Taxes: UK - Swiss tax agreement, what it means for UK Citizen and Europe (includes advice for UK non-doms)

Continuing news coming from the Euro zone keep us alert that the shocks that we have forecasted coming over the next few months are going to be on time.

As countries, especially European one are coming to terms with their mounting debts, the same are focusing more and more resources into uncovering and taxing financial resources that their citizen have traditionally kept in “safe” places such as Switzerland, Lichtenstein and Luxemburg.

It is therefore not surprising the latest news with regards to the UK/Swiss tax deal that was initialed on August 24, 2011. Please note that this deal follows a similar deal again between Switzerland and Germany initialed on August 10.

The concept is simple: both deals impose a withholding tax; the UK deal includes a withholding tax just below its top marginal tax rates of income, dividends and capital gains. The German deal includes a withholding tax rate of 26.375%, corresponding to its flat tax rate for income and capital. Both of these agreements include a one-off taxation between 19% and 35% depending on the value of the account at a specific point in time.

In essence: the Swiss authorities have agreed to tax the “illicit” funds held by UK and German citizen and share the proceeds while not divulgating the identity of account holders. In other words Swiss authorities will collect the taxes and remit them to the UK and German authorities. Please note that under the UK agreement there is a “one off” fee for UK citizen that want to retain their privacy.

Further note that according to these agreements the UK revenue service can request the details of up to 500 accounts per year versus the German agreement allows for up to 999 account requests per year.

For whoever is not familiar with this matter please note that the European’s Union Savings Directive (EUSD) in place since 2005 already includes provisions for a withholding tax. The latest unilateral moves by the UK and the German government with Switzerland are obviously moving away from the perspective of a concerted European Union effort, putting into question whether a EUSD is going to see revisions added very soon or whether given the current economic climate each country is going to move forward by itself in regulating its tax relationships with Switzerland. A recent comment by senior of officials of the HM Revenue & Customs (HMRC) to Accountancy Age

With regards to the UK: this latest agreement takes precedence over the EUSD. What does it mean for the investors? Well, savings will be taxed at 48%, but the agreement covers more than liquid assets and it includes: shares, commodities, interest, dividends or capital gains (27%) that are generated in Switzerland.

The commitment on sharing records by the number per year is also an important signal to keep in mind. Further, I am unclear on how the accounting system is going to be managed between the Swiss authorities that collect the information but don’t share them and the HMRC or German authorities that receive them.

The US approach

The US government has stepped up the pressure "on" the Swiss authorities but followed a separate path which is consistent with its quest for full disclosure.

The US made it clear that it has no interest in a deal including a withholding tax with Switzerland, it wants full disclosure of US citizen’s accounts instead.

The US Foreign Account Tax Compliance Act (FATCA) requires all banks to disclose information about accounts held by US citizen of businesses. Such Compliance Act is going to be unilaterally imposed on July 1, 2013. Foreign banks that don’t comply with the Act will face sanctions, including large financial liabilities that will affect their operations in the US (see USD denominated transactions). This follows the famous UBS inquiry by US government authorities, the investigation has been ongoing since 2007 and that forced UBS to disclose more than 4,500 customer names and received a settlement of $780M USD.

The US government puts pressure on foreign banks and its citizen alike. Recently a Federal appeal last week ruled out that the Fifth Amendment doesn’t apply to non-disclosure of offshore accounts. Please note that the Fifth Amendment gives US citizen the right to remain silent on issues that incriminate themselves.

Although there are serious doubts over the legality of FATCA, given its extraterritorial nature, it is clear that the USA have the necessary “might” to force the situation since banks, Swiss or not, have the necessity to operate in the US. Small boutique banks will have more latitude in their operation if they succeed in carving out niche markets for themselves.

Options for the UK non residents/domiciled or better called “Non Doms”

Many of the non-doms in the UK are American and their status is perhaps the most intriguing. Unlike UK domiciled individuals, non-doms are not necessarily taxed on their whole worldwide income. Therefore, if they wish to maintain the secrecy of the account, the one-off charge might not be appropriate, as it would be taxing income that is not subject to UK tax.

Because of this, the agreement makes specific provisions for them. They have the option to fully disclose or retain their privacy and pay the one-off fee, the same as all taxpayers. However, non-doms have two more options. First, they can self-assess their UK taxable funds in the account as of 31 December 2010 on which they will be charged 34%. The benefit of this is that they will not have 19% to 34% of their whole funds taken out. Second, they can also opt out of this part of the agreement. This is, of course, not without controversy. The Telegraph quotes one expert who says: "It's no secret that Switzerland houses non-doms' cash and this immunity looks very unfair for everyone else."

HMRC has been keen to stress that non-doms who opt out of the agreement or self-assess and are later found to have had undeclared UK taxable funds will be treated with severe penalties, including criminal prosecution.

There is no opting out on the withholding tax. Non-doms on the remittance basis will face a withholding tax on their UK-sourced income and remitted income. Of course, they would have to remove their privacy so that the taxman knows they are on the remittance basis. However, unlike UK-domiciled individuals, when non-doms remove their privacy, they will only be charged the withholding tax rates and not the UK top rate of tax – for example, 48% on income as opposed to 50%.

Having said all this, non-doms are in a better position than UK-domiciled individuals as they have more choice available. But, contrary to some reports, this does not represent a complete immunity. Perhaps to hammer this point home, we can expect to see HMRC focusing on non-doms who have self-assessed or opted out. More than anything, a prosecution along these lines would be a public relations coup and would dampen down the understandable criticisms of non-doms getting an easy ride.

Advice to applicable UK taxpayers
Although there is choice available to non-doms, the overwhelming advice from tax professionals to all taxpayers is to fully disclose through Liechtenstein. The Liechtenstein Disclosure Facility (LDF) allows taxpayers to become fully compliant with a fixed penalty of 10% plus interest on all past liabilities since 1999 and, importantly, immunity from prosecution.

Conclusions

Switzerland banking secret and its role as a tax heaven is obviously becoming part of the past, as so it is for Liechtenstein.  The recent UK and German agreements seem to me more a transitory step towards the type of full transparency that European countries and the USA require given the necessity to recovery as much funds as possible to manage the growing debt related concerns.

As always in life, I am sure that other jurisdictions will take leading roles in filling the void. It is also clear though that the same pressure coming down to Switzerland will be asserted against other obvious traditional tax heavens like BVI (British Virgin Islands, Cayman Islands, etc.), although the effectiveness of such pressure is yet to be measured.

Current trends highlight the strategic role of jurisdictions such as the United Arab Emirates that rather than a tax heaven is a country with a solid economy and thriving trade but still retain a tax-free regime. I expect to see more and more investors and retiree to opt for residency in the Emirates to take advantage of the friendly lifestyle, tax-free regime and the advantageous bilateral trade agreements. Further note that the UAE is neither a signatory to the relevant directory, nor agreeing to cooperate with the Organization of Economic Cooperation and Development (OECD).

Don't hesitate to contact me directly if you are interested in any further information about this topic or you would like to discuss any related problem or strategy.

Georgia: an emerging economy in the heart of the Caucasus, a player of the new Silk Road

I have recently answered the call of a friend of mine that asked me to take a closer look at country system that could benefit some of my existing and new clients: Georgia.

I therefore took the time to study the macroeconomic data available via secondary sources prior of the trip and planned to visit the country first hand to match the data sourced with first hand experience.

Following is a high level summary of findings that I would like to share with the audience of my blog.

KEY COUNTRY DATA ABOUT GEORGIA

Located in the hart of the Caucasus, Georgia is a country with 4.6M people and a size of 70,000 Km2, comparable to the state of South Carolina in the USA. Mostly known to neighbors for its wine production, fine mountains and beautiful seaside, for the past 7 years this country has been undergoing profound legislative and economic changes that de facto make it the most liberal and less corrupted country in the Caucasus.

Georgia borders with Russia to its North side, the Black sea to the West, Turkey and Armenia to the South and Azerbaijan to the South East.

Since 2004 after the victory of the so called Rose Revolution, Georgia was able to jump start the economy by virtue of drastically reduce the red tapes necessary to build infrastructure, start businesses and favor foreign direct investment.

Taxes were reduced, tax law simplified and a strong movement against corruption, including in the judiciary system, initiated.

While the methods adopted by the government led by President Saakashvili have been the object of criticism by a fragmented opposition the results have been very encouraging.

Till the conflict with Russia in 2008 the GDP was growing at an average of 9%. The conflict with Russia: Georgia?s main trading partner and the global economic crises stopped growth and in 2009 Georgia has posted a net decline in its GDP by 4% according to the IMF.

Still at the end of 2009 the same IMF officially declared that Georgian economy was on the verge of restarting its growth: a remarkable result given the circumstances.

Of the same opinion was the report published by the Economist Intelligence Unit of March 2010 and in the same year Standard & Poor's has raised from B to B+ the sovereign debt of the country with an outlook rated "stable" due to its particularly friendly business environment (29th rank globally).

Further, according to surveys promoted by the World Bank, the level of perceived corruption has been reduced to only 1/4 as compared to 2002: 11% of the companies declares to resort to corruption practices as compared to 44% in 2002.

"Business Freedom" Graph in comparison to Italy and Russia:

The country's leadership is maintaining a clever political balance with all partners and neighbors. The visa regime is very liberal and favorable, for example both Europeans and Iranians receive free visa on arrival.

In spite of recent signal of ease the most difficult relationship remains the one with Russia. After the war of 2008 the situation has recently improved: reopening of the of the border pass of Kazbegi-Lari and the reactivation of the Moscow-Tbilisi flights. The government has deployed a new strategy for what are defined as the Occupied Territories of Abkhazia and Ossetia and it includes the re-establishment contacts with individuals and the re-connection of economic ties although at certain determined conditions.

Worth noting is the "Economic Freedom Act" that includes a series of constitutional reforms aimed at:

• containing public expenses and manage the debt to GPD ratio (debt not to exceed 30% of GDP);
• regulating the activities of government authorities
• and try to impede the participation of the state in the banking system.

It is important to note that some foreign institutions, such as the EU, have expressed some doubts with regards to the content and extent of deregulation envisaged.  It is my personal opinion that such foreign organization already suffer of over regulating everything and the results are far from encouraging, I personally hope that the Georgian government will resist these attempts and find its own Georgian way of developing keeping the balance among the so many different parties at play.

ON THE GROUND EXPERIENCE

The renowned Georgian hospitality and the beautiful landscape made it easy to match business with pleasure.

During my time in Georgia I was able to connect with the country leaders in the political, economic and art fields. 

Spending time on the ground is not only essential to develop workable professional relationships but also to experience first hand what any investor would experience when trying to establish a business or simply live and explore the country: the ease of communicating with taxi drivers to go from location to location, ability to open a business without any institutional help or recommendation, opening of a bank account, ability to feel safe when walking in the streets, access to primary goods, pharmacies, etc.

Since the Rose Revolution the government leadership has been focused on enacting legislative changes to liberalize the economy and reduce ex Soviet style corruption. The end result has been a sweeping generational change that has propelled to power a new generation of young, generally Western educated, politicians and business people.

One of the significant and consistent feelings that I experienced across my entire set of meetings has been the significant desire for progress that animated all parties I came into contact with. 

Walking the streets of Tbilisi felt safe at every time of the day. I walked by myself the entire center city in the morning, afternoon and evening.

While English is still not widely known most of the young generation has a working knowledge of English and it is easy to get by for all basic operations including banking.

Taxi drivers or people over 45 find it easier to communicate in Russian and a basic knowledge of this language is useful to get by in the country.

Over various conversations with government officials and representatives of the economic world I narrowed down the sectors of most interest for foreign investors to:

Energy: hydro electric

In 2005 Georgia exported 122,000 KWh of electricity valued at only $3M USD; in 2010 1B kWh were exported valued at $37M. Hydro electric power supplies 85% of the country?s needs and the ministry has identified approximately 300 rivers around the country powerful enough to generate 15,000 Megawatts. The entire sector has been privatized including the distribution system. In 2007 18% of the total FDI in the country was dedicated to the energy sector.

Note: further opportunities exist in the oil & gas related activities such as logistics and pipelines.

Agriculture

While it employs 50% of the labor force it only contributes to 10% of the country GDP. The ownership is particularly fragmented preventing access to credit and economies of scale. Technology is antiquated and needs additional investment. During Soviet Union time as recently as the 80s agriculture was a sector growing at 10% a year. Foreign direct investment in this sector would benefit from a ready made local market that is currently more and more dependent on expensive goods coming from abroad. While a new strategy by the Minister of Agriculture is about to be drafted there is an untapped resource that looks interesting: 150,000 hectares of state owned agricultural land that is available to investors. Please note that Italian Ferrero S.p.A has already acquired land to grow hazelnut for its Nutella product.

Tourism

Although Georgia is a relatively small country it has been blessed with access to pristine nature suitable for 5 star tourists: beautiful mountains and seaside. Both represents untapped opportunities to cater to tourists in the region and outside. The combination of nature and the rich history of the country: remember the memorable tales of the Silk Road and the numerous historical sites sprinkled all over the country are able to provide tourists with "smart" vacations where relaxation meets art and history. Particularly worth noting is the focus to develop ski resorts in Mestia and Khulo in the Adjara district. Further, numerous sites on the Black Sea are available to resorts. To favor the development of tourism the private sector and the government have partnered to create the necessary supporting logistics infrastructure: the airports of Mestia and Batumi are fully functioning and able to cater to both national and international traffic.

Foreign investment in these key areas comes with government exemption from taxes for a number of years. And the usage of Georgia as a logistic platform to reach out to other countries can be done using free trade zones that also reduce taxes to zero for foreign investors (1 free zone is available right now, 2 other free zones will be created shortly).

Last but not least the art scene is vibrant and diverse. The theater and the opera have rich programs and the quality of the performers is very high. It is not by chance that many Georgian performers are sought after internationally: they offer high quality at a cheaper price point than Europe and North America.

In consideration of the generational change it is also clear that Tbilisi and Georgia in general are becoming a point of reference in the Caucasus art world with performers and talent from the neighboring countries reaching out to Tbilisi to take advantage of the "scene" and the network that the city is developing internationally.

It is worth noting how the private sector is starting to integrate seamlessly with the arts creating an important example for the neighboring countries.

WHAT DOES IT ALL MEAN?

It means that while the consumer product market is relatively small in consideration of the population and the average income level, this country offers great opportunities for what concerns infrastructure, energy,  logistics, art and agricultural projects.

Further, its location in the heart of the Caucasus in connection with its liberal laws makes it the ideal place to set up a base to reach out to other countries part of the new Silk Road. 

--------------------------------------------

Lastly, please note that detailed reports are available from our company for each of the sector and opportunitie that have been noted in this summary. Don't hesitate to contact me directly if you would like to know more.

--------------------------------------------

A particular thanks goes to ALL that welcomed me to Georgia and went the extra mile to make me feel at home and comfortable, especially:

• David Sakvarelidze, General Director of Tbilisi State Opera and Ballet Theater;
• Gianluca Marciano', Director of Orchestra, Tbilisi Opera;
• Franco Impala', DHoM, Ambasciata d'Italia a Tbilisi;

From BRIC to BIC? Is Russia worth the emerging market status?

It took me a while to get back behind my desk and write for this blog. Too many projects have diverted some of my attention elsewhere although the topics over which to share my humble views are a lot.

Numerous times over the past few weeks I had the opportunity to share with clients, investors and friends alike my negative opinion about Russia's future economic outlook.

I went back to substantiate some of my qualitative comments with data gathered from the recent World Economic Forum report.

The data from the report is not encouraging, following is a summary that I have provided in an earlier post:

Russia: 63th position, same as last year. After the significant slide of the previous year, Russia maintains its position. While infrastructure, health, education and technology improves significantly other components of the index suffer. The major area of concern highlighted in the report are market competitiveness and efficiency of the goods markets. Competition is hindered by inefficient anti monopoly laws and restrictions on trade and foreign ownership. One of the main issue highlighted further in the report remains the weak institutions that translate in weak property rights (126th rank) and weak corporate governance standards (119th rank).

In spite of the large amount of natural resources available for development the country doesn't seem to be able to attract large amount of foreign capital due to poor market efficiency and regulatory frameworks able to give proper guarantees to foreign investors. 

Further to the contingent stagnant situation I believe there are some more fundamental weaknesses of the system that is worth outlining:

• very negative demographic trends;
• limited communication skills in the international arena as most of the business people tend not to be able to speak basic English.
• weak and non competitive SME sector

The first is the most worrisome of the trends. It has been recognized by the local government as a serious problem and some measures have been taken to stimulate the natality rate.

Low birth rates and abnormally high death rates caused Russia's population to decline at a 0.5% annual rate, or about 750,000 to 800,000 people per year from the mid 90s to the mid 00s.

The population peaked in 1991 with 148,689,000 and it is now at 141,927,000 as of January 1, 2010.

The language aspect is more difficult to quantify in its impact but in my opinion remains an important one. While the Indian subcontinent for example presents clear difficulties in regulatory frameworks and infrastructure among others remains a lot more dynamic and integrated with the global economy due to the pervasive use of the English language among the average business person.

On the other hand Russia remains insulated as most of the business people, even of young age, are barely able to speak basic business English.

Russians have developed their own set of social network website separate from the rest of the world: Vkontakte (www.vkontakte.ru) and they are trying to develop their own set of domain names in cyrillic: Russian domain names. 

In a world where being connected and communication is the underlying basis for all business it is hard to imagine how big is the cost of this type of "isolation".

The SME sector is undersized for this nation as the entrepreneurial class has only a very brief history. During the entire Soviet Union time there was a systematic dismantling of the entrepreneurial spirit and only after the break up and the savage deregulation following SMEs have found a reason to exist. 

In both emerging markets and developed countries SMEs often tend to be the most resilient during an economic downturn as well as a consistent source of innovation. Without such developed strata of companies combined with some of the difficulties outlined above the Russia economy appears lacking a necessary component to long term prosperity. Please note that to support the claim above according to the latest World Bank's survey (Doing Business, 2009) Russia ranks 120 out of 181 economies in 'ease of doing business'.

Overall, my position remains that given the existing economic issues and moreover due to the long term demographic trends currently in place Russia no longer belongs to the emerging market economies in spite of the large natural resources available on the territory.

Too many changes are to be applied at the same time to reverse the situation. It would be at least necessary to create a more favorable set of predictable rules to favor and regulate foreign investment in the country such to develop and modernize further the natural resources industries.

Swift and deep additional efforts are to be made to integrate additional foreign workers in the country to be able to reverse some of the underlying demographic trends and more importantly collect the related taxes.

As many friends and clients come from this beautiful country I hope to assist to a swift reversal of such trends.

Emerging markets - SME confidence higher than in developed economies

Emerging markets have been making headlines in all publications globally. The global recovery is led by emerging economies and this is a fundamental fact bound to stay long term.


I receive an average of 3-4 business delegations a month here in Ras Al Khaimah. Delegations come from all corner of the worlds since our free zone has investors from 120 different countries. While meeting businessmen part of a delegation may not be a statistically viable sample to determine the trends in a specific country, it is nonetheless a good viewpoint to develop a perspective about so many different economies. Over time, over many delegations, consistent trends tend to set in.


I was therefore very happy when on February 2nd, HSBC has published the results of the its most recent research on SME Confidence (20 markets were surveyed). The primary data was gathered last October and November 2009.
I have now the statistical confirmation of the trends I have been collecting over the past year: not only emerging markets are leading the economic recovery but SMEs are going to play a leading role in the recovery.

The report also confirmed a wide differential in confidence levels between the so called highly industrialized economies (G7++) and the emerging markets.
Emerging markets are significantly more confident than developed markets. With an index of 100 as neutral emerging markets have scored an aggregate of 121 and developed markets an aggregate of 106 (France registers below 100 at 96).


Nicholas Levitt, Regional Head of Business Banking at HSBC said: "Confidence levels appear to be back to pre-financial crisis level. The Middle East outlook correlates strongly to the global emerging market outlook, and as a major international trading hub, the region is well-placed for future growth."


From the survey we learn that the Middle East is the second most optimistic area after India.
I can related personally to this finding since every month I receive one or two business delegations from India. During my presentation on emerging markets with them I always ask: "How is business during these challenging times?", invariably I receive feedback about how the impact goes from mild to negligible.


In the Middle East the SME survey confirms:

• 47% plans to increase capital expenditures;
• 41% commits to current levels of capital expense;
• 11% are planning capital expense reductions;
• 36% is committed to increase staffing;
• 58% will keep the same staffing levels;

SMEs were also asked about their propensity to engage more in international business and the survey has confirmed the role of the Middle East as an international trading hub.

• 72% of the SMEs in Qatar planned to grow their business internationally within the next 2 years;
• 28% in Egypt;
• 19% in Saudi Arabia;

The top international locations for business for the Middle East are China, South East Asia and Europe.

While this research presents gaps[1] in its approach to define the geographical footprint, it highlights something that is at the core of the economic global shift currently underway. 

In order to validate the aspirations for internationalization of many SMEs both in the Middle East and other emerging markets it is necessary for local governments to support the development of a solid and more sophisticated banking system specifically tailored to support trade and investment.
As Dr. Butcha, vice president and managing director at A.T. Kearney Middle East, said in a recent article “A.T. Kearney has worked with governments across the world to improve the SME sector. SMEs are the backbone of any successful and sustainable economy, they are the blood cells behind successfully diversified economies and large corporations. Successful long term economic growth plans for the GCC can only succeed with strong support to SMEs...”. A.T. Kearney research in emerging markets shows that successful SMEs create jobs at a rate which is four times faster than the rate of larger corporations and create revenues and GDP at a rate which is six times faster than large corporations. This is largely due to the fact that successful SMEs tend to grow more exponentially than large blue chip and established business (more at: http://www.eyeofdubai.com/v1/news/newsdetail-38845.htm)

It is because of the essential role of SMEs in the global economy that we at Ras Al Khaimah Free Trade Zone have created a business environment specically designed to facilitate SME business. Especially the newly created "valued added services" for RAK FTZ clients are focused on reducing the "incubation" period of new companies and to put them in the condition to generate successful business in the region in the fastest and most cost effective way.

[1] the survey did not include the United Arab Emirates in the emerging markets, developed markets surveyed included only US, Canada, UK & France, results in confidence in the developed economies would have been slightly different if Spain, Greece, Italy would be included.