EU Savings Tax Directive
On 13 November 2008, the European Commission (‘Commission’) proposed amendments (‘Proposal’) to Council Directive 2003/48/EC of 3 June 2003 (‘Directive’) in order to ‘stamp out’ tax evasion and increase revenue. The Proposal would amend the Directive in a number of areas, including taxation of interest payments channelled through intermediate structures, expansion of ‘interest payment’ to include income from financial products substantially similar to debt claims and level treatment of investment funds irrespective of their legal forms. To apply, the Proposal requires unanimous approval by the European Union (EU) Member States.
The Directive enables the EU Member States to apply their own rules of taxation on interest payments received by individual residents (i.e., natural persons) from paying agents of other Member States. Resident taxation is achieved through the automatic exchange of information. Certain non-EU States, such as Switzerland and Liechtenstein, have entered into bilateral agreements with the Member States whereby the non-EU States may either levy withholding tax or share information.
Before it became applicable to the Member States on 1 July 2005, the Directive’s limited scope was already apparent. The Directive had failed to account for, among other trends, recent developments in financial products and investor behaviour. Indeed, the tax fraud cases involving wealthy European investors in Liechtenstein foundations underscored the Directive’s deficiencies.
According to the Commission, several problems hindered the Directive from achieving effective taxation of savings income and removing distortions on competition. The Proposal would address these problems, in large part, either by expanding the Directive’s scope or by clarifying its operative rules.
The Commission found that the current Directive could be avoided by making use of intermediate investment structures (whether legal persons or arrangements) not compelled to act as paying agents or not covered by the current formal definition of beneficial owner (which refers to individuals only). Targeted intermediate structures include certain trusts, partnerships and foundations.
To address this loophole, the Proposal would add Article 2(3) to cover situations in which paying agents within the EU make interest payments to certain intermediate structures established outside of the EU and whose taxation is unsure. Under new paragraph 3, those paying agents already subject to the anti-money laundering obligations (AML) would use the information available to them to establish the actual beneficial owner. If the beneficial owner is an individual resident in another Member State, the paying agent treats such payment as being made directly to the individual. In other words, the paying agent ‘looks through’ the intermediate structure. To ease the administrative burden on paying agents, the Proposal would include a list (i.e., Annex I of the amended Directive) of categories of intermediate structures established in non-EU states subject to new Article 2(3).
To illustrate, if a French bank pays interest income to a Swiss trust and if the bank knows (under the AML framework) that the trust’s beneficial owner is a German resident, then the French bank is required to apply the Directive when it makes an interest payment to the Swiss trust as if this payment were made directly to the German resident.
To further close the loophole involving intermediate structures, the Proposal would clarify Article 4(2) to apply to cases in which economic operators (e.g., banks or other financial institutions) make interest payments to certain intermediate structures established in the EU but not taxed on their income or part of their income arising to non-resident beneficiaries. Amended Article 4(2) would require these intermediate structures to apply the Directive upon receipt of any interest payment from any upstream economic operator (wherever established) if the beneficial owner is a resident of another Member State. Thus, the intermediate structure would act as a ‘paying agent upon receipt’ of payment.
Except for four types of intermediate structures, the ‘paying agent upon receipt’ rule would apply to intermediate structures set forth in Annex III of the amended Directive. The Commission cautions, however, that Annex III is not meant to be an exclusive list.
To illustrate amended Article 4(2), if a Luxembourg ‘trust’ receives interest income from a US bank, that trust must either exchange information or withhold tax upon receipt of payment as required by the Directive, regardless of any actual distribution of the income to the beneficial owner resident in Germany.
The Commission observed that the current Directive failed to include an explicit reference to certain investment funds not authorised as ‘undertakings for collective investment in transferable securities’ under Directive 85/611/EEC or ‘non-UCITS’. In particular, incorporated non-UCITS (such as investment companies with variable capital or ‘SIVACs’) are outside of the Directive’s present scope while non-incorporated non-UCITS with the same composition of assets are always within the Directive (either because non-incorporated non-UCITS are treated as paying agents upon receipt or their income is taken into consideration as income from authorised UCITS).
Under amended Article 6, all EU collective investment vehicles of whatever legal form (i.e., UCITS or non-UCITS, incorporated or non-incorporated) would be subject to the scope of the Directive. Level treatment is achieved by replacing the reference to Directive 85/611/EEC with a reference to only the registration of the undertaking or investment fund in accordance with the rules of the Member States. Similarly, non-EU investment funds or schemes would also be subject to the Directive regardless of their legal form and of how they are marketed to investors.
Comparable financial products
With recent developments in savings products, investors have been able to circumvent the Directive through arrangements whose income remains outside of the current definition of interest payment, but which provide equivalent benefits of limitations of risk, flexibility and agreed return on investment of debt claims.
To close this loophole, the Proposal would extend interest payments in new Article 6(aa) to include payments relating to securities where the investor receives (1) a return on capital in which the conditions are defined on the issuing date and (2) at least 95 per cent of the capital invested at the end of the securities’ term. All securities meeting these two conditions would be included, regardless of whether or not the underlying assets included debt claims. This new provision would apply to payments relating to such securities first issued on or after 1 December 2008.
To limit avoidance through insurance contracts, interest payments would also include benefits payments from life insurance contracts (1) whose performance is linked to income from debt claims or equivalent income under the Directive and (2) where the biometric risk coverage is insignificant (i.e., lower than 5 per cent of the capital insured when expressed as an average over the duration of the contract). This new provision in Article 6(e) would apply to benefits payments relating to such life insurance contracts first subscribed on or after 1 December 2008. The Commission intimates, however, that the criteria-based Article 6(e) applies until a more appropriate ‘information-exchange-based’ solution becomes fully operational.
Information on beneficial owners
Under the Proposal, some of the purported improvements with regard to quality of information would rest with the paying agents. For instance, under amended Article 3, the regular updating of information on the permanent residence of beneficial owners would be refined through paying agents on the basis of the most recent documentation that is available to them. This information would include data available for AML purposes. Under amended Article 8, the paying agents would provide not only information on identity and residence but also certain details on the amount reported for each beneficial owner.
Procedure to except from withholding
Current Article 13 provides for two procedures to except from withholding for non-EU citizens – certificate procedure and voluntary disclosure procedure. Because the certificate procedure does not provide directly usable information to tax authorities and may be inconsistent with the free movement of capital, the Proposal would amend Article 13 so as to allow only the voluntary disclosure procedure.
Statistics from Member States
In order to improve the quality of information for the Commission’s report to be presented every three years, the competent authorities of the Member States are invited under amended Article 18 to provide the Commission with relevant statistics on the application of the Directive.
Ratification and Non-EU States
The EU Member States must reach a unanimous agreement on the Proposal. Once the Member States agree, the Commission will confer with non-EU States and jurisdictions participating in the Directive’s mechanism on how to update their respective agreements.
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