In a world largely shorn of exchange control restrictions, it is generally lawful for an individual to maintain a bank account with an institution outside his country of residence. This does not, however, exempt the account holder from the obligation to declare any resultant interest income to the revenue authorities in his home country. The first of these propositions has proved to be popular; the second, perhaps inevitably, has been greeted with less enthusiasm.
The opportunities for evasion offered by such accounts have been further enhanced by the use of "linked" debit or credit cards. The holder can thereby make use of his funds without first having to transfer them to an onshore account, where they might fall under the gaze of the local revenue inspectors.
Unsurprisingly, governments take a very negative view of these arrangements. Many holders of offshore accounts are high net worth individuals and, as a result, the scope for revenue loss is very significant. The difficulty for the revenue authority lies in the fact that the declaration of interest derived from such accounts, whilst mandatory in legal terms, is effectively voluntary in practice. The authorities have no power to demand information from banks outside their jurisdiction; moreover, the laws of the well-known offshore banking centres include stringent confidentiality rules for the protection of depositors.
Governments have started to take action to counteract these perceived abuses. Since 2001, the US Internal Revenue Service has been using reports filed under the 1970 Bank Secrecy Act in an effort to detect the use of bank payment cards linked to overseas accounts, where these arrangements were being used as a means of concealing reportable income. In 2003, the Australian Crime Commission initiated "Operation Wickenby" which was prompted by the Australian Taxation Office and its concerns about suspicious tax haven transactions. Again, many of these schemes involved credit/debit cards which were charged to offshore accounts and thus remained opaque as far as the revenue authorities were concerned.
The European Union has also been alive to these problems. Following much controversy, the Savings Directive came into force in 2003, and required Member States to exchange information on interest income paid on non-resident accounts. The Directive seems to have had limited impact thus far, perhaps because it may have resulted in the movement of deposits to offshore banking centres beyond the geographical reach of the Directive, or perhaps because individuals have diverted their funds to other investments which are outside the scope of the Directive.
Against this background, the Revenue decided to use its powers under Section 20 of the Taxes Management Act 1970 in an effort to obtain information about certain offshore accounts and transactions effected through tax haven vehicles. The purpose of this Briefing is to examine the rulings which flowed from these initiatives, and their implications for international banks.
The Power to Demand Documents
Section 20 of the Taxes Management Act 1970 allows the Revenue to require any person to make available "...such documents as are in his possession and power and as contain, or may contain, information relevant to any tax liability to which the taxpayer is, or may have been, subject..." Since this is a wide-ranging power exercisable against persons other than the target taxpayer, Section 20 includes certain safeguards which are designed to ensure that any intended use of the power is legitimate. In particular, (i) the notice can only be given with the approval of a General or Special Commissioner and (ii) the Commissioner should only consent if he is satisfied that the use of Section 20 is justified in the circumstances of the case.
Generally speaking, a notice must name the taxpayer who is the subject of the inquiry. However, a notice may be given with respect to a class of taxpayers whose individual identities are not known but where (i) there are reasonable grounds for believing that they have not disclosed taxable income and (ii) the requested information is not readily available from another source.
Recent applications to the Special Commissioners to use these powers against a UK financial institution and two of its UK incorporated subsidiaries gave rise to two rulings. The first involved offshore accounts linked to credit cards whilst the second related to "stand alone" offshore accounts. In a separate development, a Section 20 application resulted in a notice directed to an investment bank which had acted as a broker in relation to share transactions effected by a tax haven company.
The Credit Card Ruling
The first ruling involved a request for information relating to credit cards issued by the bank but which had a sort code associating them with an offshore bank account - mostly in the Channel Islands or the Isle of Man. However, the relevant credit card transactions were processed in the UK.
The Section 20 notice sought the names and addresses of customers who had a UK address and a UK credit card which was associated with a non-UK account, together with details of the interest earned. Statistics produced by the Revenue suggested that a very small proportion of those known to hold an offshore account had declared any interest income from that source. As a result, the Special Commissioner decided that the Revenue's approach was legitimate and he sanctioned the issue of the Section 20 notice. The credit card ruling thus, in some respects, followed the earlier initiatives by the US and Australian tax authorities in this sphere.
Whilst the decision makes a passing reference to the duty of confidentiality which the bank owed to its customers, the point is not pursued in any detail. The issue did, however, achieve a marginally greater prominence in the second ruling.
The Offshore Account Ruling
The second ruling takes matters a step further, and is perhaps most likely to be a cause of concern to international banks.
Once again, the Section 20 notices were directed to a UK bank and to two, named subsidiaries. However, the notices were unconnected with the holding of credit cards. After various categories of customer had been excluded, the notices would require the bank to provide specific account details (including interest earned and the source of the deposit) for private companies and individuals who have a bank account outside the United Kingdom but an address within it. It may be anticipated that the notices would therefore embrace thousands of customers; this expectation is borne out by the Revenue's estimate that disclosure of the required information was likely to lead to the recovery of some £1,508 million in unpaid tax.
A variety of arguments were put forward in an attempt to resist the notices. For the purposes of this Briefing, however, the two connected issues are as follows:
a) were the requested documents in the "possession or power" of the bank; and
b) if so, were they protected from disclosure by the banker's duty of confidentiality?
Possession or Power
A Section 20 notice can only compel the production of documents which are in the "possession or power" of the recipient of that notice.
It was argued for the bank that the documents were not in its possession or power. The bank contracted to provide processing or other services to its overseas subsidiaries, subject to an obligation of confidentiality. The information was held "...under the electronic equivalent of lock and key..." because only a limited number of employees had access to it.
These arguments were rejected by the Special Commissioner. He held that the relevant hard disk was in the possession of the bank, and that there were employees in the United Kingdom who held the passwords necessary to access the information stored on that disk. The information was thus in the "possession or power" of the UK bank for Section 20 purposes.
Duty of Confidentiality
It seems to have been only faintly argued that the provision of the requested information might expose the bank or its subsidiaries to civil claims or criminal prosecution in other countries. According to the Special Commissioner, the bank's advisers stated that "…it is a crime under the operative law in some foreign jurisdictions in which it operates to disclose documents relating to the accounts in that jurisdiction. I have no information about the operative law in those jurisdictions other than this assertion and, in any case, it is not obvious to me that such law is relevant to a notice given to a UK company to make available documents situated in the UK..."
The relevance of the point lies in the fact that:
a) disclosure of information relating to bank accounts will, in most jurisdictions, expose the bank to civil claims for breach of the duty of confidentiality. Indeed, in some jurisdictions (e.g., Switzerland and the Cayman Islands) criminal penalties may be incurred; and
b) as a result, there are grounds upon which the Special Commissioner could exercise his statutory power to vary or cancel the notice on the basis that it would be onerous for the bank to comply with it.
It is unfortunate that this line of argument seems not to have been pursued. The fact that the relevant account information has become available in the UK as a result of processing or outsourcing arrangements does not exempt the bank or its subsidiaries from compliance with confidentiality laws in other jurisdictions. The mere fact that disclosure was made under compulsion of UK tax laws will likewise not assist overseas bank branches or subsidiaries which become involved in foreign proceedings relating to accounts held outside the United Kingdom.
Even if the confidentiality argument had been pursued more vigorously, it is by no means certain that the bank would have succeeded in establishing that compliance would be onerous on that ground. Reflecting the British tendency to follow American trends, the decision is reminiscent of an order issued in 1984 by a District Court for the Southern District of New York, requiring Chase Manhattan Bank to produce documents held by its Hong Kong branch, in order to facilitate an IRS tax investigation. In that case, the Court held that the United States' interest in collecting tax outweighed Hong Kong's interest in its bank secrecy laws. There have been many other US decisions to similar effect. That said, the point certainly deserved more detailed consideration, especially since the Revenue is now likely to invoke the Section 20 procedure against other banks.
The Tax Haven Ruling
The final ruling involved a Section 20 application in relation to an investment bank in London. The institution had acted as a broker in share transactions effected for a company incorporated in the British Virgin Islands.
The Revenue obtained sanction for the issue of a Section 20 notice to the investment bank on the basis that the ultimate beneficiaries of the transactions were UK taxpayers and there were grounds for believing that income from these transactions had not been declared.
The legal difficulties which confront the investment bank in this case are probably less acute, in that any duty of confidentiality owed to the clients is probably governed by English law. There will thus be no breach of that duty where customer information is disclosed pursuant to a Section 20 notice. Nevertheless, the decision serves to emphasise the determination of the Revenue to attack the use of offshore accounts and tax haven vehicles as a means of concealing income.
Section 20 Notices and Banks
It may be that banks which receive Section 20 notices can take comfort from a variety of factors. First of all, customers who are found not to have evaded tax will suffer very limited losses as a result of the disclosure; indeed, they are unlikely ever to discover that the information was provided to the Revenue. Secondly, those customers who have evaded tax may have a valid claim for breach of confidentiality laws in the jurisdiction concerned, but no court is likely to view such a claim with great sympathy.
There may, however, be a minority of account holders who are approached by the Revenue but whose activities are ultimately found to be entirely legitimate. Customers in this category may be sufficiently aggrieved to start proceedings against the bank; even if they do not, the bank is perhaps likely to lose their business and this could be significant in some cases.
There is no doubt that compliance with Section 20 notices may expose banks and/or their foreign subsidiaries to civil proceedings and claims for damages in certain jurisdictions. In some countries, employees may even be exposed to criminal prosecution although, under the particular circumstances, such action is perhaps unlikely.
There are a few practical steps which an institution should take when the proposed issue of a Section 20 notice is intimated to it.
First of all, the bank must take some steps in an effort to defend the confidentiality of its customer information. It should endeavour to restrict the scope of the persons and information to be covered by the notice. If appropriate, it may have to challenge the notice on the basis that compliance would be onerous.
Secondly, it will need to take advice in the jurisdictions to which the notice relates, in order to determine whether it runs the risk of criminal or civil prosecution. In the case of claims for damages, the bank will need to ascertain the manner in which the compensation would be calculated. If the potential liability is significant, then this may add force to the argument that the notice should be set aside on the "onerous" ground.
Thirdly, and perhaps following consultation with the Revenue, it may be advisable to discuss the intended disclosure with the market regulator in the jurisdiction concerned. This may to some extent depend upon the nature of the relevant confidentiality law and the applicable penalties.
Fourthly, institutions may wish to re-examine their group outsourcing arrangements, given that any confidentiality undertaking can apparently be overridden by a Section 20 notice.
As noted above, it is anticipated that the Revenue intends to direct similar Section 20 notices to other UK financial institutions in due course. It remains to be seen whether any of the recipients will elect to challenge the notice and, if so, whether it will seek to argue the confidentiality issues in more depth.