Trouble in Paradise Berlin Takes on the Tax Havens

The German government is applying pressure on offshore tax havens. It is also taking action against German banks operating in Switzerland, where they maintain accounts for shadowy Liechtenstein foundations. In a time of economic crisis, Berlin needs all the tax euros it can get.
Von Beat Balzli, Markus Dettmer und Nana Gerritzen

Martin Maurer remembers that fateful gray November day all too well. Maurer runs the Association of Foreign Banks in Switzerland from his office above an upmarket men's clothing store only a stone's throw from Zurich's exclusive Bahnhofstrasse. The organization represents the interests of more than 150 financial institutions, 20 of them German.

On that day last November, Maurer received a number of calls from nervous fund managers, who were alarmed by a seven-page letter that Germany's Federal Financial Supervisory Authority (BaFin) had sent to all German banks with Swiss subsidiaries. The agency, based in Bonn, was asking unpleasant questions about an explosive subject. It wanted to know how many accounts the Swiss subsidiaries were managing for foundations and trusts, and how many of these foundations were headquartered in the tiny principality of Liechtenstein, which is famous as a tax haven. 

The letter "was worded unclearly and not coordinated with the Swiss Financial Market Supervisory Authority," says Maurer. His concerns prompted him to meet with a few German members of his association 10 days later. The purpose of the meeting was to discuss how to interpret the BaFin letter, says Maurer, noting that the Germans "discussed how to respond."

The Bonn bank regulators, for their part, smelled a conspiracy and suspected secret agreements were being made. In mid-February, BaFin contacted several German banks with additional, more specific questions.

BaFin's unprecedented move is intended to apply pressure to banks as part of its fight against tax evasion. It is the discreet part of a two-pronged strategy with which Germany intends to overturn Switzerland's role as a tax haven as quickly as possible.

The public part of the campaign has been waged by German Finance Minister Peer Steinbrück over the past few months, who has made it into his personal crusade . On one occasion, Steinbrück threatened Germany's stubborn neighbor with the "whip," and on another he compared the Swiss to "Indians" who had apparently been successfully intimidated by the "cavalry." His attacks have routinely ruffled feathers in the diplomatic arena. Last week, the Swiss foreign minister summoned the German ambassador to her office and described Steinbrück's remarks as "unacceptable, aggressive and insulting." Steinbrück, for his part, has complained about threatening letters from Switzerland describing him as a "Nazi henchman."

The tone has turned ugly in the eternal battle between finance ministers and tax evaders. While the investment industry is constantly finding new ways to shelter its clients' assets from taxation, governments worldwide are proceeding against tax havens with almost unprecedented vehemence.

When the 20 leading industrialized and emerging nations, the G-20, meet in London next week for the second world financial summit, a political project will be on the agenda that was already believed to have failed internationally: the fight against tax evasion and tax havens. Ironically, the global financial crisis  provides an opportunity, for the first time in years, to curb tax evasion worldwide.

Tax authorities have scored a number of successes in recent months. In February of last year, the spectacular raid of the offices of Deutsche Post and the home of its chief executive, Klaus Zumwinkel , who had evaded German taxation by transferring millions to a bank in Liechtenstein, brought the problem into focus.

After that, the United States, using political and economic pressure, cracked through the barrier of Swiss banking secrecy to obtain information on the accounts of US citizens who were customers of UBS , a major Swiss bank.

Governments worldwide discovered that there is a reciprocal relationship between tax havens and the fragility of the global financial system. In addition to protecting tax evaders, banking secrecy arrangements in offshore centers helped the banks escape the scrutiny of government regulators for at least some of their reckless lending practices.

Most of all, however, there is a perfectly mundane reason why the industrialized nations are upping the pressure on tax oases: With the global economic crisis worsening from month to month, finance ministers need the outstanding tax revenues from their citizens. A surfeit of bad economic news is taking government budgets beyond the pain threshold. In such dire economic times, tax evasion is treated as a felony and those who facilitate it in tax havens as accomplices.

The unfettered global movement of capital has made both corporations and the assets of private citizens more mobile. The Boston Consulting Group estimates that $7.3 trillion (€5.4 trillion) in personal wealth is held in offshore centers and tax havens, including about $2 trillion (€1.5 trillion) in Switzerland alone (see graphic).

The BaFin survey of 31 German banks, conducted on behalf of the Finance Ministry, revealed how often dubious arrangements are involved. With the aim of reviewing compliance with the obligation to exercise diligence against money laundering, Steinbrück's team wanted to obtain "an overview of the business relationships between the banks' subsidiaries and holdings in Liechtenstein and Switzerland and foundations established under Liechtenstein law and other nontransparent vehicles," a ministry spokesman confirmed.

Steinbrück's experts were amazed at the results. According to one insider, the banks reported that they maintained "accounts of at least several hundred Liechtenstein foundations" through their Swiss subsidiaries. The Swiss subsidiary of Deutsche Bank manages a large share of these accounts. The bank, like other banks with significant Swiss business, such as Commerzbank and its subsidiary Dresdner Bank, has refused to comment.

The results of the survey have already had consequences. The regulations on the obligation to exercise diligence were sharpened in the context of recent reforms to German bond legislation. Starting in April, banks will be required to instruct their subsidiaries to "terminate non-transparent business relationships," the ministry said. The goal is to put an end to German banks' dealings with shadowy Liechtenstein foundations. And to ensure that bankers are not tempted nonetheless, the finance ministry announced "special audits by BaFin."

On the Black List

But the pressure on the domestic financial industry alone is not enough to win the fight against tax havens. Last October, Steinbrück met with French Budget Minister Eric Woerth and 15 other government representatives from OECD countries in Paris. The OECD attendees proposed compiling a blacklist of uncooperative tax havens by the summer.

The threat to ostracize suspect territories like the Caribbean Turks and Caicos Islands by placing them on a tax haven blacklist triggered an unforeseen effect. To prevent such a blacklist and sanctions from being approved at the G-20 summit, even previously intractable financial centers have suddenly discovered an urge to promote openness in tax affairs. In addition to Liechtenstein and Switzerland, Hong Kong and Singapore announced in recent weeks that they intended to adopt OECD standards on the exchange of information. Luxembourg and Austria also plan to cooperate in the future.

Last Wednesday, a Swiss delegation paid an initial visit to the German Finance Ministry to discuss the issue, just as a group of officials from Liechtenstein had done a few days earlier. The Swiss told the German officials that if they wanted more information on tax matters in the future, they would have to approve an amnesty for existing customers. Steinbrück's staff has remained tight-lipped on the meetings, noting only that no plans have been made yet.

The Swiss demand is controversial in the German parliament. Gerhard Schick, the Green Party's spokesman on financial issues, considers such a condition unacceptable. "We cannot allow criminal acts to be rewarded after the fact with acquittals and interest earnings," he says. Edelgard Bulmahn, a member of parliament with the center-left Social Democratic Party (SPD), also objects to such concessions. "We must consistently fight tax evasion," says Bulmahn, the chairwoman of the Bundestag's Committee on Economics and Technology. "This is not a trivial offense but a criminal act."

SPD floor leader Peter Struck, on the other hand, does not categorically rule out an amnesty. "It important to us that we arrive at an adequate and sustainable solution with Switzerland," he says. "But if the Swiss government were to absolutely insist on a far-reaching amnesty for tax evaders, we would not be able to accept that."

The freshly erupted conflict over the amnesty demands shows how difficult the battle against tax havens is. The finance ministers are claiming spectacular successes, and yet they must ask themselves how sustainable their victories will be. Opponents are gearing up to offer resistance to, for example, planned legislation on fighting tax evasion. The philosophy of the draft bill, which Germany's grand coalition government of Merkel's Christian Democrats and the SPD intends to introduce this summer, is simple: If a government refuses to provide information, it will be up to the taxpayers to do so.

The authors of the legislation want to give the government the power to require citizens and companies doing business with uncooperative tax havens to provide detailed information to the tax authorities. In the future, the tax authorities would be able to demand sworn affidavits and powers of attorney from taxpayers, which would allow them to obtain information from foreign banks. Anyone who refused to cooperate could expect to face financial penalties.

Even though the draft legislation was already softened, it has had to be removed from the cabinet's agenda twice. The Economics Ministry has so far rejected the plan due to "fundamental concerns." It is also controversial among some members of the business wing of the Christian Democrat Union's parliamentary group.

If the legislation fails, pressure on the tax havens to change their practices will decline. This has happened many times in the past, when countries have repeatedly tried to take on the tax havens. These experiences have been more sobering than anything else.

The OECD has been taking action against unfair tax competition since 1998. It originally branded 41 countries as tax havens. Thirty-five soon disappeared from the list after agreeing to the OECD standards on the exchange of information, although few have actually implanted the standards to date.

In 2005, the political world celebrated the EU guideline on the taxation of interest income as a milestone. Since then, all interest payments by banks to foreigners are supposed to be reported directly to the tax authorities in their country of origin -- except it doesn't always happen that way in practice.

To protect their banking secrecy and their foreign clients, EU members Luxembourg, Austria and Belgium, as well as Switzerland and Guernsey, are entitled to impose an anonymous source tax on foreigners' accounts. But because it only covers a portion of the balances and assets, "the interest guideline is as full of holes as Swiss cheese," say officials at the Finance Ministry, "except in this case there are more holes than cheese."

The problem with tax evasion is that havens everywhere are booming and taxes can also be avoided on a grand scale legally. "Tax evasion has become old-fashioned," says Jürgen Schneider, a Hamburg expert on criminal tax law.

Legal tax tricks, such as Maltese holding companies, are becoming more common. A tax avoidance industry has blossomed in the small country for years, and even the German tax authorities have let it stand. Undisturbed by Steinbrück and other finance ministers, EU member Malta offers multimillionaires a tried-and-tested tax savings model.

"The assets are paid in to the subsidiary of a Maltese holding company," explains Munich tax expert Stefan Süss. The subsidiary's earnings are taxed, but then the taxes are reimbursed at the holding company level. "As a result, the earnings ultimately remain untaxed," says Süss.

Even if Switzerland, Singapore and the like were to permit the exchange of information, there will be a sufficient number of new avoidance models. And there is no urgency to the matter. "Most tax evaders still have enough time to clean up their unreported income situation," says tax law expert Schneider, noting that banking secrecy in tax havens "will only weaken gradually."

Translated from the German by Christopher Sultan
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