But there are also losers, of course. These are the people affected, who must now expect legal proceedings against them as suspected tax cheats, and who had, until relatively recently, been promised that precisely this would not happen. Promised by whom? By the bank concerned (among others), which had generously interpreted and intensively exploited an explicit gap in the 2001 "Qualified Intermediary" (QI) agreement; by the supervisory authorities, which were fully cognizant of all this activity, but never questioned it; by the Swiss government, which only a few months ago had spoken of the "brick wall" that foreign authorities would encounter, were they to attack Swiss banking secrecy - for example through fishing expeditions, such as an application for administrative assistance against several thousand clients. Promises, connivance, a pretence of resolute behaviour - and now collapse. The appearance of success conceals the reality of a breach of trust.

There then follows a quite delicious deconstruction of the concept of "morality" vis a vis those who might be considered "tax cheats" and the activities of the US Government over the last half century. Not at all what one might expect from a staid, conservative Swiss private bank!

But they are just getting started:

American inheritance tax rates are variable, with the top rate at 45 percent. Significant exemptions, of over 1 million US dollars, are allowed for US citizens; the limit for non-Americans is 60,000 US dollars, unless there is a double taxation agreement setting a higher limit. For Switzerland, the limit is calculated on the basis of the double taxation agreement of 1951, based on the proportion of the entire estate represented by the assets in the United States. To claim the allowance, the "estate" - that is, in continental terms, the heirs - must disclose the entire, global legacy to the IRS. On account of the IBM shares that he was so attached to, the children of the late Hans Rüdisühli of Melchnau must file with the IRS and present a valuation of all other family assets. There is a remarkable lack of double taxation agreements with the countries of Latin America, Asia and the Middle East. Mr Abdullah of Dubai, let's say, a typical owner of treasuries, industrial bonds and GM shares, is liable to American inheritance tax on his decease. Not his problem, but it may well become one for his 12 sons, Omar, Yakub and all.

Or maybe not? For he had placed his securities in an institutional structure, a trust or a company domiciled on one of the Caribbean islands - and institutions cannot die, can they? Indeed not. However, the Americans are increasingly going over to regarding such structures as look-through entities, and trying to get access to the beneficiaries and their tax liabilities.

Many of the most alarming possibilities raised concern the estimated future developments of this whole process, and it must be borne in mind that this is all coming from an institution that has made its living for almost 300 years by keeping its client's affairs secret, but the genius of the US tax system is the manner in which the taxpayers are conscripted into being their own tax collectors. One can hardly fault Wegelin for finding being cast into such a position on behalf of their clients uncomfortable in the extreme. And they think the extent of the burdens on "Qualified Intermediaries" are about to increase.

Another common objection: it's impossible anyway. How on earth can the IRS make the connection between a US security and a deceased foreigner? The USA is not even capable of registering its own residents, so how should it be able to control the rest of the world? Simple answer: it doesn't have to. Rather, American inheritance tax law focuses on the executor. If there is no executor, the role is fulfilled by the custodian bank, which is liable for the tax due. In order to exclude this liability, the American custodians of foreign banks will go over to requiring their partners abroad to freeze the estate when one of their clients dies.

Final objection: it was a dead letter for foreigners anyway. Yes indeed. But with the revised provisions of the Qualified Intermediary agreement, the USA will require the signatory banks to enable an American auditor to control their compliance with the agreement, which entails giving such auditors access to all files, including client data. This will create the means of directly linking US securities with non-American owners. Anyone who believes that this will not soon result in obligatory reporting by the US auditor is as naive as those who failed to realize that "fraud and the like" would eventually be interpreted to the almost unlimited advantage of the tax authorities.

An act passed in 2001 by the previous President Bush envisaged a "sunset clause" for the then controversial but reintroduced inheritance tax. Unless extended, the Estate Tax would expire in 2010 and, if not reformed, come into effect again on 1 January 2011. The Obama administration is currently working not merely on an extension, but on making the law stricter with regard to recognized loopholes. The possibility of further unpleasant surprises can certainly not be ruled out.

Guess they are not "Death Taxes" if they apply to "non-resident aliens! Since the US Government cannot raise taxes on wealthy US citizens, it appears that they will try to increase the take by going after hapless foreigners. And even if you have never been a US citizen and don't have any US securities, it would be most inopportune to die while an heir is attending or has recently attended a US University.

There are three definitions in this QI agreement that are of decisive importance: that of a US person, that of a US security, and that of a legal entity belonging wholly or in part to a US person. The definition of a US security is fairly unproblematic, in that it is effectively determined by the retention of the withholding tax by the custodian. The other two definitions, however, have caused, and continue to cause, almost insurmountable problems for QIs, and thus generate considerable legal uncertainty.

Sadly, it is entirely unclear who actually counts as a US person and who does not. In addition to the clear case of US citizens resident in the USA, the American understanding of the category also includes foreigners living in the USA, those in possession of a social security card, holders of a "green card", US citizens not resident in the USA, and also those who pass the so-called "Substantial Physical Presence Test". This "Presence Test" has a particularly delightful design: it is passed when someone has been in the USA for at least 31 days in the current year and a total of 183 days over a period of three years; in the first year the days count for 1/6, in the second for 1/3, and in the third year they are counted full. By this definition, a student, perhaps Muhammad Abdullah's son Omar, who is doing an MBA at Harvard, very probably counts as a US person. The problem is that the QI has to know whether he does or not. For the agreement has turned the QI into the extended arm of the American tax authorities.

Even trickier is the question of how far the beneficiaries of legal entities are liable to withholding tax. Clearly liable, according to the text, are active businesses; an American company holding securities in Switzerland, for example. Trusts, institutions and foundations are exempt if they meet certain - naturally highly complex - conditions. This was probably the trap in which the UBS
clients were caught. Once the trap had closed, the American tax authorities shouted "Abuse, fraud (and the like...)!" They set the trap themselves.

Matters become really awkward when an impeccably non-American legal entity suddenly becomes "contaminated" by a US person. Let's assume that Mr Abdullah has named his son Omar, as well as some of his other adult sons, as a beneficiary of his trust. As American tax law has turned him into a US person, Omar renders the trust liable to tax, and when Mr Abdullah dies, this may mean that the entire inheritance becomes liable to US estate tax, possibly at 45 percent, for Mr Abdullah was extremely wealthy. Perhaps, and then again, perhaps not. But that
doesn't matter - the QI should have known.

If any of the foregoing is of concern to European Union residents and governments it now should be considered in light of the SWIFT program, consideration of which as been discussed in the Salon here, here, and here. Marla Singer of Zero Hedge has a background post on this subject:

Normally, discussion of the "Surveillance State" touches on Zero Hedge's core focus (finance) only tangentially.  But every once in a while something significant bounces us radar returns in this sector.  This definitely qualifies: (All double-indent, orange box quotes are from brusselblogger via Zero Hedge.)

   SWIFT is now moving all its data centers outside the EU and the US, to Switzerland. In order to continue allowing the US authorities accessing all banking data a high level agreement between the EU and the USA is currently being negotiated. It is likely to be agreed on in the EU council of minister meeting next Monday, 30 November 2009.

For the uninitiated, the Society for Worldwide Interbank Financial Telecommunication ("SWIFT") is...

   ...a member-owned cooperative through which the financial world conducts its business operations with speed, certainty and confidence. Over 8,300 banking organisations, securities institutions and corporate customers in more than 208 countries trust us every day to exchange millions of standardised financial messages.

Given the backbone nature of the SWIFT network, it was the natural home for the (eventually scandalous) Terrorist Finance Tracking Program, in no small part part of the large rift that grew between the most recent Bush administration and Europe.  Brusselsblogger explains:

   The move of SWIFT the data server to Switzerland would be an excellent opportunity to stop the nearly unlimited access of US authorities on EU bank transactions. But EU justice and interior minister are apparently keen agree a deal as soon as possible, on 30 November. Why 30 November? Because one day later, on 1 December 2009, the EU's Lisbon Treaty will be in force and would allow the European Parliament to play a major role in the negotiations of the deal with the USA. A deal one day before will be a slap in the face of democracy in the EU.

    SWIFT handles 15 mio bank transactions daily for more than 9000 banks worldwide. Nearly every transnational bank transaction within the EU is recorded in the SWIFT data centers, including amount, sender, recipient, and transaction comments. The agreement will even allow to transmit "other personal data".

    This will allow US authorities to establish a huge data mining database, allowing to query [sic] every substantial business link within the EU. No question that the United States will never admit that openly.

Interestingly, the agreement is not bilateral.  The EU enjoys no reciprocity in data sharing.  For the United States here it is all take and no give.  In its role as the latest American lapdog, Switzerland is unlikely to hinder the New Moon-like U.S. thirst for the financial lives of others (like tax evadersterrorists, for instance).  Nice work if you can get it.

The Wegelin Report is an eight page PDF and is well worth a read. It should be noted that, especially among its commenters, but also among its posters, Zero Hedge has a significant libertarian bent and, for some, Keynes and Keynesian are pejoratives, but they certainly come up with a lot of inside info.

Jimmy Carter famously called the US income tax system "a disgrace to the human race." It shares with the estate tax system the delightful feature of co-opting the taxpayer as an agent of the tax collector. It appears that the US Government is in the process of extending the benefits of that system to the entire world, via the broad definition of the reach and scope of the code.  It would seem that the European Union should be attempting to protect the estates of its citizens from unwarranted intrusion and taxation by the USA. But perhaps there are other considerations that can be brought forward in the comments. Security uber alles?