Was Bank Leumi Too Hasty in Revealing U.S. Clients' Info to the IRS?

The issue of whether Israeli banks should take the Swiss approach and refuse to disclose customer identities may be a moot point, in light of a new international anti-tax-evasion treaty that is taking shape.

Bank Leumi in Tel Aviv.
Bloomberg

There is a direct line connecting the disclosure of the identities of 6,200 Israelis with Swiss bank accounts, and the settlement Bank Leumi reached with U.S. authorities concerning the help its American-based staff allegedly provided to their customers in evading tax payments. That connection, however, doesn’t relate to the tax evasion per se, but rather to the disclosure of the names.

The incident involving the Swiss banks involved a leak by a disgruntled employee who stole computer files with bank clients' details and essentially sold them to the highest bidder. In the case of Bank Leumi, Israel’s second-largest bank, the case concerned some 1,500 American clients whose identities were eventually made known to the U.S. Internal Revenue Service. The differences between the two cases are huge.

In the Swiss case, an essential element was the theft of the computer files, leading to the leak of the names. In the Israeli case, the threat of a criminal investigation against Bank Leumi over suspicions that it had helped clients evade tax motivated revelation of the information. Actually, the disparities between the two cases is even greater since banks in Switzerland have always been considered a center of global tax evasion. As a result, the first bank investigated by U.S. authorities over suspected assistance to U.S. clients in evading taxes was the leading Swiss bank, UBS.

The investigation against UBS began back in 2008, but did not result in the disclosure of client names, in contrast to the investigation of Leumi, which did. In the process, a precedent was set: Now other Israeli banks targeted by the U.S. authorities – Hapoalim and Mizrahi Tefahot – will apparently also be required to follow suit in providing names.

Did Leumi surrender to the American dictates too quickly and too easily, and create serious harm to its image – begging the question of whether Israeli banks are not taking a tough enough stance in protecting the confidentiality of their clients’ banking information?

The whole issue is very embarrassing to Leumi, but the bank claims the situation is much more complicated. It turns out the Swiss banks refused to provide customers’ names to U.S. authorities because Swiss law bars them from doing so. In essence, the negotiations involving UBS and the American authorities were actually handled by the Swiss government, and it was the one that set the disclosure limits.

In Israel, on the other hand, there is no banking secrecy law and the government is also not involved in local banks’ contacts with foreign tax authorities. In practice, however, in the Leumi case, the Israeli government was involved by virtue of the Israeli-American tax treaty. That agreement says that if one of the governments suspects that one of its citizens is involved in tax evasion – it can demand that the other government provide all available information on the individual, including that related to his banking activities.

The bilateral accord states that in such a case, a formal request is to be filed in the court system of the other country, which in turn will lift banking-confidentiality provisions and disclose the information.

Locating tax scofflaws

Such tax treaty provisions are common, and they were invoked in the case of Bank Leumi, with Israeli court approval. This time, however, the situation was handled differently and set a precedent: Instead of requesting information about a specific bank customer whom the American authorities had suspicions about – the U.S. officials presented a more general demand, seeking details regarding all Bank Leumi clients who met the following criteria: the individuals are U.S. citizens with accounts whose holders' names are kept anonymous, or which included instructions not to send mail to the account-holder’s home; or, persons who have back-to-back loans (in which two companies loan identical amounts to one another in different currencies) or who are registered in a tax haven.

The Americans said that their experience was that in cases involving persons meeting these criteria, there is a reasonable suspicion of tax evasion. Furthermore, the officials argued, in such cases, the bilateral tax treaty could be invoked to demand provision of the clients’ names even if thousands of customers were involved and not just one.

The American position regarding the confluence of factors that spark suspicion of tax evasion is not baseless. Among the Israeli clients, for example, the number of accounts bearing instructions that information not be to sent to their account-holders’ home address (usually involving divorced people trying to hide assets from their former spouses) is very small.

When it comes to accounts held by persons living abroad, however, there is a substantial difference. On the other hand, the American contention that a reasonable suspicion against someone can be based on statistical information alone rather than other possible accusations has constituted a precedent.

The U.S. request vis-a-vis Leumi was filed with the courts in Israel for approval. Leumi did not submit objections to the request after agreeing to the demand in the course of negotiations with American officials.

It’s hard to assess what would have happened if Leumi had objected to the precedent-setting demand, which actually alters the terms of the U.S.-Israel tax treaty. The Israeli court approved the request, and the names of 1,500 American Leumi customers who fit the criteria were provided to U.S. authorities. It should be noted that Leumi gave its customers advance warning that their names may be disclosed, giving them the opportunity to voluntarily declare any previously unreported assets to the U.S. tax authorities.

Israel and the 2018 treaty

The precedent that has altered how the bilateral tax accord works is already an accomplished fact. One might have had concerns that it would cause serious damage in the Israeli banking sector, but it apparently didn’t because there is a reasonable prospect that the same precedent will become widespread international practice in the near future.

The Organization for Economic Cooperation and Development, representing the world’s developed economies including Israel, has been attempting for several years to close global tax loopholes. It recently managed to launch an important international effort that would call for automatic disclosure among tax authorities of bank accounts held by foreigners.

More than 50 countries have so far signed onto this new, so-called Common Reporting Standard, which provides that beginning in 2017, all bank accounts held by foreigners will be disclosed to the tax authorities of their home countries. Israeli tax officials have expressed a desire to join the new reporting system as of 2018, a step that would require legislation.

On the assumption that Israel does sign onto the treaty, as of 2018, the names of foreigners with accounts in Israeli banks would be subject to disclosure vis-a-vis most of the world’s tax authorities. Leumi’s precedent-setting step in disclosing its clients’ identities could therefore become routine practice in the future, albeit entirely.

Moran Harari, who heads the Israeli branch of the Tax Justice Network, an organization seeking to create an international coalition to close tax evasion loopholes, asserts that the future tax agreement has loopholes of its own: There are no sanctions against countries that violate its terms; Switzerland, which as mentioned is considered a tax-evasion hub, has announced that it will join the treaty, but with conditions (agreeing to provide information only to some countries); developing countries are not capable of meeting the reporting requirements of the accord; real-estate trust accounts and yachts are not included in the reporting requirements; there would be a bizarre provision allowing countries to forgo receiving information on its citizens (and in the process allowing the countries to declare themselves the ultimate tax havens, where no questions are asked); and worst of all, the Americans are making their own rules for themselves.

We should recall that the Americans were trendsetters when it came to dealing with global tax evasion. Following the 2008 world economic crisis, they enacted the Foreign Account Tax Compliance Act (FATCA), which demanded that banks that did not comply with American disclosure requirements could not operate on U.S. soil – a demand most major banks around the world could not stand up to.

The astounding steps taken by the Americans, which undoubtedly jump-started major international efforts to combat tax evasion, were entirely one-sided. The U.S. was demanding data on its citizens but was refusing to provide other countries with information about their citizens who were evading taxes through accounts in American banks. This one-sided approach, together with the existence of official tax havens in the United States – in the form of a low corporate tax system in Delaware, or the tax haven in the U.S. Virgin Islands — could turn America into the world’s largest tax haven of them all.

This American hypocrisy harms international efforts to fight tax evasion, yet the expectation is that the automatic disclosure provision of the Common Reporting Standard will dramatically change the global tax-evasion picture.

For Israel, it has particularly important consequences since local banks hold large sums deposited by foreign account-holders – about $40 billion. Generally, those involved are well-to-do Diaspora Jews whose motives to choose Israeli banks include their own Zionist sentiments in addition to a desire to evade paying taxes in their home countries. Indeed, it is thought that 80 to 90 percent of the assets in these accounts are not reported in an attempt to shirk tax payments.

The new treaty is a direct threat to the accounts held by foreigners in Israel; the fear is that large sums may be hurriedly withdrawn from these accounts. The loss of $40 billion in deposits would be a real blow to Israeli banks. Nonetheless, since this is all part of a global shift in policy to which other countries are exposed to the same extent – that is, the money can’t be hidden in those countries either – it’s possible that the blow to Israel will be softer.

Banks in Israel believe that most of the foreigners with local accounts will voluntarily disclose their assets to tax authorities in their countries of residence, where they will pay penalties of 25 to 50 percent of the amounts on deposit. That means that a quarter to a half of the sums held here will be withdrawn in any event. The hope is that the rest will remain on deposit in Israel – this time not as part of an effort to evade taxation, but as a way of fulfilling the Jewish desire to keep some money in Israel if, heaven forbid, things get bad elsewhere.