Tax Information Exchange (TIEA): an Opportunity for Latin American to Clawback Its Capital Flight Back from America?  Perhaps even Switzerland?

This blogticle is a short note regarding the potential risk management exposure of US financial institutions’ exposure to a UBS style strategy being employed by foreign revenue departments, such as that of Brazil, and Switzerland.  Of course, such foreign government strategies can only be productive if US financial institutions are the recipient of substantial funds that are unreported by foreign nationals to their respective national revenue departments and national reserve banks, constituting tax and currency/exchange control violations in many foreign countries. 

The important issue of Cross Border Assistance with Tax Collection takes on more relevance when foreign governments begin seeking such assistance from the USA Treasury in collecting and levying against the hundred thousand plus properties purchased with unreported funds, and whose asset value may not have been declared to foreign tax authorities where such reporting is required in either the past, or the current, tax years.  

In the 15 week online International Tax courses starting September 14, we will be undertaking an in-depth analysis of the topics covered in this blog during the 10 online interactive webinars each week.

Tax Elasticity Of Deposits

In the 2002 article International Tax Co-operation and Capital Mobility, prepared for an ECLAC report, from analysing data from the Bank for International Settlements (“BIS”) on international bank deposits, Valpy Fitzgerald found “that non-bank depositors are very sensitive to domestic wealth taxes and interest reporting, as well as to interest rates, which implies that tax evasion is a determinant of such deposits….”[1]  Non-bank depositors are persons that instead invest in alternative international portfolios and financial instruments. 

Estimating How Much Latin American Tax Evasion are US Banks Involved With?

Within two weeks I will post a short blogticle that I am preparing regarding an estimated low figure of $300B capital outflow that has begun / will occur from the USA pursuant to its signing of a TIEA with Brazil.  Some South Florida real estate moguls have speculated that this TIEA has played a substantial role in the withdrawal of Brazilian interest in its real estate market, which has partly led to the sudden crash in purchases of newly contrasted condominium projects.  

Three historical benchmarks regarding the imposition of withholding tax on interest illustrate the immediate and substantial correlation that an increase in tax on interest has on capital flight.  The benchmarks are (1) the 1964 US imposition of withholding tax on interest that immediately led to the creation of the London Euro-dollar market;[2] (2) the 1984 US exemption of withholding tax on portfolio interest that immediately led to the capital flight from Latin America of US$300 billion to US banks;[3] and (3) the 1989 German imposition of withholding tax that led to immediate capital flight to Luxembourg and other jurisdictions with banking secrecy[4].  The effect was so substantial that the tax was repealed only four months after imposition.

The Establishment of London as an International Financial Center

The 1999 IMF Report on Offshore Banking concluded that the US experienced immediate and significant capital outflows in 1964 and 1965 resulting from the imposition of a withholding tax on interest.  Literature identifies the establishment of London as a global financial centre as a result of the capital flight from the US because of its imposition of Interest Equalisation Tax (IET) of 1964.[5]  The take off of the embryonic London eurodollar market resulted from the imposition of the IET.[6]  IET made it unattractive for foreign firms to issue bonds in the US.  Syndicated bonds issued outside the US rose from US$135 million in 1963 to US$696 million in 1964.[7]    In 1964-65, the imposition of withholding tax in Germany, France, and The Netherlands, created the euromark, eurofranc and euroguilder markets respectively.[8]  

The Establishment of Miami as an International Financial Center

Conversely, when in 1984 the US enacted an exemption for portfolio interest from withholding tax, Latin America experienced a capital flight of $300 billion to the US.[9]  A substantial portion of these funds were derived from Brazil.  In fact, some pundits have suggested that Miami as a financial center resulted not from the billions generated from the laundering of drug proceeds which had a tendency to flow outward, but from the hundreds of billions generated from Latin inward capital, nearly all unreported to the governments of origination.

The Establishment of Luxembourg as an International Financial Center

In January of 1989, West Germany imposed a 10% withholding tax on savings and investments.  In April it was repealed, effective July 1st, because the immediate cost to German Banks had already reached DM1.1 billion.[10]  The capital flight was so substantial that it caused a decrease in the value of the Deutsche mark, thereby increasing inflation and forcing up interest rates.  According to the Financial Times, uncertainty about application of the tax, coupled with the stock crash in 1987, had caused a number of foreign investment houses to slow down or postpone their investment plans in Germany.  A substantial amount of capital went to Luxembourg, as well as Switzerland and Lichtenstein.

Switzerland’s Fisc May Come Out Ahead

Perhaps ironically given the nature of the UBS situation currently unfolding, a Trade Based Money Laundering study by three prominent economists and AML experts focused also on measuring tax evasion uncovered that overvalued Swiss imports and undervalued Swiss exports resulted in capital outflows from Switzerland to the United States in the amount of $31 billion within a five year time span of 1995-2000.[11]  That is, pursuant to this transfer pricing study, the Swiss federal and cantonal revenue authorities are a substantial loser to capital flight to the USA.  The comparable impact of the lost tax revenue to the much smaller nation of Switzerland upon this transfer pricing tax avoidance (and perhaps trade-based money laundering) may be significantly greater than that of the USA from its lost revenue on UBS account holders.  Certainly, both competent authorities will have plenty of work on their hands addressing the vast amount of information that needs to be exchanged to stop the bleeding from both countries’ fiscs.

Let me know if you are interested in further developments or analysis in this area.  Prof. William Byrnes (www.llmprogram.org)

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[1] International Tax Cooperation and Capital Mobility, Valpy Fitzgerald, 77 CEPAL Review 67 (August 2002) p.72.

[2] See Charles Batchelor, European Issues Go from Strength to Strength: It began with Autostrade’s International Bond in 1963, The Financial Times (September 25, 2003) p.33; An E.U. Withholding Tax?

[3] Globalisation, Tax Competition, and the Fiscal Crisis of the Welfare State, Reuven Avi-Yonah, 113 HVLR 1573, 1631 (May 2000).

[4] Abolition of Withholding Tax Agreed in Bonn Five-Month-Old Interest Withholding To Be Repealed, 89 TNI 19-17.

[5] See Charles Batchelor, European Issues Go from Strength to Strength: It began with Autostrade’s International Bond in 1963, The Financial Times (September 25, 2003) p.33; An E.U. Withholding Tax?

[6] 1999 IMF Offshore Banking Report  p.16.

[7] 1999 IMF Offshore Banking Report  p.16-17.

[8] 1999 IMF Offshore Banking Report  p.17.

[9] Globalisation, Tax Competition, and the Fiscal Crisis of the Welfare State, Reuven Avi-Yonah, 113 HVLR 1573, 1631 (May 2000).

[10] Abolition of Withholding Tax Agreed in Bonn Five-Month-Old Interest Withholding To Be Repealed, 89 TNI 19-17.

[11] Maria E. de Boyrie, Simon J. Pak and John S. Zdanowicz The Impact Of Switzerland’s Money Laundering Law On Capital Flows Through Abnormal Pricing In International Trade Applied 15 Financial Economics 217–230 (Rutledge 2005).