Obligations and options

Tuesday, 01 May 2012
The EU Saving Tax Directive from a trustee's perspective.

Towards the end of the 1990s, the European Commission accelerated its drive towards achieving information exchange and transparency across Europe and on 1 July 2005, the EU Savings Tax Directive (the Directive) came into effect. The Directive provides that EU member states and ‘accession states’1 (together, the states) must report certain interest payments made to citizens resident in a member state to that state’s tax authority.

The objective is to ensure that individuals residing in the EU pay the appropriate amount of tax on interest earned on their EU deposits and investments, as summarised in article 1 of EU Council Directive 2003/48/EC: ‘The ultimate aim of the Directive is to enable savings income in the form of interest payments made in one member state to beneficial owners who are individuals resident for tax purposes in another member state to be made subject to effective taxation in accordance with the laws of the latter member state.’

Some territories, including Austria, Luxembourg and some of the accession states, are not subject to mandatory information exchange during a transitional period (which is still running nearly 12 years later), but must instead automatically withhold tax on interest payments. The withholding rate began at 15 per cent, increased to 20 per cent on 1 July 2008, and increased further to 35 per cent on 1 July 2011.

Notwithstanding that the Directive does not make any special provision for trusts, professional trustees who reside in one of the states and make payments to individuals residing in a member state are within the scope of the Directive.

Beneficial owner

The application of the Directive to trustees will depend on whether there is an absolute entitlement to income arising under a trust, as an individual must be the beneficial owner of the income to be within scope. If a trust is fully discretionary, if the trustee has the power to accumulate the income, or if the trust confers on the beneficiary a right to have the trustee account to them for the balance of income after expenses (i.e. if the beneficiary has a chose in action rather than an equitable interest in the trust income), the Directive will not apply. This is because beneficiaries of such trusts are not beneficially entitled to the income as of right.

However, for the more usual life interest trusts where the beneficiary enjoys an absolute right to the income, trusts where the capital entitlement may not be fixed but a beneficiary is entitled to the income as it arises, and bare trust/nominee arrangements, trustees need to consider their obligations under the Directive.

Paying agents

Professional trustees are deemed to be ‘paying agents’ for the purposes of the Directive as they are the economic operator paying interest to, or securing the payment of interest for the benefit of, the beneficial owner (the beneficiary). The definition does not extend to individual non-professional trustees as they do not make interest payments in the course of a business or profession.

There is no de minimis amount below which the Directive does not apply

If the trustee has appointed an investment manager to manage the trust assets and mandate the income directly to the beneficiary, the investment manager is the paying agent notwithstanding that the trustee may not be a professional trustee. This is because the paying agent is deemed to be the operator whose hands the interest passes through last before being paid to the beneficial owner.

Interest payment

Income caught includes interest credited to an account, interest paid on debts (including capitalised income), income from government securities, bonds and debentures, income from interest payments deriving from undertakings for collective investment in transferrable securities (UCITS), and income realised upon the sale, refund or redemption of shares or units in UCITS.

Therefore, income arising in a life interest trust in the form of dividends (except those paid by corporate mutual funds and those derived from shares in a building society), rents and trading profits falls outside the scope of the Directive, alongside capital gains.

Trustees should be mindful that they may be brought within the Directive’s scope if the trustee is lent money on an interest-bearing basis from a settlor or beneficiary who resides in a member state. As the lender will be entitled to payments of interest on the loan from the trustee paying agent, such income is within the Directive’s scope. This is the case regardless of the nature of the trust, thus extending the Directive’s reach to discretionary trusts in these circumstances.

Only income arising after 1 July 2005 is relevant and there is no de minimis amount below which the Directive does not apply.

Information exchange

Trustees resident in a member state, excluding Austria and Luxembourg, must report to their national tax authority the identity and residence of the beneficial owner, the name and address of the paying agent, the account number of the beneficial owner (or identification of the debt claim giving rise to the interest), and information concerning the interest payments.

Trustees in the remaining states are subject to the withholding mechanism (unless they have agreed to enter the automatic information exchange system), meaning the details of the beneficial owner and the account and interest need not be disclosed, but instead the trustee must apply a withholding tax of 35 per cent of the interest as it arises. A total of 75 per cent of the withheld sum is payable to the member state in which the beneficial owner resides and the remaining 25 per cent is payable to the tax authority of the state in which the trustee is resident.

Withholding tax?

If the territory in which the trustee resides applies the withholding tax, an individual can obtain a tax certificate (exemption certificate) from their tax authority that authorises the trustee not to withhold any tax (so long as both territories have adopted this option). The certificate must be reissued every three years.

Alternatively, the individual beneficiary may authorise the trustee to report the details of the savings income to its own tax authority, which will in turn pass on the information to the beneficiary’s tax authority. Essentially, the beneficiary can opt out of the withholding regime into the information exchange regime. If neither of these options is taken, the payee can claim a credit for the tax withheld, to avoid double taxation on the same income.

What steps should trustees take?

Trustees residing in a state should take the following steps to ensure that they comply with the Directive:

  • Obtain appropriate documentation to establish those beneficiaries resident in a member state.
  • Determine those beneficiaries deemed to be the beneficial owner of income.
  • Identify payments of income within the scope of the Directive.

When the above points have been clarified the obligations and options are:

  • If the trustee resides in a state that is subject to the automatic exchange of information, the appropriate notifications must be made. It would be prudent for trustees to (i) give beneficiaries advance warning of the information they will be disclosing to their tax authority to manage risks associated with disclosing confidential information, and (ii) review their trust instruments to determine any provisions governing disclosure of information and consider amending the terms (if permissible).
  • If the trustee resides in a state that is subject to the withholding, it must retain 35 per cent tax on the interest (accounting to the tax authority of the state in which the beneficiary resides for 75 per cent on the withheld sum and its own authority for the remaining 25 per cent).

Alternatively, the beneficiary may request that the trustee exchanges information or may provide the trustee with an exemption certificate.

Finally, for remittance-basis users, the jurisdiction in which the trustee resides may have adopted the custom of allowing paying agents to abstain from withholding and notifying if they are satisfied that the beneficiary is a remittance-basis user and is not remitting the income.

It is advisable for trustees with the ability to either withhold or disclose to explain their obligations under the Directive to beneficiaries so that beneficiaries can request which option they wish the trustees to select.

Remittance basis

Where the trustee resides in a state subject to automatic information exchange, the details of payments of interest to a UK resident beneficiary who has elected to be taxed on the remittance basis (for UK tax) (a remittance-basis user) will be passed to HMRC in the usual way. The same process will occur for interest paid to individuals resident in a member state in which they are subject to an equivalent basis of taxation.

Where the trustee resides in a state that operates the withholding tax, the remittance-basis user may have an alternative on top of the existing options of (i) providing an exemption certificate, (ii) requesting disclosure and (iii) being subject to the withholding. Many of the withholding states are prepared for their paying agents not to withhold or report if they are satisfied that an individual is a remittance-basis user (supported by a declaration of intent given by the beneficial owner at the beginning of the tax year and confirmation of the position by a solicitor or accountant at the end of the tax year) and is not remitting the income.

Recent reform

In recent years there have been proposals to reform the Directive to close some of the loopholes that restrict its scope. Most notably, one of the proposed amendments is to oblige trustees of discretionary trusts to identify the beneficial owner as the settlor (even if the trust is irrevocable and the settlor cannot benefit) or if this is not possible, e.g. if the settlor is deceased, the beneficiaries upon receipt of distributions from the trust.

It is also likely that the categories of income and payments caught will be extended to include dividends and capital gains.

Even if these proposals are accepted, the date of implementation remains to be agreed.

Tax agreements

Switzerland has negotiated agreements with the UK and Germany by which Swiss banks will apply withholding tax on existing capital and the future income of accounts held by UK or German resident individuals (unless the account holders consent to disclosure of the account details). If the tax is applied, the names of the account holders and details of the account and its income will remain anonymous and there is immunity from prosecution for the account holders.

The ability of Swiss banks to maintain the anonymity of their account holders is regarded by critics as undermining the principle of automatic information exchange enshrined by the Directive. Switzerland is not presently subject to mandatory exchange of information under the Directive, but is increasingly under pressure to change this. These recent agreements suggest that Switzerland does not intend to give up its traditional code of confidentiality in the near future.

  • 1. The accession states are Andorra, Anguilla, Aruba, the British Virgin Islands, the Cayman Islands, Jersey, Guernsey, Gibraltar, the Isle of Man, Liechtenstein, Montserrat, Monaco, the Netherlands Antilles (this stopped from 10 October 2010), San Marino, Switzerland, the Turks and Caicos Islands, and Lebanon. Barbados, Bermuda, Hong Kong and Singapore are not within the definition.
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Katy Shayle

Katy Shayle TEP is a Legal Officer at Investec Trust (Switzerland) SA in Geneva.

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