EU Tax Savings Directive



The E.U. banking secrecy jurisdictions are: Belgium , Luxembourg and Austria . Belgium , Luxembourg and Austria agreed to the Directive, on the condition that other non-E.U. jurisdictions agree to the terms of the Directive also. These other non-E.U. jurisdictions are: Switzerland , the USA , Liechtenstein , Andorra , Monaco and San Marino and the dependant territories of E.U. States. The European Union must agree that these other jurisdictions will implement (or already have) "equivalent measures". The purpose of the equivalent measures is to protect the banking industry in Belgium , Luxembourg and Austria .

The USA is considered to already possess equivalent measures. This in itself is an interesting development, since the extent to which exchange of information measures in the USA would be compatible to the new regime in the European Union is questionable.


The other non-E.U. jurisdictions do not, and will need to reach agreement with the European Union for equivalent measures to be installed. The position of Switzerland is paramount amongst these other non-E.U. jurisdictions. The other non-E.U. jurisdictions are widely expected to follow Switzerland 's lead.


The Directive will have massive impact on the banking industry in Europe , particularly Switzerland . Substantial resources will need to be devoted by the industry to properly plan for and manage the consequences of the Directive. Compliance systems will need to be introduced to effectively classify and define payments as "interest" or as "non-interest", and to track the potential payees under accounts. Communication of the tax and its consequences will need to be made to the client base. Restructuring and planning opportunities will exist at the client level.


The following summarises the background and objectives of the Directive. In light of this some comments are then made on the significance of the Directive. The mechanics of the Directive are then outlined. This outline includes speculation as to possible planning methods around the Directive. Comment is then made on the potential impact of the Directive on the private banking industry in Switzerland.


This article is the first of a two-part series on the European Union Savings Tax Directive. This portion will focus on what is certain in the European Union Savings Tax Directive, and will introduce some of the uncertainties that the European Union Savings Tax Directive raises. The second part will continue the analysis of areas of uncertainty under the European Union Savings Tax Directive.


I. Background to the Directive

On June 3, 2003 , the ECOFIN formally adopted the tax package of the Directive. The Directive will be effective from January 1, 2005 , assuming each E.U. jurisdiction enacts the relevant provisions by January 1, 2004 .


The June 3, 2003 agreement followed a period of negotiation after preliminary agreement had been reached on January 21, 2003 . The January 21 st preliminary agreement was intended to have been formally adopted in March 2003.


The Directive builds upon the conclusions of the FEIRA European Council, and subsequent meetings of the ECOFIN. The conclusions of the FEIRA European Council included the automatic exchange of information between E.U. States as an ultimate aim. Importantly, the ultimate aim of the Directive, as agreed on June 3, 2003 was not stated as the automatic exchange of information between E.U. States. The ultimate aim of the Directive is to enable effective taxation of savings income in the State in which an E.U. person resides. The initial objective of the exchange of information between E.U. States has been altered to be a possible method through which the objective of effective taxation of savings income can be achieved. This is an important nuance. It is probably this that has allowed agreement to be have been reached.


Reservations had existed on two levels: (i) that the banking secrecy jurisdictions would lose their banking secrecy by exchanging information, and thereby lose capital to non-E.U. banking secrecy jurisdictions; and (ii) that even if some alternative measure were adopted to protect banking secrecy ( e.g. , the introduction of a withholding tax on savings) then these jurisdictions would still be at a competitive disadvantage vis-à-vis the non-E.U. banking secrecy jurisdictions.


Specifically, Austria , Luxembourg , and Belgium refused to enter into any sort of agreement until there was sufficient guarantee that the USA , Switzerland , Liechtenstein , Monaco , Andorra , San Marino , and the dependant territories of E.U. States would be bound by equivalent measures. If these jurisdictions agreed to possess equivalent measures, or would agree to be similarly bound by any agreement executed by the European Union, then Austria , Luxembourg and Belgium would not be at a competitive disadvantage and therefore would be willing to enter into the agreement themselves. In other words, implementation of a savings directive will be contingent upon the successful execution of bilateral agreements between the European Union on one hand, and each of the USA , Switzerland , Liechtenstein , Monaco , Andorra and San Marino , but also the dependent and associated territories in the Caribbean , on the other hand, providing that equivalent measures do not already exist. This means that the implementation of the Directive may be postponed if only one single E.U. state or other country has not implemented equivalent measures before June 30, 2004 .


Interestingly, the USA has been declared to already possess equivalent measures. For this reason the implementation of the Directive will not rely upon the successful conclusion of an agreement with the USA . The decision that the USA already possesses equivalent measures is not without controversy. Fundamentally, it is probably a decision led by Realpolitik. Acquiescence by the USA to the provisions of the Directive would likely have been extremely difficult to achieve in practice.

In any event, agreement on the Directive is a breakthrough, since the matter of exchange of information and taxation of savings has been on the E.U. agenda for several years, without resolution.


The successful execution of agreements with the third party jurisdictions is likely. A draft agreement has been negotiated between Switzerland and the European Union, which seems close to execution. Debate is continuing on the draft agreement. The European Union has stated that the draft constitutes its "final offer" on the matter, whereas Switzerland is still seeking to negotiate some terms. Irrespective, the expectation is widely held that the draft will be executed, if not in the current format, then close to it. A draft of the agreement is not publicly available.


II. Operation of the Directive

The Directive provides for the automatic exchange of beneficial ownership information of accounts. Where a tax resident of an E.U. jurisdiction is the beneficial owner of an account in another E.U. jurisdiction where savings income is generated, the details of the income generated and of the beneficial owner will be delivered to the relevant authority in that beneficial owner's resident jurisdiction. The Directive is only applicable if the beneficial owner is an individual. For Belgium, Luxembourg and Austria, and almost certainly for the non-E.U. jurisdictions that have not been identified as possessing equivalent measures, a withholding tax on the savings income will be levied instead of the information about that beneficial owner and the interest income being exchanged. The 10 countries that will enter the European Union in 2004 are not entitled to levy a withholding tax and will therefore be obliged to exchange information automatically.


The mechanics for the exchange of information, and for the collection of the withholding tax, are outlined in the Directive. However, the precise application of the mechanics will raise questions. The mechanics stipulated in the Directive are outlined below. The different components for the operation of the mechanics are then analysed more closely. The questions that arise in respect of these components are also considered.


A. Mechanics

The Directive will require Member States to collect information relating to the beneficial owner, and the savings income received, in respect of tax residents of Member States, and to exchange this information with the relevant authorities in those Member States. If the Member State is Austria , Belgium or Luxembourg , (or the non-member countries that agree to the Directive - "third countries") then withholding tax will need to be levied on the savings income generated.

The beneficial ownership information required to be collected relates to the identity and residence of the beneficial owner.

"Paying agents" are required to collect the beneficial ownership information, and the savings income information, and to pass this on to the relevant authority in that jurisdiction where the account is held. The relevant authority of that jurisdiction is then required to exchange the information with the Member State where the beneficial owner is tax-resident, at least annually. Presumably the total information in respect of each Member State would be collated, and delivered together.

The withholding tax on the savings income will be levied at a rate of 15 percent during the first three years starting on January 1, 2005 . It will increase to 20 percent from January 1, 2008 , and to 35 percent from January 1, 2011 (the "transitional period").

The revenue received from the savings tax will be shared between the withholding State, and the State of the E.U. tax resident beneficiary according to a 75/25 ratio - i.e. , such that the withholding State will receive 25 percent of the savings tax collected, and 75 percent will be paid to the E.U. resident's State.


B. Paying Agent

The collection of information, or the levying of the withholding tax, will occur via a "paying agent". A paying agent is defined as "... any economic operator who pays interest to, or secures the payment of interest for the immediate benefit of, the beneficial owner, whether the operator is the debtor of the debt-claim which produces the interest or the operator charged by the debtor or the beneficial owner with paying interest or securing the payment of interest". This definition is extended to include "(a)ny entity established in a Member State to which interest is paid or for which interest is secured for the benefit of the beneficial owner ..."

Clearly a bank or other financial institution will be a paying agent. However, the definition of paying agent includes "any entity" established in a " Member State " that will receive interest for the benefit of the beneficial owner. The limit of "any entity" is not clear. Further, it is important to note that it will only be Member State entity to which the obligation will apply. The scope of " Member State " does not include the other jurisdictions which will become parties to the Directive. These are "third countries".

It is clear from this definition that a company incorporated in England or Ireland will be included as a paying agent, where a benefit is paid for the beneficial owner. It appears from the text of the Directive that it would seem not to include a company incorporated in a third country, such as Jersey , or the British Virgin Islands . However it is the intention of the European Union to extend the provisions of the Directive to these third countries. In any event it would not include companies incorporated in other countries, than Member States or third countries, such as Singapore . Similarly, a foundation founded in Liechtenstein might possibly be included in the definition, but then certainly it would not include a foundation founded in Panama . However, this is an area of uncertainty that will be discussed in greater detail in the next portion of the article.

In respect of a trust, the situation is even less clear. Is it correct to consider that a trust, with a Jersey trustee, for example, as an "entity"? A trustee has legal personality, but a trust itself is not correctly an entity, but is rather a legal relationship. If a trust was to be included in this definition of "entity", and the definition would be extended to third countries as well as Member States, then it would seem that the definition could simply be avoided by using, for example, a New Zealand trustee. Again, this is an area of uncertainty that will be discussed in greater detail in the next portion of the article.

Clearly an arrangement that would avoid being captured by the definition of a paying agent will not necessarily avoid the imposition of the withholding tax. This is because the actual financial institution at which an account is held will be defined as the paying agent. However, the lack of precision in the definition of what exactly will be a paying agent will lead to problems. Both the financial institutions and the administrators of arrangements that may or may not be an entity and thus a paying agent, will be confused as to their obligations.


C. Beneficial Ownership

The "beneficial owner" is defined in Article 2 of the Directive as: "... any individual who receives an interest payment or any individual for whom an interest payment is secured, unless he provides evidence that it was not received or secured for his own benefit ..."

Information pertaining to the identity and residence of the beneficial owner is then required to be collected by the paying agent. The minimum standards for this information are then further defined. For contractual relations that were commenced before January 1, 2004 the information already at hand will need to be used to supply the identity and residence. After this time the tax identification number of the beneficial owner allocated by the beneficial owner's jurisdiction of residence will also need to be collected, if one has been issued.

Although no comment is made, the beneficial ownership accorded to the receipt of savings income will presumably need to be identifiable. A beneficiary under a trust, where the trustee has been granted discretion to distribute and allocate income amongst a class of beneficiaries, should not be a "beneficial owner" according to the definition of the Directive. This is because no one beneficial owner is identifiable. This may particularly be the case where a class of beneficiaries under a trust includes both tax residents of E.U. States as well as non-tax residents of E.U. States.

It is difficult to imagine that the intention is to penalise any possible beneficiary under an account, whether an interest has been vested or assigned to that beneficiary or not. If, however, this is the intention, then the practical compliance issues that will result will be immense. In any case, planning opportunities will exist for structures to be erected where the beneficial entitlement will be difficult to assign. Furthermore, the burden placed upon the banking industry to track and to identify the beneficial ownership behind accounts will be substantial.


D. Interest Payments

Interest is defined broadly. Interest is defined as "... interest paid, or credited to an account, relating to debt-claims of every time, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures ... interest accrued or capitalised at the sale, refund or redemption of the debt-claims referred to (above) ..."Income deriving from interest payments, either directly, or through entities defined as paying agents that collect income from certain further-defined vehicles, is also defined as interest.

The reason for interest having been defined broadly is clear. If the duty to exchange information, or to levy a withholding tax on savings income, could be easily avoided through financially re-engineering a product, then the Directive would easily be avoided. Indeed, it is difficult to imagine that some attempts in the industry to engineer products so as to escape this definition of interest will not occur.

Mention also needs to be made of the particular case of negotiable debt securities. Where a negotiable debt security has been issued before March 1, 2001 (or in other particular defined circumstances), and provided that no further issue is made after March 1, 2002, then income earned on it will escape the definition of "interest". This exception will only apply until December 31, 2010 .


III. Significance of the Directive for Switzerland

As stated above, although agreement has not yet been reached between the European Union and Switzerland on the Directive, it is expected soon. When it is adopted, Switzerland will impose the withholding tax regime, rather than the automatic exchange of information regime. Indeed, the Swiss Federal Department of Finance has released on its official website the heads of the draft agreement. A review of these shows that they contain the same stipulations and requirements as are contained in the Directive. A table (although in German) describing the impact of the agreement on different types of investment accounts, and financial products, has also been published on the website by the Swiss Federal Department of Finance.

Also of interest is the comment made on the willingness of Switzerland to provide administrative assistance (exchange of information), in cases of tax fraud. Switzerland does not only commit itself to providing assistance in cases of tax fraud under the agreement, but it states it will begin to adopt this language in bilateral treaties, outside the scope of the Directive. As surprising as this immediately appears, it will surely rely on an act falling within the definition "tax fraud" under both the Swiss conception as well as the conception of a foreign jurisdiction. Tax fraud in Switzerland requires something more than the simple act of tax evasion.

By specifically broaching the topic of exchange of information in this manner, Switzerland appears to be marking a line in the sand, that it will very unlikely be willing to enter an automatic exchange of information agreement in the foreseeable future.


IV. Conclusion

The Directive evidences several extremely interesting and important developments. On one hand, it could be argued that the Directive displays a softening of recent supra-national pressure towards the goal of automatic exchange of information between jurisdictions. The Directive does seem to indicate an acceptance by the European Union that banking secrecy will continue. This is a most remarkable genesis - the development from an initiative to ultimately dispel banking secrecy, it has morphed rather into a regulatory framework that will, if not ensure, then quite possibly prolong the future of banking secrecy in Europe .


These grander questions put to the side, what is certain about the Directive is that it will have massive significance to the way banking is conducted in the secrecy jurisdictions. The banks will have to institute a system whereby interest paid from all accounts will need to be monitored. Planning opportunities will also exist, of which some clients will want to take advantage. Devising, communicating, and implementing planning opportunities for these clients will also require substantial resources. The industry will need to be well-prepared for the challenges that the introduction of the Directive will bring.

Switzerland , not surprisingly, is a major protagonist. Switzerland is the major jurisdiction with which agreement needs to be reached by the European Union for the Directive to be effective, and there are of course political negotiations that naturally follow from this.


It is debatable how truly impressive Swiss banking secrecy remains, or will remain, but since it seems that the wider perception is held that it does remain, then the maintenance of banking secrecy (or the veneer of banking secrecy) cannot be understated as far as the vitality of the Swiss banking industry is concerned.

Should you require further advice as to how you may manage your affairs, so that you do not fall under this Directive, please Contact Us.


Corporate accounts are not subject to this legislation. Under US FATCA legislation Financial Institutions outside the USA (who are signatories to FATCA by country) are required to report details about the beneficial owners or signatories of any US person or entity with a Bank account to the IRS.

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