will be required to determine whether their clients are United States persons, and to determined possible U.S. beneficial ownership of foreign corporations and trusts with bank accounts. If they are, then the bank must let the IRS know about the client and withhold taxes on dividends in the account at rates of up to 30 %. The IRS' Mr. Shott declined to say whether the new rules would be retroactive or only apply to new clients.
The IRS says it will soon allow foreign banks in the QI program to use third-party databases, such as those from credit reporting firms, to determine who their clients really are and what taxes they should pay.
Douglas H. Shulman, the I.R.S. Commissioner, said the goal of the coming QI changes "is to get a clear line of sight into the owners of the bank account, and to know where there’s fraud." Inherent in such an over reaching statement is the misguided IRS belief that everyone with an offshore bank account is engaged in tax evasion -- and that offshore banks have a duty to act as IRS informers.
Let me suggest that it is the duty of the American government to investigate and indict anyone suspected of violating laws -- on an individual case basis. It is not the government’s duty or right to coerce offshore bankers to act as IRS agents, or to presume tens of thousands of Americans legally engaged in offshore financial activity are therefore criminals.
Conflict of Laws
It remains to be seen how any new QI rules can be made to square with strict laws guaranteeing financial and banking secrecy in many nations, such as Switzerland, Liechtenstein, Andorra, Monaco, Singapore, Belize or Panama. Typically those laws make it a criminal act to reveal any information about bank account holders, foreign or domestic, unless order to do so by a court.
Offshore banks may be forced to choose between obedience to their home country laws, or to the grasping long arm laws of the IRS.
* There still are many legal ways to bank and save taxes offshore; I tell you Where To Stash Your Cash: Click Here. And if you're interested in Switzerland, Click here for Swiss Money Secrets.
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