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Tax Monitor

The Savings Directive
The long saga of a Directive imposing withholding tax on interest paid within the EU to individuals appeared to reach a conclusion in Lisbon this summer. But what, if anything, has been agreed?
Fudged compromise
The draft Savings Directive has been knocking around now in draft form for some years. Its declared objective is to ensure ‘that all citizens resident in a member state of the EU should pay the tax due on their savings income.’

The method originally envisaged was to apply withholding tax on payments of interest to EU resident individual investors.

The UK quite sensibly pointed out that since the obligation to withhold tax would be confined to paying agents within the EU, the result would not be to ensure the taxation of all interest, but merely to drive paying agents to locate outside the EU. The UK has succeeded in persuading its fellow members that the emphasis on withholding tax was misguided and that the emphasis must shift to agreement on exchanging information regarding the recipients of interest.

They have also ensured that their fellow member states appreciate the dangers of proceeding at all, without co-operation from the major non-EU financial centres. These include the USA, Switzerland, Liechtenstein, Monaco, Andorra, San Marino, and Britain’s various offshore islands.
The shift of emphasis achieved by Britain has not gone down well with all member states. In particular, Luxembourg and Austria are not keen on breaching bank secrecy, and identifying non-resident recipients of interest. Some high tax states (France and Germany) are eager to ensure their resident’s cannot evade tax, by placing savings offshore. Britain is determined that the imposition of withholding taxes at paying agent level does not damage the City of London. Nonetheless a compromise was patched together.

Was anything agreed?
You can interpret the compromise positively or negatively. Positively, it is a commitment within two years to get a directive operational with states being entitled to either adopt the withholding tax or the exchange of information solutions. In five years from the directive becoming law exchange of information must become universal.

From a negative viewpoint, since the agreement to get the directive up and running is dependent on securing the co-operation of the US, Switzerland etc, and since universal exchange of information is not foreseen for at least seven years, it is an agreement to long finger the entire matter for at least seven years and probably longer. Despite the appearance of the agreement, Austria has not definitely committed itself to an exchange of information even in seven years time.
Even if there had been agreement on basic principles (and that is not at all clear) key questions remain unanswered.
• What should the minimum rate of withholding tax be? 20 per cent to 25 per cent is favoured but no rate has yet been agreed on.
• What is interest? The pittance you get on your deposit account is of course interest but is a premium on redemption of a bond, or a discount on the issue of a bond, interest? How is a zero coupon instrument to be treated?
• How do you combat bond washing, with individuals who would be liable to withholding/exchange of information selling the bond just ahead of the interest accrual date to a corporate?

Under the current French presidency these issues are being explored. Whatever prospect the draft directive had of getting adopted and implemented when it dealt with interest in its simplest forms, any attempt to expand the draft directive to include the taxation of parts of the proceeds of bond sales seems doomed to failure.

The draft directive could be likened to a second world war bomb. It has been sitting around for so long now that it probably will never go off, but if it does go off, a lot of people could get hurt.

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