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Savings Directive on way for January 1 Back  
The EU draft directive on interest on savings has been slowed down, but seems likely to impact the Financial Services community sooner rather than later. The first key date is 1 January 2004, and some businesses may not yet have geared up to deal with it.
<Anti evasion
The focus of the draft directive on interest on savings is to ensure that EU resident individuals cannot fail to report their full income in so far as it arises from interest paid within the community. To this end the directive is seeking to impose reporting obligations on those who, in the course of a business, pay interest to EU resident individuals.

Three states with strong traditional bank secrecy laws (Austria, Belgium and Luxembourg) will be allowed to apply withholding tax to interest paid in those states to individuals resident in other EU member states, at rates that escalate to 35% by 2010. The remaining EU member states, including the new entrants due in 2004, are expected to instead adopt a system whereby those paying interest report it to their Revenue Authorities.

A summary of the draft directive was published by KPMG in February 2003 and can be accessed on www.kpmg.ie.

It will happen
The savings directive has been around so long that any mention of it now sounds like "shouting wolf". Although the directive is not yet law, there now seems to be fair confidence that it will become law, and that its implications for business are imminent and not long-term.

The savings directive was part of a tax package, to be adopted in total or not at all. The programme against harmful tax competition, and the interest and royalties draft directive were the other two components of the package. All three have been approved. However the savings directive approval was tied to securing equivalent measures in major financial centres outside the EU. This requirement had led to lengthy negotiations with Switzerland (considered to be the only territory likely to provide resistance against the demand for equivalent measures). These negotiations have not yet concluded. However since Switzerland has extracted concessions it seems likely its agreement will be forthcoming.

The adoption of the savings directive was further held up by Italian demands for concessions in relation to the unrelated claw-back of unlawful state aids. These concessions were given. Belgium subsequently demanded and received concessions in relation to the phasing out of co-ordination centres as a price for its agreement to the directive. However that may have been a deal too far as the Commission of the European Union have now challenged the concessions to Belgium and are taking the matter before the European Court of Justice.

All of this might suggest that the savings directive is in never never land. However the more likely interpretation is that there is a real determination to enact it no matter what obstacles have to be overcome, and that it will be enacted in the coming year.

Start-up date
The difficulties with the adoption of the directive have led to its official start-up date being postponed until 1 January 2005. For those with an obligation to report the payment of interest, there is an earlier relevant date of 1 January 2004. From that date changes occur in the nature of the information which they must capture regarding those to whom they pay interest, and means of verification of the information. For most financial institutions in the EU, 1 January 2004 is the key date by which they need to have systems in place to capture the necessary information.

Irish legislation
The savings directive has to be implemented through domestic law in each member state. Ireland has not yet published legislation to implement the directive. Given the approach of 1 January 2004 date which is relevant to analysis of information by paying agents, the time allowed for adaptation of software and systems is becoming short.

The UK has passed legislation that enables the Government to activate the directive at short notice. It has also published a series of discussion documents on practical aspects of the operation of the directive and its impact on those paying interest, and those receiving interest.

All EU member states are required under the directive to pass the necessary national legislation for its implementation not later than 1 January 2004.

Key questions
Those paying interest have to ask themselves three key questions, and be able to answer them.
* Am I paying interest as defined in the directive? The definition in the directive goes far beyond the normal meaning of "interest".

* Am I paying the interest on foot of a contract or instrument issued before or after 1 January 2004? This may affect the procedures that have to be applied to verify information, and the nature of the information which must be reported.

* Is the recipient of the interest an individual resident in the EU and the beneficial owner of the interest?

These questions are relevant to anybody who pays interest (as very widely defined) in the course of a business, and who are established within the EU.

Irish financial institutions will be familiar with the difficulties created for them by the operation of the DIRT system. The savings directive system does not involve withholding tax as did DIRT, but it does involve reporting requirements. The importance of operating the system correctly, and of correctly identifying the recipients of interest payments, and of payments as being interest payments, is likely to be considerable.

What is interest?
Interest is defined for the purposes of the savings directive in quite a wide way and can actually include the consideration given for purchasing or redeeming a loan note or a fund unit.

Interest can include
* Interest paid out or credited to accounts, in respect of debts of any kind including bank accounts, loan notes, bonds etc.

* Interest which is rolled up and paid out when a debt claim of any sort is either repaid or redeemed, or purchased. It is likely therefore that most purchases of debt instruments by financial institutions will contain an element of interest.

* Distributions made by collective investment undertakings (unit trusts, SICAVs, etc) where the fund pursues an investment policy involving investment in debt instruments beyond specified percentages of its assets.

* Consideration for the redemption or sale of units in a collective investment undertaking whose investment in debt claims exceeds a specified percentage.

The fact that the definition of "interest" is extended to include the purchase price for buying or redeeming debt instruments and certain fund units is likely to make the operation of the directive more complex than a straightforward deposit interest retention tax system. Financial institutions can readily identify payments of interest in the narrow sense. Not all will have systems designed to identify "interest" as more widely defined for the purpose of the directive, although some may do so for accounting purposes.

The obligation to operate the system is not confined to financial institutions, although it is financial institutions that will be most widely impacted. Any business making payments of interest, as defined, within the EU, is exposed to the new system in principle.

What to do?
A response to the obligations imposed by the directive is going to require software changes in most affected companies and may also require fundamental systems changes within those companies. There is a need for analysis to ensure that as far as possible the systems changes are integrated with existing accounting and "know your client" procedures so that there is not duplication of effort within the business.

The problem is of course that since the Irish legislation has not even appeared in draft most Irish businesses are unable to commission software changes, or definitively plan systems changes.
Some groups will be exposed to reporting requirements both in the UK and in Ireland, and even conceivably in other EU member states. Hopefully the Irish legislation will be as close as possible to the UK legislation so as to ensure that a single approach can be adopted by businesses to meet any requirements in both jurisdictions.

There is a need for the Government to publish its intentions regarding the implementation of the directive at an early date. Otherwise Irish financial institutions may be placed at a competitive disadvantage in being unable to operate the system successfully, or incurring unnecessary costs in the areas of software and systems changes.

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