Substance over form A

Saturday, 01 October 2011
A review of recent Swiss cases on the definition of 'Beneficial owner'

The Swiss banking sector has experienced more downs than ups in recent years, not least the highly controversial ‘UBS affair’ where the Internal Revenue Service (IRS) overcame the bulwark of Swiss banking secrecy in an unprecedented campaign to obtain the names and account records of thousands of US taxpayers with unreported foreign bank accounts at UBS. People in Switzerland are likely to use more colourful terms such as UBS-Schlamassel, -Skandal,-Super-GAU, or half-jokingly say it even amounts to a Steuerbetrug (German for ‘tax fraud’) on the Swiss taxpayers themselves, who ultimately pick up the cost to the nation. This is no small irony. The definition (or, rather, presumption) of ‘tax fraud or the like’ agreed upon between the US and Switzerland as sovereign states, and the interpretation by the Swiss courts in a series of recent cases of the determining criteria – notably that of‘beneficial owner’ or ‘beneficially owned–are examined in this article.

UBS background

Key events in the chronology were:

June 2007

Former Geneva-based UBS private banker Bradley Birkenfeld, a US citizen, blows the whistle on his employer to US agencies.

June 2008

The IRS issues a ‘John Doe summons’, seeking information from UBS about US taxpayers using Swiss bank accounts to evade federal income taxes.

February 2009

To escape criminal indictment, UBS agrees to pay a USD780 million fine and, backed by an ‘emergency’ order from FINMA, the Swiss Financial Market Supervisory Authority (later declared unlawful), to divulge to the IRS the names of US account holders.

August 2009

In view of the risk that the country’s largest bank may lose its US banking licence, the Swiss government enters into a special tax agreement with the US, dealing with the process for the exchange of information relating to 4,450 UBS accounts over a 360-day period (the 2009 Tax Information Exchange Agreement (TIEA)).

‘Tax fraud’

The three-page annexe to the 2009 TIEA states that the US clients of UBS need not be identified by name but by defined criteria, including US persons (irrespective of their domicile) who ‘beneficially owned’ ‘offshore company accounts’ established or maintained between 2001 and 2008 where there is a reasonable suspicion of ‘tax fraud or the like’, in turn defined as a reasonable suspicion that the US ‘beneficial owners’ engaged in either:

(a) activities presumed to be fraudulent conduct, including those that led to a concealment of assets and underreporting of income based on a ‘scheme of lies’ (defined below), or incorrect or false documents, except where the account stayed below the threshold of CHF250,000; or

(b) continued and serious tax offences, specifically those which generated unreported revenues of more than CHF100,000 on average per annum over any three-year period, including at least one of the years 2001–2008.

Nowhere in the 2009 tax information exchange agreement between switzerland and the us is the concept of “beneficial owner / beneficially owned” explicitly defined; a fatal flaw

Nowhere is the concept of ‘beneficial owner’/‘beneficially owned’ explicitly defined; as will be seen, a fatal flaw. Also, para 1 of the annexe introduces ‘non-operating’ as a qualification to ‘offshore companies’. As for ‘scheme of lies’, this is helpfully expanded on as:

‘Such “scheme of lies” may exist where the Bank’s records show that “beneficial owners” continued to direct and control, in full or in part, the management and disposition of the assets held in the offshore company account or otherwise disregarded the formalities or substance of the purported corporate ownership (i.e. the offshore corporation functioned as nominee, sham entity or alter ego of the US “beneficial owner”) by: (i) making investment decisions…; (ii) using calling cards/special mobile phones…; (iii) using debit or credit cards… for the payment of personal expenses…; (iv) conducting wire transfer activity or other payments from the offshore company’s account to accounts… held or controlled by the US “beneficial owner” or a related party…; (v) using related entities or persons as conduits or nominees to repatriate or otherwise transfer funds…; or (vi) obtaining “loans” to the US “beneficial owner” or a related party… These examples are not exhaustive 1.’

The problem with these suggestive criteria was: how could the special administrative assistance task force set up by the Swiss Federal Tax Authority (SFTA) to evaluate the 4,450 UBS accounts by 31 August 2010 be expected to distinguish between outright tax cheats (such as the UBS clients named on the IRS and US Department of Justice websites following their indictment and conviction) and honest, law-abiding US persons with discretionary foreign trust structures, in some cases complex, tax-advised ones, where assets had been placed in good faith, and not hidden, with UBS?

Swiss cases

An initial key breakthrough was a decision of the Federal Administrative Court (FAC) of 10 January 2011 2. An American woman appealed against the SFTA’s order to disclose to the IRS the bank records for a Liechtenstein foundation’s account of which she had been named as ‘beneficial owner’ in the form A 3.provided to UBS. Although the appeal was rejected, the case is nevertheless a cause célèbre due to the FAC’s analysis of the concept of ‘beneficial owner’/‘beneficially owned’ in respect of an offshore company’s account and the court’s findings, drawing in particular on footnote 3 to the annexe, that:

    • regard must be had to the economic reality (‘substance over form’)
    • the decisive factor is whether and to what extent the US person was able to continue to control and have a power of disposition over the account assets and revenue
    • this is a question of fact in each case, with the criteria or indicia to be applied being dependent on the particular (legal) form of offshore company used (the FAC went on to enumerate several indicia/criteria relevant to a (Liechtenstein) foundation)
    • the US person beneficially interested in the offshore company can be seen as beneficial owner of the UBS account if she could materially influence the timing and extent of distributions to her;
    • the onus is on the US person to rebut ‘clearly and conclusively by means of documents’ the SFTA’s presumption of ‘beneficial ownership’, by demonstrating either that she was wrongly named in the bank forms as ‘beneficial owner’ of the account, or that at no time during 2001–2008 did she have the economic power of disposition and control over the account assets and income4.

How could the special administrative assistance task force be expected to distinguish between outright tax cheats and honest, law-abiding US persons with discretionary foreign trust structures?

The FAC also interpreted ‘offshore company accounts’ widely as bank accounts of any legal entity or legal arrangement capable of having a customer relationship with a financial institution or of holding property, thus encompassing foreign law trusts and foundations.

One month later, the FAC neatly summarised its earlier decision in a second, rather tenuous case 5 involving a Liechtenstein foundation. After the death of the initial beneficiary, the US person was the sole beneficiary named in the foundation by-laws, was receiving yearly distributions of 5 per cent of the foundation’s capital and income for life since 2005 and had been declared as ‘beneficial owner’ in the form A. Notably, the foundation council had written to UBS about the form A, stipulating that the ‘beneficial owner’ was not to be given information about the amount of the assets, was not entitled to give investment instructions and the like, and could not make withdrawals unless the foundation council was notified of the amount in advance and approved it.

The FAC took into account other factors, including provisions in the foundation articles that distributions to beneficiaries were entirely within the council’s discretion, that distributions for charitable purposes were also possible and that the foundation benefit was inalienable, non-hereditary and not encumbered. The FAC held that the US person was not entitled to exert influence, whether directly or via the foundation council, over the UBS account, as confirmed by the absence of any indication to the contrary in the bank records. Thus the court ruled that the US person could not be deemed the ‘beneficial owner’ of the foundation’s account.

It was evident that even more persuasive arguments could be advanced in respect of a discretionary trust. An opportunity presented itself in February when the FAC quashed an SFTA decision on procedural grounds (violation of the right to be heard)6 and sent the matter back to the SFTA, allowing all three affected parties (the US person, the trustee of a fully discretionary trust and an Isle of Man hybrid company) to make submissions. The following arguments were advanced by the trustee:

  1. No mandate relationship existed between the US person and the trustee; moreover the trust instrument was a unilateral declaration of trust to which the US person was not a party.
  2. This was an irrevocable discretionary trust with an independent professional trust company as trustee, which was empowered by the trust instrument to exercise its own discretion and had in fact always done so.
  3. Neither the US person nor a related person could amend the terms of the trust.
  4. She was not sole beneficiary during her lifetime with a nominated successor in the event of her death.
  5. Nor was she the beneficiary of last resort.
  6. She was not the trustee or the protector.
  7. She had no signing authority on the trust’s bank account.
  8. She was not a member of the class of capital beneficiaries (her lawful descendants), i.e. she had neither a right to, nor even any prospect of, a capital distribution.
  9. She was just one (albeit the only one named) of the class of possible income beneficiaries (together with her lawful descendants) and, the trust being fully discretionary, had no legal right to either a single or a recurring distribution of income.
  10. The UBS records contained no indication that she had ever received a payment or that she had ever contacted the bank.
  11. The trust instrument provided that all capital and income should not, until actual distribution, vest in a beneficiary nor be liable to attachment, execution or sequestration.
  12. It also stipulated: ‘No beneficiary shall have any claim, right or entitlement whatsoever to any part or parts of the trust fund or the income thereof except only to the extent that same may arise by virtue of any power of appointment herein contained or by virtue of exercise of the trustee’s powers [in respect of income and capital] in favour of such person.’
  13. In 2004, the trustee resolved to close the trust account and, in exercise of its discretion, directed that the entire remaining trust fund be distributed to one of the capital beneficiaries.

The ruling of the federal administrative court on 18 March 2011 suggests that Swiss courts might not be favourable towards an alleged “beneficial owner” who has a fixed life interest under a trust

Meanwhile the FAC had occasion, in March, to consider an irrevocable discretionary trust in another appeal case 7, and ruled as follows:

  • The beneficiaries (whether ascertained or ascertainable) of a trust are its ‘equitable owners’. Nonetheless, at no time do they have a right to administer, or dispose over, the trust assets.
  • If the trust is discretionary, the beneficiaries acquire ‘equitable ownership’ only when the trustee exercises its discretionary power and, until then, have merely an expectancy, i.e. a kind of future and uncertain interest that manifests itself through the exercise of the prerogatives given to the trustee8.

One factor highlighted by the FAC was that the trustee had no obligation to distribute income on a continuing basis but was free – with the consent of the protector – to accumulate the income. This suggests that Swiss courts may not be so favourable towards an alleged ‘beneficial owner’ who has a fixed life interest under a trust.

The FAC found that the trust beneficiary, although indicated in the form A in 1998 as the ‘beneficial owner’ of the assets in the trust’s UBS bank account, was, in fact, not, and accordingly refused administrative assistance to the IRS.

Form T

The FAC felled another appeal decision in March 9 which differed slightly because the form A had been replaced with a form T (declaration for organised associations of individuals, assets or patrimony without specific beneficial owners) 10. Since 2008, form T, rather than form A, is the correct declaration for Swiss bank accounts for an irrevocable discretionary trust (as well as for an underlying company of such a trust) 11. In the end, the court considered the presumption of ‘beneficial owner’ had been rebutted irrespective of the form T, which it noted had been supplied only in February 2009, several months after the issue of the ‘John Doe summons’ against UBS. It is therefore unclear what weight a Swiss court or the SFTA might attach to a form T in other circumstances.

Unreported case

After a lengthy lead-up, including reference to the preceding FAC decisions, the SFTA conceded and this time refused administrative assistance to the IRS in respect of the UBS accounts of both the discretionary trust and the Isle of Man hybrid company, simply observing that:

  • the trust was irrevocable and discretionary (pointing to the particular stipulation in item 12, above)
    • the trustee was a trust company in Switzerland
    • the US person had no signing authority on the account or on behalf of the trustee
    • there was no indication in the bank records that the US person had ever instructed the trustee with regard to the trust income (not that such power existed anyway);
    • nor had the US person received any sum during the period in question.

    Likewise, a single paragraph dealt with the hybrid company, the SFTA relying on bare essentials: the US person had neither possessed signing authority, nor given instructions to the bank, nor received any payment. The SFTA made no mention of the more intellectually challenging control argument based on the two co-existing classes of membership (non-voting guarantee members versus shareholders with voting rights), nor did it see the need to consider any of the other heads of argument made by the respective parties.

    Quo vadis?

    Whether this discretionary trust anomaly will last in the context of Swiss tax treaties depends partly on the reaction of the Organisation for Economic Cooperation and Development (OECD). Noting that the concept of ‘beneficial owner’ found in articles 10, 11 and 12 of the OECDModel Tax Convention has given rise to different interpretations by courts and tax administrations, and given the risks of double taxation and non-taxation arising from these different interpretations, the OECD launched a public consultation between 29 April and 15 July 2011 on the interpretation of the term ‘beneficial ownership’ in double taxation treaties. Comments (including those of STEP) will be examined in September 2011 by the OECD working party. Watch this space.

  • 1. Annexe to the 2009 Tax Information Exchange Agreement, footnote 3.
  • 2. In German: Urteil des Bundesverwaltungsgerichts A-6053/2010 vom 10 Januar 2011.
  • 3. ‘Declaration of Identity of the Beneficial Owner’, required to be provided by so-called ‘domiciliary companies’ under article 4 of the agreement on the Swiss banks’ code of conduct with regard to the exercise of due diligence (CDB08).
  • 4. A-6053/2010, in 7.3 to 8.1.
  • 5. In German: Urteil des Bundesverwaltungsgerichts A-5974/2010 vom 14 February 2011.
  • 6. In French: Arrêt du Tribunal administratif fédéral A-7710/2010 du 11 février 2011.
  • 7. In French: Arrêt du Tribunal administratif fédéral A-7013/2010 du 18 mars 2011; also published on www.trusts.ch
  • 8. A-7013/2010, in 6.1 and 6.3.2.
  • 9. In French: Arrêt du Tribunal administratif fédéral A-6903/2010 du 23 mars 2011.
  • 10. CDB08, article 4, point 43.
  • 11. See David Wallace Wilson, Le Trust, Janus de la réglementation bancaire: Formulaire A ou formulaire T in Schulthess, Les enjeux juridiques du secret bancaire, Actes du colloque de l’ILCE, p125ff; also available on www.trusts.ch.
Author block
Right
Jason Lofts

Jason Lofts TEP is Director and Head of Risk and Compliance at Investec Trust (Switzerland) SA, Geneva.

The content displayed here is subject to our disclaimer. Read more