Increasing Exchange of Information V’s Withholding Tax

by Bill Blevins, Financial Correspondent
Blevins Franks International Limited

It was only a matter of time. Reforms and advances continue to move the European investment arena forward, establishing new globally competitive financial centres and confidence in the growing market. And as the funds industry continues to blossom in Europe, supporting member states have at long last stepped up efforts to reap the benefits.

The European Union (EU) directive on savings was created to enable member states to collect tax from its citizens on income derived from interest paid on investments made in a different state. As the December 2002 deadline for a final EU vote on the Savings Directive approaches, there is much work to be done in order to prepare for the inevitable changes brought about by the long-awaited legislation.

The new tax initiatives have been in the making for five years now, as in November 1997 the EU Commission introduced a directive to address increasing tax competition between member sates in the European Union. The original draft gave states a choice of either applying a withholding tax on interest or releasing beneficial owner details to all other EU countries. The European Council of Finance Ministers (Ecofin) voted unanimously in June 2000 to accept a proposal, with the ultimate goal of information disclosure for all member states.

A transitional period will be allocated to some participating states, enabling them to avoid disclosure of beneficial owner details when the directive is first implemented. A limited number of member states, specifically Luxembourg, Belgium and Austria, have opted to utilise this transitional period. As compensation for the grace period, these states will pay a withholding tax until the allotted time frame expires. The three countries, meanwhile, will receive final beneficiary information from other member states but will not be required to adhere to the same disclosure requirements.

In order to compensate for the different reporting standard, 75% of the withholding tax applied in these excepted states will be paid to the investor’s member state of residence, although that state will not be aware of investor details. Application of the tax will take place when the fund distributes and when a shareholder redeems out of a fund or transfers units to a new owner. Within the borders of excepted states, individual shareholders will have the option of providing their paying agent with a certificate from their resident tax authority stating that their holdings have been declared, enabling the agent to pay proceeds without applying the tax.

Although details have yet to be finalised, it appears the disclosure and tax will only apply to retail shareholders. There is still some question on whether or not additional Ucits funds will fall under the directive.

Ucits Awaits

The introduction of the savings directive from each member state’s tax regulator point of view is tailor-made to suit the highly anticipated adoption of Ucits 3 Directive, which should increase the range of cross-border distributed products available in the states.

The European Commission has recently taken the position that although some member states may incorporate the new Directive into local law, no funds will be eligible for a European passport effectively enabling cross-border activity until all member states have achieved compliance. This removes all incentive for incorporating the Directives early, as there will most likely not be any benefit from them until 13 February 2004, the deadline for EU member states’ compliance and not coincidentally, one month after member states must start implementing the savings directive.

Minor Adjustments

With great advances, however, come great adjustments in this case, in the arena of reporting. Once the new taxation directive is adopted, beneficial ownership details will be released to the Ucits’ local tax authority and all EU tax authorities will transmit received data back to each investor’s country of residence. ‘Paying agents’ will be responsible for disclosing information. The paying agent has thus far been defined as the last intermediary who pays interest to or secures interest for the beneficial owner.

The exact nature of the information and the method of transmission both from the paying agent to the tax authorities as well as information between the various EU tax authorities have yet to be determined. Shareholders that invest in a UCI domiciled in their resident country, or those who invest through a paying agent in their resident country will not be included in the reporting process. In addition, shareholders who are not EU residents will also be excluded from the reports.

While approaching these Ucits concerns, there remain multiple hurdles which the industry needs to overcome in order to apply the new tax directive as well. Most importantly, for shareholder disclosure to succeed, key nations outside the EU must also adopt the reporting requirements. To date, it has proven to be difficult for the EU to come to an agreement with the Swiss authorities.

In addition, tax calculation methodologies across the EU are inconsistent. As a result, the application of tax for the transition period will be tedious for funds with shareholders from multiple counties. In order to paying agents to be able to adhere to both tax applications for the transition as well as to disclosure requirements, investments must be made into systems enhancements.

The key message is that there will be much more automatic, direct disclosure of information than ever before and those who have used non disclosure as a means of evading tax will have to re think their strategy.

To keep in touch with the latest developments in the offshore world, check out the weekly news update on our website,
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