Be prepared for the savings tax directive

Bob Reynolds is consultant editor of Offshore Red.

Families that have invested offshore to avoid disclosing where they hold their savings must review their options now, say experts familiar with the European savings tax directive. Bob Reynolds explains

After years of political chicanery, the European savings tax directive looks destined to be implemented on 1 July 2005. To have reached this juncture is a remarkable testimony to the tenacity of the officials of the European Commission and the finance ministers of France, Germany and the UK.

It seems a lifetime ago they set out on their journey to oblige the members of the EU and their associated jurisdictions to sign up for this controversial directive. It provoked some of the bitterest conflicts inside the Union and between the EU and its dependent states.

Many offshore jurisdictions were flatly opposed at the outset because the directive gave Switzerland – already the favoured destination for personal savings – a significant advantage. While Jersey, Guernsey, Cayman, the British Virgin Islands, the Isle of Man and others would be obliged to disclose personal details of the status of EU account holders, Switzerland would not.

The directive's protagonists hoped to get the US and Switzerland to give their support. America was not interested. The Swiss, however, were another matter.
 
From the start, winning Swiss compliance was the hardest nut to crack. But despite the unwavering line of countless voices from Bern and Zurich, the Swiss knew their policy of isolation from the rest of Europe was costing them. They wanted a variety of trading agreements which would allow the federation to secure its prosperity for decades into the future.

And so, after years of playing two steps forward four steps back, Swiss ministers have promised the legislation will be in place for compliance by 1 July. Old hands are still doubtful but this time it looks as if the Swiss will be unable to put off the inevitable.

The deal is not entirely the package the EC had in mind originally. The plan was for a universal acceptance of automatic information exchange for all members and dependent territories. For three EU members this was intolerable. Luxembourg, Austria and Belgium have agreed only to a withholding tax.
 
In the same vein, the Channel Isles and the Isle of Man would not agree to disclosure. In fact, the Manx finance sector industry saw no problem with information exchange but believe the three jurisdictions should adopt a common line.

Phil Austin, CEO of Jersey Finance, says: "The European savings tax directive is one of three measures relating to tax which together are known as the EU tax package. In summary, the directive is an agreement between the member states of the EU to exchange information automatically with each other about customers who earn savings income in one EU state but reside in another (the automatic exchange of information option)".

The difference between the two approaches lies in disclosure. Automatic exchange of information means that local agents must supply details of accounts held by EU residents to their home tax agencies. In contrast, where a withholding tax exists, a sum of money is remitted to the home authority which is the total for all residents of that state. No details of individual account holders are supplied. Initially the tax is set at 15% but it will rise in stages to 35% of the interest earned on savings.

Stephen Herring, tax partner at the UK's BDO Stoy Hayward, says: "We live in an era of greater disclosure. Taxpayers should have no problem with disclosure. They do not pay tax on money earned outside the home jurisdiction".

For family offices, he says that now is the time to begin a complete review of all holdings to ensure the information which is supplied to home tax authorities is up to date and accurate.

Financial adviser Nick McBreen, of Worldwide Financial Planning which specialises in offshore investments, says: "Some families have invested offshore to avoid disclosing where they hold savings. In the present climate, this is a bad policy. Families should take the opportunity to reassess their holdings ahead of the introduction of the savings tax in July.

"Non-disclosure is not really an option and any failure to re-examine options now could lead to significant problems further down the line."

Their argument is supported by PwC's Charlotte Worthington who says: "All accountants regard withholding taxes as counter productive. Clients really should have no problem with disclosure." She says that a well-run family office should have a clear strategy for its investments and these should be coherently managed. The advent of 1 July should provide no surprises for the family and decisions on the direction of the strategy in the light of the implications of the directive should be made with the intention to disclose.

Those territories backing a withholding tax during the transitional period will be deducting at source from income earned by EU resident individuals on savings held in other EU countries.
 
According to Jersey Finance, "The directive specifies that any jurisdiction implementing the withholding tax option will also need to provide one or both of the following procedures in order to ensure that a relevant payee may request that no tax be withheld:

- a procedure which allows the relevant payee expressly to authorise a paying agent to report information to his member state of residence;
- a procedure which ensures that withholding tax is not levied where a relevant payee presents to his paying agent a certificate drawn in the name of a competent authority of his member state of residence".

For individuals, banks and other paying agents will automatically deduct tax from interest and other savings income earned and pass this to their local tax authority, indicating how much of the total amount relates to customers in each member state. The local tax authority will then keep 25% of the total amount collected and remit 75% to the various tax authorities within the member states.

Austin emphasises: "The receiving state gets a bulk payment but does not receive personal details in respect of individual customers".

Politically and commercially, the key question is how long can those states which have adopted a withholding tax hold out given the large majority of subscribers to disclosure?