New U.S-Swiss FATCA IGA Compels Cross-Border Strategy Review

This piece first appeared as a featured piece on Bloomberg Tax. You can read the original article here

Since July 1, 2014, the U.S. has imposed a set of unilateral banking reporting requirements on the international community known as the Foreign Account Tax Compliance Act (FATCA). Broadly, this legislation obliges all foreign financial institutions (FFIs) to disclose the U.S. account information of any U.S. taxpayers in their system. A full list of FFIs is maintained on the IRS website.

The objective of the legislation is to inhibit U.S. tax evasion practices such as the storage of wealth in offshore accounts. However, the objective has historically faced implementation hurdles from both FFIs and U.S. taxpayers who hold foreign accounts; the former are disinclined to incorporate another layer of administrative processes into their operating structure, while the latter resists the complications the legislation adds to their cross-border planning considerations, which are already complex for people who qualify as U.S. taxpayers (See “IRS Classification of Taxpayers for U.S. Tax Purposes,” for a list of the criteria classifying an individual’s U.S. tax reporting liability). Both parties resist the intrusion into a space discreet by nature.

To nudge reluctant FFIs into compliance, the penalty for noncompliance is a steep 30% withholding tax on certain U.S.-source income for an FFI. This has been generally effective in compelling countries to cooperate. The Foreign Account Tax Compliance Act (FATCA) is a U.S. law enacted March 18, 2010, as part of the Hiring Incentives to Restore Employment (“HIRE”) Act (Pub. L. No. 111-147). Broadly, it aims to prevent tax evasion by U.S. citizens using foreign accounts, requiring foreign financial institutions to report to the IRS about assets held by U.S. taxpayers.

Moreover, the practical application of FATCA legislation depends on a key factor: whether the intergovernmental agreement (IGA) between the U.S. and a foreign country is Model 1 or Model 2. While the U.S. negotiated favorable Model 1 arrangements with most countries, a few countries preserved an exceptional measure of their clients’ privacy via a Model 2 agreement. With respect to Switzerland, the strength of the country’s banking sector and preexisting bank secrecy laws insulated it against U.S. pressure to conform to Model 1 reporting, resulting in a Model 2 arrangement.

The key difference between a Model 1 and a Model 2 agreement concerns how the information is transferred. Historically, intergovernmental agreements (IGAs) have evolved to improve tax compliance and facilitate the reporting of accounts held by U.S. taxpayers abroad.

In Model 1, the FFI automatically transmits the information of U.S. citizens to the IRS. In Model 2, however, the FFI preserves a measure of autonomy. This, in turn, secures a measure of protection for U.S. taxpayers with foreign accounts. While the FFI is still required to register with the IRS, clients retain the right to decline the sharing of their identifying account details. In the case of Switzerland, the country has historically provided the IRS with unidentifiable aggregated information about the account(s) in question. However, recent developments spell change for Swiss institutions’ reporting relationship with the U.S. tax authority – and vice versa. “Negotiations were finally concluded on November 13, 2023, and preparations for signing are now underway, the Swiss State Secretariat for International Finance has now announced. The new IGA follows Model 1, so that Switzerland is entitled to receive details of Swiss-held accounts from the US IRS.” (Swiss FATCA information exchange agreement with US changes to reciprocal disclosure | STEP ).

In reviewing these changes, this article focuses on the impact the FATCA IGA has on U.S. taxpayers in Switzerland. This article is intended to contextualize the changes signaled in the move to a Model 1 IGA against the prior, lesser-used Model 2 framework. To illustrate these changes, we discuss the historical precedent for FATCA IGA review between the U.S. and Switzerland, drawing on real-world examples of FATCA missteps made by macro-level financial players to underscore the timing of this significant change. We also highlight key areas of review for U.S. taxpayers, particularly those with complex reporting cases. Finally, we urge U.S. taxpayers to take a proactive, hands-on approach to ensuring FATCA compliance with a renewed emphasis on holistic cross-border financial planning.

Understanding how FATCA has historically been applied in Switzerland: Comparing Model 1 and Model 

Switzerland Shifts Gears: Model 2 to Model 1

Until recently, Switzerland was a prime example of a Model 2 beneficiary. Meaning, FFIs were not obliged to transmit the U.S. account information of their clients. Further, the FFI was permitted to request the information from the client but had no immediate authority to insist on the transmission of information if the client declined to share their details.

If the IRS had grounds on which to pursue a U.S. taxpayer in Switzerland, the agency was relegated to standard (and often cumbersome) communication channels with the FFI in question. Essentially, this process left the IRS vulnerable to being out-maneuvered by wealthy U.S. taxpayers and their nimble, internationally-savvy tax teams.

Image credit: SIF, FATCA Agreement

Key Changes in the U.S./Swiss IGA

The primary shift in the model involves a bi-directional flow of specific account information, indicating a departure from a unidirectional transfer solely from Switzerland to the U.S. The adoption of Model 2 not only introduces this reciprocal exchange but also enhances legal certainty for Swiss banks. Instead of direct transmission to the IRS, under Model 2, information is routed to the Federal Tax Administration (FTA). The Federal Tax Administration in Switzerland oversees tax collection, ensures compliance, and implements tax legislation nationally.

In the Model 2 framework, Swiss financial institutions furnish the IRS with relevant information contingent upon the consent of involved customers, primarily U.S. citizens or those with U.S. ties. In cases where customer consent is withheld, an anonymized, aggregated report with select details is submitted. The IRS can leverage this aggregated report to initiate specific customer and account information disclosure, such as through a request for administrative assistance, as outlined in the Swiss-U.S. Tax Treaty. Article 26 of the Swiss-U.S. Tax Treaty addresses the “Exchange of Information,” a crucial aspect of implementing treaty provisions. Notably, Article 26 exemplifies an on-request information exchange paradigm. This marks a significant transition from the original treaty-based information exchange to the change to the automatic exchange of information.


A Gradual Shift

This isn’t the first time the U.S. and Switzerland have revisited their FATCA agreement. The arrangement was altered slightly in 2019, amended to permit the IRS to both retroactively and going forward make “group requests.” In 2019, Switzerland and the U.S. revised their FATCA agreement to enhance reciprocal disclosure, facilitating group requests for non-consenting account owners since June 30, 2014. The resulting change essentially overrode a U.S. account holder’s option to decline to share identifying information associated with an account held at an FFI. In December 2022, then-Swiss State Secretary Daniela Stoffel met the Deputy Secretary of the U.S. Treasury, Wally Adeyemo, to discuss, among other things, an update to the FATCA agreement that envisaged “the automatic and reciprocal exchange of information.” The 2019 FATCA update between Switzerland and the U.S. focused on a mutual approach to exchanging tax information, enhancing the agreement’s effectiveness in combating tax evasion.

The impact of this updated FATCA relationship has major implications for non-compliant U.S. expats living in Switzerland, but also Swiss expats living in the United States. The updated agreement signals an increased commitment by both countries to collaborate to enforce tax compliance where necessary and with respect to their own citizens. As noted in the introduction, the scope of this article does not include the effect these changes will have on Swiss taxpayers, however, it would be remiss not to mention that they are the other affected party by this event.

On November 13, 2023, the Swiss and U.S. governments concluded negotiations, aligning on a Model 1 agreement. Below, we outline what this means for U.S. account holders in Switzerland, pending the signing of the agreement.


Anticipating Challenges for U.S. Citizens

Challenges will increase substantially for U.S. citizens seeking to avoid IRS scrutiny in Switzerland. Through the updated agreement, the information of U.S. account holders at Swiss FFIs will occur automatically. This visibility will allow the IRS to refine and develop a more sophisticated approach to determining targets for audits and reviews. In turn, U.S. taxpayers with complex cross-border financial situations will need to work with their cross-border financial support network to review and, as necessary, update their current tax and financial operations for soundness.


Pre-planning Before Moving Abroad

Pre-planning to ensure compliance before moving abroad will become essential for certain expat demographics. For qualifying individuals planning to relocate to Switzerland, proactively connecting with a certified cross-border financial planner specializing in the jurisdiction ensures two things. Firstly, you possess a comprehensive overview and understanding of how your new geographic location will impact your tax and financial reporting obligations. Secondly, a certified cross-border financial planner will be able to interpret your unique needs based on updates to international tax law and in consultation with international tax experts.


Significant Tax Updates Necessitate Action

The best cross-border tax and financial plans are designed with long-term goals and strategy in mind. They should also be adaptable and designed to withstand the unpredictable nature of international tax laws. The evolving U.S./Swiss IGA is an excellent reminder for U.S. taxpayers in Switzerland to take stock of their financial plan’s design from a holistic perspective to ensure it’s properly (and legally) inoculated against any IRS inquiries that may arise as a result of the countries’ deepening cooperation.


Spotlight On Banks Behaving Badly

If recent breaking stories in the international banking and finance realm are any indication, closer cooperation via a Model 1 IGA will lead to the unearthing of more stories such as the aforementioned Banque Pictet scandal, and the more sprawling international drama from Credit Suisse’s epic flame-out in early 2023. Credit Suisse collapsed due to multiple scandals, mismanagement, risky investments, and leadership instability, leading to significant financial losses and customer trust erosion.

Reflecting on recent events, also in 2023, a notable Swiss FFI, Bank Pictet, acknowledged assisting U.S. taxpayers in concealing over $5.6 billion from the IRS. Banque Pictet & Cie SA admitted to conspiring with U.S. taxpayers to hide assets and income, highlighting FATCA’s role in uncovering tax evasion. This incident underscores a recurring theme since the inception of FATCA. Preceding FATCA, the Qualified Intermediary (QI) regime and the treaty framework were in place, indicating that where incentives and demands for tax havens and secrecy exist, such practices persist.

The evolution from treaty-based mechanisms to the automatic exchange of information highlights the ongoing struggle to address tax evasion, revealing that new frameworks emerge as loopholes are closed, reinforcing the need for vigilant oversight and regulation.


Conclusion

Tax and financial complexities abound for U.S. taxpayers in Switzerland and directly implicate cross-border practices. The transition from Model 2 to Model 1 under the U.S./Swiss FATCA IGA marks a tectonic shift for affected taxpayers. For their part, this change underscores the necessity for cross-border financial professionals to remain vigilant. The unique and ever-evolving needs of cross-border U.S. taxpayer clientele merit special consideration and attention to international tax and finance developments, which, as we have seen can be shaped by numerous factors that may be spontaneous or planned in nature.




About the Author

Arielle Tucker is a Certified Financial Planner™ and IRS Enrolled Agent with Connected Financial Planning. She's spent over a decade working with US expats on US tax and financial planning issues. She is passionate about working with US expats and their families to help secure a financial future that is reflective of their core values. Arielle grew up in New York and has lived throughout the US, Germany, and Switzerland.