John Doe summons means Swiss banks may have lost their mystique

On July 8th, the IRS met with several major accounting firms that have foreign offices - a group which is thought to include Ernst & Young, PricewaterhouseCoopers, KPMG, Deloitte, BDO Seidman and Grant Thornton - to solicit their help with the Qualified Intermediary program. That program began in 2000 and is designed to help the IRS track funds that may be secreted in foreign accounts.

Just days ago, a U.S. District Court Judge Joan A. Lenard gave the IRS authority to issue a John Doe summons to Zurich-based Union Bank of Switzerland, commonly known as UBS, to turn over information about U.S. taxpayers who use Swiss bank accounts to evade U.S. taxes. Taxpayers subject to U.S. tax law are required to report all financial accounts in foreign countries when the value of the account exceeds $10,000 at any time during the calendar year. Willfully failing to report such an account can result in a penalty of up to 50 percent of the balance of the account at the time of the violation, according to a Department of Justice press release.

This summons puts UBS in the crosshairs between the U.S. tax authorities and a Swiss law that prohibits banks from revealing the identity of accountholders without client permission. If successful, this could explode the traditional secrecy that those wishing to hide from U.S. tax law have traditionally found in Swiss bank accounts.

The John Doe Summons seeks information about U.S taxpayers who held accounts at UBS in the years 2002-2007. Part of the leverage that the U.S. has in seeking this information stems from a pact between the U.S. and Switzerland in 2001, wherein Switzerland agreed to report the citizenship of account holders and to require U.S. accountholders to fill out forms detailing the ownership for foreign accounts.

In June, former UBS official Bradley Birkenfield plead guilty to assisting an American billionaire and others avoid U.S. tax reporting requirements on income in Swiss bank accounts. Birkenfield created sham entities and through false reporting claimed that the hidden income was owned by those entities. He now says that UBS may be holding $20 billion in assets that represent unreported income by up to 20,000 U.S. taxpayers. This case is damaging to the reputation of UBS, which has been doing business in the U.S. since 1939.

Swiss banks are not the only foreign banks that the IRS is targeting. In February, the IRS announced it was initiating action against more than 100 individuals who may be holding secret bank accounts in Liechtenstein. The IRS and tax authorities in Australia, Canada, France, Italy, New Zealand, Sweden, and the U.K. are working together in a cooperative effort to ensure proper reporting of income and payment of taxes that arise from these foreign accounts.

A relatively low percentage of U.S. income flows through Qualified Intermediaries, about $36.6 billion, or 12.5 percent of total U.S. source income of $293 billion in 2003, according to the latest figures available. But this income could represent $300 million in unpaid taxes. The rest flows through U.S. withholding agents, who are allowed to take the word of accountholders concerning their identities without independent verification. QIs also agree to allow external auditor oversight of their transactions, which gives the IRS added assurance that they are properly withholding taxes.

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