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Contents:

Introduction

Executive Summary

Origins of the Savings Tax Directive (STD)

Impact of the STD

Table of Jurisdictions

How To Escape The STD

FAQ

STD Glossary

Text Of The Savings Tax Directive

Disclaimer: The Lowtax Network has taken reasonable care in assembling this report but accepts no liability for any actions taken or not taken as a result. In particular, this report does not constitute investment advice. Anyone contemplating an investment, or a change to a current investment, needs to take appropriate professional advice.

Introduction

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 swingeing 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 channelling 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 emphasised 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 neighbour 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.

Executive Summary

The European Union Savings Tax Directive (STD), which went into effect on 1st July, 2005, in fact forms merely one part of a major tax reform package launched by the European Commission in 1997. As originally drafted, the STD aimed at a uniform 'information exchange' regime to apply across the Union, with all countries agreeing to report interest on savings paid to the citizens of other Member States to those States' tax authorities.

Because of resistance from EU Member States with strong traditions of banking secrecy, the Commission had to allow Austria, Luxembourg and Belgium to apply a withholding tax (at 15%) until 2009. Many of the UK's offshore financial centres have been forced to join the STD, along with the Netherlands Antilles, Aruba and some European centres (Andorra, Monaco, Liechtenstein and San Marino). Most of these places took the withholding tax route, as did Switzerland, which was the hardest nut for the EU to crack.

The STD applies to many types of return on savings instruments, all loosely described as interest, when received by individuals, but does not affect interest paid to companies. Under the information exchange system, the identity of recipients will be known to their home tax authorities; when tax is withheld, the identity of the recipient will not be reported, thus preserving confidentiality.

The Origins of the Savings Tax Directive

The now notorious European Union Savings Tax Directive in fact forms merely one part of a major tax reform package launched by the European Commission in 1997. They certainly didn't expect their proposals to lead to an 8-year battle involving Switzerland, the USA and twenty or more offshore financial centres, only eventually resolved by one of the stickiest fudges ever cooked up in Europe's capital city.

The Commission's tax package included two other major elements, the Code of Conduct Committee's assault on Harmful Tax Practices, and a proposal for a Council Directive to eliminate withholding taxes on payments of interest and royalties made between associated companies of different Member States. The interest and royalties directive was by far the least contentious of the three initiatives, and after being held up for years by the interminable negotiations over the Savings Tax Directive, it was agreed by the Council and put into effect in 2003.

This is not the place to describe the tortuous history of the Code of Conduct Committee, a kind of 20th Century version of King Henry VIII's Star Chamber presided over by the baleful Dawn Primarolo, whose spring-like name brought only autumnal shadows to the 66 sets of tax incentives targeted by the Committee. The Primarolo Committee, as it became known, found its work entangled with the twin assaults of the OECD and the FATF on 'offshore', but was partly successful in smoothing the fiscal playing field for companies in the EU and its 'near abroad' of associated tax havens. Many of the 66 'harmful tax practices' have survived in truncated form, but many others have been abolished, albeit with extended 'grandfather' provisions for existing beneficiaries.

The Original Savings Tax Directive

As originally drafted, the Savings Tax Directive (STD) aimed at a uniform 'information exchange' regime to apply across the Union, with all countries agreeing to report interest on savings paid to the citizens of other Member States to those States' tax authorities, thus removing the possibility for citizens of the Union to hide the returns on their savings from their home tax authorities. It's evident that such a proposal runs headlong into the tradition of banking secrecy which was well-established in a number of Member States, notably Austria, Luxembourg and Belgium.

It was also envisaged from the start that EU Member States would impose information-sharing regimes on their associated dependent territories, making up a substantial proportion of the world's tax havens. Many of these were British, of course, and two are Dutch, so that from the beginning the UK's financial sector regarded the STD as a Franco-German conspiracy against 'les Anglo-Saxons'.

Alongside the STD, and planned in coordination with it, was the OECD's 'level playing field' attack on 'unfair tax competition' which sought to iron out the low tax regimes applying in offshore financial centres and force the centres to agree to information-sharing regimes that were equivalent to the STD.

Opposition To The STD

Opposition to the STD focussed initially on the threat to the City of London's Eurobond business; it was only later that the offshore dependencies woke up to the threat when they realised with horror that, far from supporting them against the dragons of Brussels, the British Government in general, and Gordon Brown in particular, were going to cooperate willingly and even enthusiastically with Brussels in imposing the STD on their fragile economies, so painfully emancipated (as they would see it) from dependence on slaves, sugar and bananas.

It is important to realise that the STD represented just the European dimension of a world-wide assault by the high-taxing countries of the OECD on the 'leakage' of tax represented by 'offshore' in its various manifestations. This grand vision of a world without low taxes (very Colbertian in its origins) was defeated partly by the new US Republican administration which took power in 2001 and partly by the strenuous efforts of 'offshore' itself, which perhaps improbably saw an alliance between numerous island financial centres fighting effectively against the massed tax inspectors of the OECD.

The gradual routing of the OECD by 'offshore' in 2001 and 2002 forms the backdrop to the context of the later stages of the EU's battle to impose the STD in Europe. Had the OECD been successful in creating a nice, smooth, global fiscal playing field, there is little chance that the stand-out EU Member States would have been able to ally themselves with Switzerland and the US right wing in their effective rearguard action against the STD.

The Feira Summit

Early negotiations over the STD in 1999 and 2000 saw strong objections voiced by a number of Member States in defence of their own interests.

In March, Taxation Commissioner Frits Bolkestein reported to the Council on the discussions that had taken place with Switzerland, Liechtenstein, Monaco, Andorra and San Marino since the Council meeting on 18th February. But in the same month, the Caymanian authorities launched legal proceedings in the EU's Court of First Instance in order to challenge the European Union's decision not to allow a consultation process over the STD. Cayman's David and Goliath act didn't last long, however, and in December Dawn Primarolo delivered an official ultimatum, warning the jurisdiction's government once again that if it failed to implement the European Union's Savings Tax Directive voluntarily, the United Kingdom would legislate on its behalf.

By March, 2004, the UK was able to tell the Ecofin Council that all of its dependent territories had agreed to comply by the rules of the STD. But Frits Bolkestein had to admit to the Council that there has been an unacceptable level of progress made in the EU’s negotiations with Andorra, Monaco, Luxembourg and Liechtenstein. By May, however, Bolkestein reported that even the more strident Member States, France, the Netherlands and Austria were able to give their approval to a compromise deal worked out between the EU, Switzerland and Luxembourg allowing these countries to adopt the directive whilst retaining a degree of banking secrecy.

The compromise ensured that Switzerland would provide legal assistance under the terms of the Schengen agreement in cases relating to indirect taxes such as customs, VAT, and alcohol and tobacco levies, but will be exempted from providing such assistance in cases involving direct taxation. Luxembourg, which had voiced concerns that a separate deal with the Swiss would harm its own banking industry, was assured that it would not be required to make any sacrifices in terms of banking secrecy which Switzerland and other countries were not also prepared to make.

The Race To The Finish 

In June, 2004, it was announced that the Council of Finance Ministers had reached a unanimous agreements on “all matters of substance” with dependent and associated territories and certain other third countries in respect of the Savings Tax Directive. “I am very pleased to report that the Commission was able to inform the Council today that not only Switzerland, but also Andorra, Monaco, San Marino and Liechtenstein have all agreed to put in place equivalent measures to those to be applied by the EU’s Member States as regards the taxation of income from savings,” announced Taxation Commissioner Fritz Bolkestein.

Mr Bolkestein continued: “In particular, they have all agreed to impose a withholding tax on the interest income of EU residents at the same rate as Austria, Belgium and Luxembourg and to hand over 75 per cent of these revenues to the Member State of the EU resident concerned. They have also agreed to exchange information on request in criminal or civil cases of tax fraud or similar misbehaviour.”

There were problems over timing, however, and the EU was obliged to delay STD implementation by six months to 1st July, 2005. The Swiss warned the European Commission that even the new July 1 deadline could only be met "in the absence of a referendum”. Under Swiss law, voters have 100 days after a law is published to collect sufficient signatures in a petition to challenge the legislation.  

The key elements of the agreement with Switzerland also constituted the basis for agreements with other third countries, namely, Andorra, Liechtenstein, Monaco and San Marino. The Commission also confirmed that “all matters of substance” with the dependent and associated territories of the Netherlands and the United Kingdom had been resolved, and model agreements had been drafted to allow for bilateral savings tax agreements between member states and each of these territories.

In November, 2004, the Swiss government indicated that a referendum on the Savings Tax Agreement was unlikely, and that the legislative process needed to approve the adoption of the Directive and the Bilaterals II agreements was proceeding smoothly. In comments made after a regular meeting of finance ministers from countries in the European Free Trade Area, Dutch Finance Minister Gerrit Zalm revealed: “The Swiss minister made us happy by informing us that everything was well underway with the savings (tax) agreement.”

In December, 2004, the Swiss parliament approved a plan to distribute some of the proceeds from the EU Savings Tax to the cantons, in a move which cleared the path towards a final ratification of the Swiss-EU agreement on the STD. Both chambers of parliament then approved the ‘Bilaterals II’ treaty, which encompasses nine separate agreements with the EU including the savings tax directive, the Schengen agreement on freedom of movement and cross border cooperation on crime, among other measures.

The agreement means that three quarters of the revenues raised as a result of the savings tax directive flows back to EU countries, with the remaining quarter distributed to the Swiss state and Swiss cantons.

So the deed was done, and the EU Savings Tax Directive came into force in all member states, and all those offshore jurisdictions beholden in one way or another to the member states, on 1st July, 2005. Only Bermuda, through an accident of geography, was left out.

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Impact of the Savings Tax Directive

There are considerable technical and administrative implications of the Savings Tax Directive (STD) for the financial services industries and the tax departments of all those countries that are caught in the STD's net; but here we are concerned just with the impact of the STD on investors and savers, so we will be describing technical and administrative changes only in so far as they impact on the relationship between relationship between financial services agencies and their clients.

More than 30 countries and jurisdictions are affected by the STD; they are listed in a Table in the next section, with basic information about the regime which each territory is adopting. Here we will focus on the types of financial product and the types of income that will be affected by the STD, and on the mechanics of information-exchange and of withholding.

Who Is Affected?

The Directive does not apply to persons (including EU Nationals) who are resident outside the 25 Member States of the EU or the Crown Dependencies of the UK (Jersey, Guernsey and the Isle of Man). Any new countries joining the EU will be obliged to accept the information-sharing variant of the Directive, and their residents will be caught by the STD as and when those countries accede to the EU.

If you are an individual (natural person) who is resident in an EU Member State, and earn bank interest or other savings income (as defined below) on deposits or investments held in your own name in another EU Member State, third country or territory included in the Table below, then it is likely that you will be affected by the STD.

NB: Alone among non-EU countries and territories, the jurisdictions of Jersey, Guernsey and the Isle of Man have reciprocal STD agreements with the Member States of the EU. This means that a resident of any of these three territories who receives savings income in a Member State of the EU will be subject to the STD, through information-sharing or withholding tax as appropriate.

Definition Of Savings Income

There are four main categories of savings income under the scheme:

• Interest paid out on debt-claims or credited to accounts;
• Interest rolled-up and paid out when a debt-claim is repaid or sold;
• Distributions made by certain unit trusts and other collective investment funds which have invested more than 15% of their investments in debt-claims;
• Accumulated income paid out when units in certain collective investment funds that have invested more than 40% of their investments in debt-claims are redeemed or sold.

In simpler language, savings income is therefore essentially interest earned on bank deposits, interest from, and proceeds on the sale or redemption of, certain bonds and income from certain types of investment funds (principally open-ended money market retail funds).

Most other types of income (for example, dividends on ordinary or preference shares of companies, salary and pension payments) fall outside the definition and are therefore outside the scope of the STD. Some specific types of payment which do not qualify are as follows:

• Payments under contracts for differences;
• Manufactured payments arising during stock loans or under sale and repurchase agreements (including where the underlying security is a money debt);
• Debts which do not arise from a transaction for the lending of money (for instance where there is a late payment and compensation interest is paid);
• 'Grandfathered bonds'. Certain negotiable debt securities are not treated as money debts if they meet certain conditions for the duration of a transitional period which will end no later than 31 December 2010. These securities (“grandfathered bonds”) do not then count as money debts for all purposes of the regulations: interest, premiums and discounts derived from these bonds are not savings income; and investment in these bonds does not count when deciding whether the thresholds which determine whether income from certain collective investment funds is savings income have been passed. A security is a grandfathered bond if it was first issued before 1 March 2001 or the prospectus was first approved by the appropriate regulatory authority before that date, and no further issue was made on or after 1 March 2002. If the bond is a government bond (or issued by a related public authority or an international organisation and a further issue is made on or after 1 March 2002, the whole of the issue (whether made before, on or after 1 March 2002) is not a grandfathered bond. The whole issue of the bond is a money debt. If the bond is issued by another type of issuer (e.g. a commercial company) and a further issue is made on or after 1 March 2002, only the part of the issue made on or after 1 March 2002 is not a grandfathered bond. This part of the bond issue is treated as a money debt; the rest of the issue (made before 1 March 2002) is not a money debt.
• Distributions and other payments derived from funds which are not UCITS or elective UCITS are not reportable as savings income under the regulations. A UCITS is an ‘undertaking for collective investment in transferable securities’ authorised in accordance with the UCITS Directive. Non-EU funds may or may not be UCITS depending in a complex way on their nature. Even when a fund is a UCITS, its distributions are only taxable under the STD when the 15% threshold for income from money debts is breached. The rules are complex.
  

Definition Of 'Paying Agent'

The STD states that ‘paying agent’ means any economic operator who pays interest to or secures the payment of interest for the immediate benefit of the beneficial owner. The ‘operator’ can either be the debtor of the debt claim or can be the operator charged by the debtor or the beneficial owner with paying or securing the interest.

The paying agent is always ‘the last link in the payment chain’ before the relevant payee or residual entity and is the person that actively initiates a payment directly to a relevant payee or residual entity, or to his or its instructions. However, banks, other financial institutions or other businesses which have a role in the payment process are not regarded as making a payment if their role is essentially passive (they act on instructions from others) or auxiliary (they merely provide services to help the paying agent). A bank or similar institution does not therefore make a payment merely by issuing or sending a cheque, or arranging for the electronic transfer of funds on behalf of one of its customers.

A financial institution which has outsourced many of its administrative or back-office functions to an independent contractor remains responsible for the transaction and is therefore a paying agent. However, registrars or other third parties involved with making payments of interest on bonds or from funds are likely to be paying agents because they have a direct relationship with the beneficiary. Likewise, trust companies, stockbrokers or other professionals may be paying agents. The situation can be complicated where trusts or their equivalent (eg foundations) are involved.

The Two STD Regimes

With minor variations, countries or territories applying the STD use one of two regimes, an 'information-sharing' regime or a 'withholding tax' regime. The Table in the next section specifies which regime is in force for each country or territory.

In the case of some countries applying the withholding tax regime, the client has a choice to accept information-sharing instead of being taxed. However, this choice is more apparent than real in most cases, since it depends on the willingness of a financial institution to enable the choice, and many banks or funds may not wish to take on the extra administrative work that is necessary to implement information-sharing.

Information-Sharing

You are paid the interest on your savings gross, ie without deduction of tax, but the bank or other financial institution which you patronise (known as a 'paying agent') will require to provide details of your tax residence.

You may be asked for your Tax Identification Number (TIN). This is your tax registration number in your country of residence. The STD requires banks and other paying agents to obtain customers’ TINs where possible. Whatever information the banks have, they will pass on to the tax authorities in your country of residence, along with information about the income you have received (as defined above).

The minimum amount of information that 'paying agents' (banks and other financial institutions - see definition above) are required to pass on to the 'competent authorities' of member states consists of: identity and residence of the beneficial owner; name and address of the paying agent; account number of the beneficial owner; and interest payment data including the amount of interest income earned, plus information regarding any proceeds from sale, redemption or refunds.

If someone claims to be resident in a country different to that on his or her passport or I.D. card, the rules stipulate that "residence shall be established by means of a tax residence certificate issued by the competent authority of the third country in which the individual claims to be resident."

Some countries or territories have issued sets of regulations to their financial institutions which may define the extent of the information you are required to give. In the absence of this local legislation, there there is no obligation placed on banks or other paying agents to request the TIN; agents are permitted to rely on passports or identity cards, or other documentary proof of identity that is in their possession.

Withholding Tax

Under the withholding tax option, banks and other paying agents automatically deduct tax from interest and other savings income earned and pass it to their local tax authority, indicating how much of the total amount relates to customers in each Member State.The local tax authority then keeps 25% of the total amount collected and remits 75% to the various tax authorities within the Member States.

The receiving country gets a bulk payment which is not broken down in terms of the individuals who are covered.

The rate of withholding tax are 15% from July 2005, 20% from 1^st July 2008, and 35% from July 2011.

However, those EU Member States which are initially permitted to apply a withholding tax (Austria, Luxembourg and Belgium) will be obliged to switch to the information-sharing regime by 2009. Only third countries (eg Switzerland) and (perhaps) some dependent territories will be able to continue to apply the withholding tax option after that date.

NB: In some countries, notably Jersey, Guernsey and the Isle of Man, the withholding tax is called a 'retention tax'. But it's exactly the same animal.

In the three Member States which will apply a withholding tax, the STD specifies that they 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; and/or
• 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.

The second of these procedures applies also to all those third countries and territories which are implementing a withholding tax. As explained above, the first procedure is effectively voluntary in the case of non-EU Member States.

The Effect Of The STD On Offshore

Now to the $64,000 question: What impact has the directive had on the flow of capital and investments into the offshore jurisdictions hit by the new rules? Opinion from industry participants and observers alike appears to be generally negative. According to a survey of the 500 senior finance professionals from the Isle of Man, Jersey and Guernsey, conducted by IoM-based firm Acuity in 2004, more than 50% of those polled believed that the directive was "bad news", although some 30% felt that the planned withholding tax would not have a negative impact on the jurisdictions. The survey results also revealed that 70% of those polled believed that the three islands had been wise to opt for a withholding tax, rather than for automatic exchange of information.

The results of this survey suggest that the industry is certainly uncomfortable with the information exchange aspect of the legislation, and many observers, particularly those opposed to global tax enforcement initiatives, believe the effect of measures like the EU directive has resulted in capital flowing to jurisdictions where interest reporting is not an issue. However, the Caribbean offshore jurisdictions appear to have survived the litany of new regulations thrown at them by the likes of the OECD and FATF over the last decade, and only time will tell what impact the EU directive will have on offshore business.

Early indications are that the Directive is a paper tiger. Whereas many commentators expected capital to fly out of such jurisdictions as Jersey, and the Isle of Man, totals for bank deposits and investment funds in these places have continued to rise, indeed they have been rising even faster than before, although it is hard to disentangle the effects of the Directive from those of a boom period in many stock markets. Even if the European offshore centres are thriving, places like Dubai, Hong Kong are Singapore are doing even better.

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Table of Jurisdictions

How to Escape the Savings Tax Directive

It's fairly obvious that the most effective way to escape the effects of the Savings Tax Directive (STD) is to be a resident of a country which has not signed up to the STD, or if that is impossible, to make sure that you don't have investments that will be caught by the STD.

Here, we will focus on the latter route, which itself has two main branches: you can either look for investments which don't attract the STD; or you can ensure that you invest through an entity which doesn't fall under the STD. Neither technique will help you to avoid legitimate taxation, and it is not the purpose of this report to do that. However, it is permissible to optimize one's tax situation within the law, and many people may object to the prescriptive and prying nature of the STD, preferring to remain in control of the amount and timing of the information that they give to governments.

Investments Which Don't Attract The STD

A brief list of some of the main categories of excluded investment was given above. The most obvious target investments for EU residents, just sticking to the traditional financial sector, are 'grandfathered bonds', excluded investment funds (ie not caught by the 15% or 40% debt threshholds), various types of offshore life assurance-based product, and equities or their derivatives. Real estate remains attractive, naturally, but is not often a popular target for long-term saving, outside the family home. The STD may of course lead to changes in the structure of European investment markets, and REITs (announced in Germany and France already) may assume a higher profile for savers.

Another type of investment that may benefit from the STD is the 'alternative' sector: investment in such targets as forests, films, venture capital funds and private equity funds may come to have greater attractions, since in all these cases returns are completely or predominantly free of a 'debt-claim' element. Not for widows and orphans, though.

In most EU countries, offshore life assurance bonds offer the following benefits:

• interest can roll up gross with no tax levied by the insurer;
• the policyholder has no annual tax liability;
• the benefits are, in certain circumstances, treated favourably, with attractive tax relief available;
• in a low interest rate environment, the deferral of income tax until a time when benefits will be taxed at a lower rate can mean the difference between the investment value keeping up with inflation or not.

Investment bank ABN Amro expects to see greater interest from retail investors in jumbo covered bonds. "On the back of the directive, we expect retail demand for grandfathered bonds to increase significantly in the months ahead," stated Christoph Anhamm of ABN Amro. Bonds issued before March 1, 2001 and not increased in volume after February 28, 2002 will remain unaffected by the STD. As the transition period lasts for seven years, only bonds maturing before July 2012 will be exempt. These issues are otherwise known as grandfather bonds. According to the ABN Amro report, the volume of jumbo covered bonds with grandfathered status maturing in this period is EUR180 billion. Income from Islamic investmemnts under Sharia'a law, an increasingly important sector, also fall outside the Directive by definition, since the payment of interest is forbidden. It is interesting that the UK government has announced its intention of setting up London as a centre for Islamic financing, presumably without any direct intention of subverting the Directive.

It's also worth remembering that by no means all offshore financial centres fall within the ambit of the STD; apart from Bermuda and the Bahamas, which are mentioned in the table above, there are a number of other low-tax territories, many of which are covered in www.lowtax.net. Some of these have significant banking sectors, and some again are the home of investment funds. Almost all of them have trust regimes which can be combined with International Business Companies or other forms to create robust asset protection structures which will incidentally often be very tax-efficient into the bargain.

Entities Outside The Scope Of The STD

Legal entities whose profits are taxed under the general arrangements for business taxation and similar entities (e.g. companies, partnerships and limited partnerships) are not relevant payees and payments to such persons fall outside the scope of the Directive, which only applies to individuals. Trusts and foundations are equally exempt in most territories.

This is possibly not that interesting for investments in the mainstream high tax countries, since the profits of companies are taxed just as highly as personal income, or are magically transformed into personal income by a wave of the Finance Minister's wand. Everyone has to retire sometime, and there is not much point having capital if you can't spend it. But many of the countries and territories caught by the STD don't have penal corporate tax regimes; many don't have corporate tax at all.

Thus, International Business Companies in the UK's dependent territories and their equivalents in the Dutch dependent territories, not to mention trusts and other tax-efficient vehicles, take on a new interest in the light of the STD. Controlled Foreign Company (CFC) legislation still lurks waiting for the unwary, and in many high-taxing jurisdictions the income of beneficially-owned offshore entities is imputed to the investor. Still, with good advice it is usually possible to form a legitimate structure which will at least defer and minimize taxation, and the STD will surely cause an upswell in investor interest in such vehicles.

Even in affluent European countries such as Switzerland, Luxembourg and Liechtenstein, which have fairly high rates of domestic taxation, there are many corporate forms which can be used to hold assets and investments - all of these will escape the STD, and for an investor with more than token amounts of money to play with, they will definitely bear investigating.

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Savings Tax Directive FAQ

When did the Savings Tax Directive come into force?

The STD came into effect on 1st July, 2005.

What types of income are covered by the STD?

Savings income is covered, which means essentially interest earned on bank deposits, interest from, and proceeds on the sale or redemption of, certain bonds and income from certain types of investment funds (principally open-ended money market retail funds). See above for a fuller definition.

Which countries are covered by the STD?

All Member States of the EU, and a number of third countries and dependent territories. There is a full list of these countries and territories in the Table above.

How will the Directive affect my income?

If your income is covered by the Directive, the entity paying you (bank, fund etc) either deducts tax from it (20% at present) or reports the income to your home tax authority.

If I receive income in the country where I reside, is it affected?

No. The Directive applies only to income you receive in affected countries or territories which are outside your country of residence.

I live in the USA. Am I affected by the Directive?

No. The US has not accepted the Directive. However, if you have investments in any of the affected countries (see the Table above), you may need to prove to the bank or fund concerned that you are a US resident, in order to avoid taxation.

What information will I have to give to my bank?

This depends slightly on where you live, and they will ask you for the information if you need to give it. The minimum amount of information that 'paying agents' will be required to pass on to the 'competent authorities' of member states under information-sharing will consist of: identity and residence of the beneficial owner; name and address of the paying agent; account number of the beneficial owner; and interest payment data including the amount of interest income earned, plus information regarding any proceeds from sale, redemption or refunds. See above for more information.

How much tax will I have to pay under the withholding tax regime?

If the country or territory where you receive income is operating the withholding tax regime (see Table above), it will deduct 15% between 2005 and 2008, when the rate rises to 20%. From 2011 the rate will rise to 35%.

What happens to the tax I pay?

If the financial institution which is paying you is using the 'withholding tax' option, it pays the tax to the authorities in its own country. They keep 25% of the money and send on the remaining 75% to your home country (where you are resident).

Does my tax authority know I have paid the tax?

No, because the withholding tax is paid on in 'bundles' and individual payments are not identified. However, if you want to claim the tax payment against your home tax assessment, you need to obtain a certificate from the institution which paid you.

I have an offshore bank account; do I have to pay tax on the interest?

Only if the country or territory in which you have your bank account is applying the Directive (see the Table above).

I have an offshore trust. Do I have to pay tax on its income?

The trust is only be 'caught' by the Directive if it is in an offshore financial centre in the Table above. If so, it then depends on the legal position of trusts in the jurisdiction concerned. In many jurisdictions trusts have no separate legal personality, so that payments to a trust are made to the trustees. If a professional trustee receives savings income and if under the terms of the settlement you as the beneficiary have an absolute entitlement to that savings income (for example, through a life interest trust), it is probable that the income will be subject to the Directive. If on the other hand the trust is discretionary (ie you don't have an absolute right to the income) then you will not be a 'payee' under the Directive, but the Trustee may be, unless of course as often happens the trust is operated by a trust management company. In that case, the Directive does not apply.

What is the position with joint accounts?

If one of the holders is resident in an EU Member State, then it may be that the income would be divided between the holders. This is a situation you need to discuss with your bank.

What is the position with companies?

The Directive applies only to individuals; companies and other corporate bodies (eg foundations and many trusts) are not covered by the Directive.

Which countries are applying the withholding tax?

See the Table above. Inside the EU, only Belgium, Austria and Luxembourg apply the withholding tax. Outside countries doing so include Switzerland, Liechtenstein, the Turks and Caicos Islands, Jersey, the BVI, Guernsey, and the Isle of Man.

Can I choose to provide information instead of paying the withholding tax?

This depends on the country concerned. All countries have the option of offering information-sharing rather than the withholding tax, but even in those that have decided to make such an offer it then depends on whether your particular financial institution has made the necessary administrative arrangements. Many may choose not to do so.

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Glossary

FATF: The Financial Action Task Force. An office of the OECD responsible for the adoption and implemention of measures designed to counter the use of the financial system by criminals.

Grandfathered Bond: A bond (a security on which interest payments are made to the holder) which was issued before 1st March 2001 and which matures before 2012. At the insistence of the UK, which has a very large bond issuance industry, such bonds were 'grandfathered' into the STD regime, and are not subject to withholding tax or information exchange under the STD.

Interest Payment: The EU has drafted a very broad definition of an 'interest payment' which seeks to encompass "debt claims of every kind." This includes income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. It also encompasses accrued and capitalised interest, such as interest accrued on zero-coupon bonds. The definition of interest includes income derived through indirect investment, through funds of which more than 40% of the assets are invested in debt instruments. Leaving no stone unturned, all payments are assumed to be interest payments if it is unclear what proportion of assets are invested in debt instruments.

OECD: The Organisation for Economic Cooperation and Development, comprising the 30 most advanced economies, based in Paris, and which was in the forefront of the attack on 'offshore' in the late 1990s.

Paying Agent: According to the Savings Tax Directive, 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."

TIN (Tax Identification Number): This is an individual's tax registration number in his or her country of residence. A financial institution in one of the countries covered by the Savings Tax Directive may ask for this information to form part of the information they 'exchange' with a payee's home country; but other information such as passport or identity card data is an adequate substitute.

UCITS: Undertakings for Collective Investment in Transferable Securities, which are covered by the EU's UCITS Directive, meaning that they can be freely marketed across the EU. Such investment funds are subject to the STD if they qualify by holding sufficient quantities of debt in their investment portfolios.

Withholding Tax: A tax which is applied by 'withholding' the appropriate percentage (15% under the STD) of a payment.