The E.U. Savings tax Directive worse to come?
This July, the rate of tax withheld from returns on savings under the EU's Savings Tax Directive increased from 15% to 20%, and in three years' time will come the final increase to a swinging 35%.
Although the Commission's attempts to broaden the scope of the tax to include jurisdictions like Hong Kong have been firmly rejected so far, it certainly hasn't given up. Urged on by Germany, which is in a stew of righteous indignation over the 'discovery' that thousands of its citizens are making hay while the sun shines in Liechtenstein, a Commission Review Group which has been working away for two years is expected to recommend a major extension of the Directive in the EU itself to close loopholes which have permitted many investors to escape the tax until now, for example by moving assets from bank accounts to vehicles such as companies and trusts - which weren't included in the legislation - or by shifting money to accounts based in territories out of the reach of the directive's information sharing provisions.
EU Tax Commissioner Laszlo Kovacs is due to issue a formal proposal by November outlining the amendments. However, as in all EU tax matters, in order to ensure that the proposal is adopted, the unanimous backing of all 27 member states is required.
While Switzerland and Luxembourg support the European Union's efforts to ensure that investment income is properly taxed under the Savings Tax Directive, the two countries are insistent that they will not be persuaded by Brussels to adopt exchange of information with other member states for tax purposes.
This was the message relayed by Swiss Finance Minister Hans Rudolf Merz following discussions on the issue of tax and banking secrecy with Luxembourg Prime Minister Jean-Claude Juncker last May, in which he stressed that a paying agent tax, as opposed to automatic exchange of information, was the only means to accomplish the EU's goal of taxing capital yields.
"Switzerland will not deviate from this stance," the Swiss Federal Department of Finance confirmed after Merz's meeting with Juncker in Luxembourg.
The savings tax directive entered into force in 2005. Under the legislation, some EU member states and certain ‘third countries’ (e.g. Switzerland, Liechtenstein and the UK offshore territories) offer savers the choice between having their details handed over to the tax authority in their home countries or paying a withholding tax instead (currently 20%), three-quarters of which is remitted to the country in question.
However, reports have suggested that the revenues raised from withholding taxes so far have fallen well below EU expectations. This is because the directive as it stands is fairly easy for investors to circumvent, either by channeling assets into business entities which are not covered by the rules, such as a company or partnership, or by parking savings in jurisdictions not included in the directive, like Dubai or Hong Kong.
Full figures are not yet available from Brussels for the results of the Directive, but some individual countries have released figures showing returns that are perhaps on the low side, while there is plentiful anecdotal evidence to suggest that most investors have either fled to jurisdictions which don't apply the Directive, for instance Hong Kong or Dubai, or have re-arranged their deposits so as to avoid the Directive - something that is quite easily done (see below).
The Swiss government for instance announced in May that gross revenues collected from interest payments under the European Savings Tax Directive had increased between 2006 and 2007, but still only amounted to CHF653.2m. That seems like a hefty chunk of change, but at a low interest rate of 5% would represent only CHF80bn in savings deposits. Nobody knows how much money is tucked away in Switzerland, but USD1 trillion is thought to be a conservative estimate.
While Switzerland and Luxembourg acknowledge that any shortcomings must be resolved first by amending the directive, the Swiss have emphasized that they have no obligation to enter into talks with the EU on a revision of the agreement on the taxation of savings income before 2013.
Furthermore, the Swiss authorities are adamant that the subject of banking secrecy would not be open to negotiation, "even within the scope of such discussions".
"This stance is shared by Luxembourg," a Swiss statement went on to add.
In fact, after three years of the Savings Tax Directive, it is clear that it has largely failed in its objective of gathering up income that had been escaping national tax nets, and it is highly likely that the Commission will bring forward a tougher regime, taking advantage of all that has been learnt in the last five years since the scheme was originally determined.
The extent of continuing tax avoidance in Europe was made brutally clear when the UK's 2007 tax amnesty was taken up by a mere 12% of the 400,000 UK individuals known to have offshore bank accounts.
HMRC had forced a number of top banks, including Barclays, HSBC, HBOS, Royal Bank of Scotland and Lloyds TSB to disgorge details of their customers' offshore accounts. Eventually just 50,000 people took advantage of the amnesty, which capped penalties at 10% of any unpaid tax.
The tax authority is now continuing the task of pursuing the remaining 350,000 people, including an unknown number of account holders whose names will have been revealed by information provided under the Savings Tax Directive.
The European Union introduced its Savings Tax Directive in an attempt to gain control of previously untaxed income flows, with particular attention being paid to offshore jurisdictions such as those in the UK's Channel Islands, the Caribbean, and European countries such as Luxembourg, Liechtenstein and (especially) Switzerland.
Jersey also reported disappointing figures for the first year of the Directive. Individuals who reside in an EU Member State with relevant savings income arising in Jersey can opt for information on the savings income received to be exchanged with their domestic tax authority rather than be liable to the retention tax. It is estimated that approximately 30% have chosen this option, but the Jersey authorities expect this percentage to increase with time. (The retention tax will eventually increase to 35%).
A statement by the States of Jersey revealed that both the Comptroller of Income Tax and the President of the Jersey Bankers’ Association are satisfied that the process of exchanging information and the retention of tax has worked smoothly.
"Both information and tax have been transferred efficiently to the Income Tax Department for onward transmission to the relevant competent authorities in the EU Member States before the 30 June 2006 as required under the Agreements," the statement explained.
Commenting, Senator Walker, Chief Minister, noted that: “This first payment of retention tax to the EU Member States is ample evidence, if it is needed, of the good neighbor policy we follow in our relations with the EU, a policy that we expect to see reciprocated." A straightforward calculation shows that, at 15% tax, with interest rates of 5%, the GBP13m collected would represent underlying deposits of GBP3.5bn. Since Jersey's assets, including bank deposits and investment funds, are nearly GBP400bn, according to a recent announcement by Jersey Finance, those figures suggest that only a tiny fraction of assets held on the island are being caught by the Directive.
Billions of Euros in assets have reportedly flown to parts of the world where the EU directive cannot reach such as Hong Kong and Singapore, while in August 2005 alone, shortly after the directive entered into force, nearly EUR7 billion poured out of Swiss accounts into Luxembourg Sicav II bonds, which are outside the scope of the Directive.
While opinions in the matter vary, it is generally thought that Hong Kong, Singapore and Dubai have benefited significantly from increased inflows of cash from European investors since the introduction of the directive. The EU will probably be unsuccessful in its attempts to bring further countries under the Directive, but will clearly attempt to prepare a revised version of the Directive, which might include some or all of the following:
- A change in the definition of a Paying Agent to include foreign branches of banks who have headquarters within jurisdictions covered by the Directive, eg the Singapore branch of a UK bank.
- A change in the definition of beneficial owner to catch private companies if their ultimate owners are individuals resident in the EU, and the settlors of many types of discretionary trust if they are EU-resident.
- Inclusion of individuals who receive income through partnerships.
- All types of partnership will be covered - the partners will be treated as the owners.
- The definition of interest (returns on savings) to be broadened to include non-UCITS funds, unregulated funds, derivatives comprising or based on interest e.g. structured products, baskets, certificates and interest swaps.
- The inclusion of insurance companies as paying agents, and application of the Directive to interest received whether or not it is paid out to policy-holders.
While this may seem a scary list, it must be remembered that the EU had a torrid time of it trying to get agreement on the original Directive, and it is a certainty that countries such as Switzerland and Liechtenstein would resist such proposals to the death.
The EU will probably try, however. It hasn't yet understood that there is a law of diminishing returns in the world of taxation.