How will the EU savings tax directive effect you?

As part of the EU's attempt to crack down on tax evasion the EU savings tax directive has been implemented as from 1 July 2005.

What exactly is the European Savings Tax Directive (ESD)?

The ESD is an agreement between the member States of the EU to automatically exchange information with each other about customers who earn savings income in one EU member State but actually reside in another.

Simple enough, and this would effectively mean that if you live in the EU and have a bank account in any other EU country details of you, and the interest you earn would be passed to your home state, who will undoubtedly check that you've been entering the information on your tax return.

Three of the EU states kicked up a fuss about this and have not followed this route. Austria, Belgium and Luxembourg have opted to apply alternative arrangements for the time being.

Under these alternative arrangements, tax will be deducted at source from income earned by EU resident individuals on savings held in other EU countries. Therefore under this option banks and other paying agents will 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 rate of withholding tax will be 15% from 1st July 2005, 20% from 1st July 2008 rising to 35% from 1st July 2011.

Its important to remember that the states that go for the withholding tax option is an alternative to the exchange of information. As such the member state receiving the payments receives a bulk payment but does not receive personal details in respect of each individual.

Note the recipient would still be able to 'contract out' of the withholding tax option and agree to the exchange of information to his home state.

Which countries are affected?

The ESD will apply to all EU Member States. "Great" you're thinking "I'll keep my cash in a Caribbean tax haven, and avoid any withholding taxes".

Unfortunately, it is not that simple. Although the legal scope of the directive cannot extend outside the EU, its implementation will also affect:

• UK Crown Dependencies
• UK Overseas Territories,
• Dependent Territories of the Netherlands,
• Other "Third Countries",which have all voluntarily agreed to apply the same measures.

Therefore, the countries that will be applying the ESD or provisions similar will be:

UK, Channel islands Isle of Man Ireland, France, Germany, Netherlands, Belgium, Italy, Luxembourg, Spain, Portugal, Greece, Austria, Sweden, Finland, Denmark, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia Anguilla, Montserrat, British Virgin Islands, Turks and Caicos Islands Cayman Islands Netherlands, Antilles and Aruba Switzerland, Andorra, Liechtenstein, Monaco San Marino

Whilst most of the EU members have gone for the exchange of information option, most of the others have opted for the withholding tax (on the basis it would do least damage to the offshore industry).

Some of the EU's own low tax jurisdictions, notably Cyprus, Gibraltar and Malta will be exchanging information on interest receipts from EU residents.

In addition, the Caribbean tax havens of the Cayman island, Anguilla and Montserrat will also be exchanging information. (Although this should come as no big hiccup if the overseas interest income is already being corrected declared in the UK).

Will it effect you?

If you are an individual who is resident in an EU Member State and earn bank interest or other savings income on investments held in one of the countries identified above, then it is likely that you will be affected by the directive and will either be subject to the withholding tax or the exchange of information.

How can the terms of the directive be avoided?

Ok - if you are effected, the next logical question is how can the rules be 'circumvented'. Well, there are a number of ways that the obligations imposed by the directive could be avoided. In other words where there would be no requirement to deduct a withholding tax or exchange information with your home state.

Options you could consider include:

• Invest your cash in a bank account in a country not listed above and one in which another automatic exchange of information agreement is not in place.

  There are plenty to choose from and as an example this could include:

  Labuan, Panama, Hong Kong, America, Bahamas Antigua Nevis

• Become non EU resident. If you're a non EU resident you can invest your cash anywhere you want. The ESD will then not apply to any income earned from your investments

• The ESD only applies to 'individuals'. One option if you are an EU resident would be to use a company (either onshore or offshore) to hold the investments. The company would then not be subject to the terms of the ESD and the rules of your domestic regime would apply. If an offshore IBC was used, perhaps in conjunction with an offshore trust or foundation, you would need to review your domestic tax regime to ascertain whether you had any filing responsibilities.

  Therefore if you were UK resident, you could use an investment company to hold your overseas investments. The ESD would not apply to it, although if you used a UK company there would obviously be a charge to UK corporation tax. If you used an offshore company, and managed to ensure this was classed as a non resident, then it would be possible to avoided UK taxes completely, as well as avoiding the ESD

• The ESD only applies to an 'interest payments'. This is drafted widely to include "debt claims of every kind." Common investments/income that will be caught by this definition include: - government securities - income from bonds or debentures, - premiums attaching to these - bonds or debentures. - accrued and capitalised interest,

There is however scope to ensure that your offshore income falls outside of the above.

The big omission here is that it won't apply to dividends from equities, capital gains or proceeds from securities transactions.

It also won't apply to any type of repayment of capital or insurance products. Therefore, careful choosing of investments could literally reap dividends!.

Investing in overseas equities as opposed to cash would avoid the terms of the ESD and you could also consider an investment bond with an offshore insurance company which would also be outside the scope (In some EU countries, including the UK, these offshore investment bonds can offer other tax benefits including the tax free roll up of interest).

One things for sure, if you want to avoid the ESD provisions you need to act sooner rather than later. If you're looking at retaining a straightforward overseas interest bearing bank account you could consider either transferring the cash to a jurisdiction which doesn't apply the ESD or using a non UK resident company.

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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