Dear Colleague,

In this month's LTX focus we take a fresh look at the Savings Tax Directive.

This July, the rate of tax withheld from returns on savings under the EU's Savings Tax Directive will increase 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. And a Commission Review Group which has been working away for two years is expected to recommend in 2008 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.

In January, 2008, senior EU tax officials, including European Tax Commissioner Laszlo Kovacs, were reported to be preparing to make a fresh approach to Asian financial centres, in a bid to have them included within the ambit of the Directive. Kovacs is scheduled to visit Hong Kong, while other senior officials will launch a new charm offensive in the territory of Macau and the city-state of Singapore.

In the case of Hong Kong, signing up to the savings tax directive could mean altering the Basic Law which safeguards the future of its financial centre under Chinese rule. Singapore on the other hand, is known to be staunchly opposed to the idea of sharing bank account information with the EU, and has rejected European overtures to include information exchange provisions within a broader economic agreement.

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.

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).

Last year, the Swiss government's Federal Department of Finance released figures showing the amount of tax withheld from the savings of individuals resident in EU member states under the Directive.

The gross revenue generated from the imposition of Switzerland’s system of tax retention on interest payments in Switzerland, on earnings liable to tax in the EU for the 2006 tax year, amounted to CHF536.7 million (EUR327 million). For the second half of 2005 the amount collected was CHF159.4 million.

Overall in 2006, approximately 55,000 declarations were received (35,376 declarations were received for the second half of 2005). The agreement on the taxation of savings income with the European Community in force since 1 July 2005 makes provision for 75% of the proceeds to be passed on to the member states concerned. 25% goes to the Confederation, of which 10% is passed on to the cantons. This meant that CHF402.54 million was passed on to EU member states, while Switzerland's share amounted to CHF134.18 million.

The figures show that by far the largest sums were remitted to Germany (CHF103.4 million) and Italy (CHF103 million).

Although a substantial sum appears to have been collected, it has to be set against the total of assets supposed to be held in Switzerland. Assuming a withholding rate of 15%, and a rate of return of 6%, the amount collected represents underlying capital of 36 billion euros, less than 3% of assets held in Swiss banks.

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 GBP350bn, 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.

You can read the rest of the feature here:

http://www.investorsoffshore.com/html/specials/february08_std.html.

-------

Please remember that you can customise your mailing preferences by visiting your own profile page to choose from 29 offshore tax and law subjects in order to receive just the information you want. You can also unsubscribe completely by following the instructions at the bottom of this page.

Kind regards,

Kate James