ABBL

The present article aims to provide some insight into recent developments concerning the EU Savings Directive.

Two aspects are to be considered separately:

• the scope of the proposal, i.e. the technical details, such as the products covered, and
• the political aspects, such as the issue of exchange of information vs withholding tax.

Scope

Two categories of income can be distinguished: direct investment products, on the one hand, and entities and legal arrangements, i.e. products where customers invest in securities and other assets through intermediary structures, on the other hand.

Direct investment products

The latest proposal by the European Commission still maintains the principal idea that only Interest payments should be covered. Some very important extensions of the definition of Interest payments were, however, introduced. So far it seems clear that, subject to a “cut off” at the date of entry into force of the modified Directive, all Interest payments transiting through investment funds inside or outside the EU, which will include non-UCITS (part II funds), will fall under the scope of the Directive. The same will apply for many unit linked insurance products. The ceiling of risk (death) coverage, which needs to be introduced into the insurance contract in order to escape from the Directive, is in fact set very high. The “cut off” rule also applies to these products. Furthermore, there is a very large extension of the Interest definition as far as structured products are concerned. Many products that were previously considered as bearing market risks (Share baskets, etc.) will be in scope of the future Directive.

Intermediary structures

The proposal distinguishes entities and legal arrangements outside the territory of the EU from those within the EU1.

In case the structure is an entity or a trust having its place of effective management2 outside the EU and is listed in an annex to the proposed Directive, a look-through approach will apply in the future. The Interest payment is deemed to be directly made to the beneficial owner in the sense of the 3rd Anti-Money laundering Directive (article 3, par. 6).

Entities and legal arrangements within the EU (for instance, trusts, foundations, partnerships, fiduciary contracts),

• whose income is not “subject to effective taxation”3, and
• which have their place of effective management in a Member State different from the Member State where the paying agent is established, and
• which are listed in another annex to the proposed Directive,

are treated in the following, rather complex, manner :

• 1st step: if the (non taxed) entity / legal arrangement receives an Interest payment, the “upper tier” paying agent (a bank) is obliged to inform the authority of the Member State where the entity / arrangement has its place of effective management of the amount of the payment made, together with the name and address of the person responsible for the management of the entity / arrangement (yet no information needs to be provided on the final beneficiary)

• 2nd step: two different situations may occur:

1. the (final) beneficiary is immediately entitled to the Interest payment: in this case, the receiving “lower tier” paying agent, i.e. the entity/ legal arrangement (not the bank), is deemed to have followed the payment immediately to the beneficiary (regardless of whether it actually did so in reality or not) and is obliged to apply the Directive immediately (exchange of information / withholding tax).
2. the final beneficiary is not (yet) known or not (yet) entitled to the Interest payment (for example, in case of a discretionary trust or a foundation): in this case, the (second) payment to the beneficiary is subject to exchange of information or withholding tax only when the beneficiary becomes entitled to the Interest payment (if this second payment lies within a period of ten years after step 1 above, otherwise the payment is out of scope4).

Countries with banking secrecy may apply a withholding tax already at step 1, if the entity/arrangement is not willing to agree to the exchange of information foreseen in step 1. This complex procedure (notably step 2) is the consequence of the fact that Member States wish to maintain their sovereign rights to decide on how to treat payments flowing “out” of the entity/legal arrangement. As it stands, the Directive will continue to apply only to cross-border payments (be it at the level of step 1 or step 2). This means that purely national payments (either at level 1 or at level 2) are out of scope of the Directive.

Political aspects

Recent events have triggered important political decisions in tax matters at G20 and OECD level. The magic word is now “transparency”. These events will in turn require some decisions at EU level. The EU Council of Ministers will be asked to decide, probably before the end of the year, on several new legal instruments. The Commission proposes to adopt the joint proposals of 2 February 2009 for

• a Council Directive on administrative cooperation in the field of taxation,

and
 

• a Council Directive concerning mutual assistance for the recovery of claims relating to taxes, duties and other measures,
• as well as the above discussed amendments to the Savings Directive.

In this “package” context, it is worth mentioning that Member States of the EU decided in Feira, in 2000, that 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.”

Following on from the co-existence model discussed before Feira, the withholding tax system was designated as a model to be applied only during a transitional period (article 10). The end of the transition period, implying that Austria, Belgium and Luxembourg would abolish the withholding tax procedure and switch to an automatic exchange of information, was made dependent on several eventualities:

“The date of entry into force of an agreement between the [EU], following a unanimous decision of the Council, and the last of [Switzerland, Liechtenstein, San Marino and Andorra], providing for the exchange of information upon request as defined in the OECD Model Agreement on Exchange of Information on Tax matters released on 18 April 2002 … in addition to the simultaneous application by those same countries of a withholding tax …” ;

“The date on which the Council agrees by unanimity that the [USA] is committed to exchange of information upon request, as defined in the OECD Model Agreement with respect to Interest payments … to beneficial owners resident in the territory to which the Directive applies”.

A further important element of the imminent political discussions will be European and worldwide level playing field considerations. From this point of view, any modification of the Savings Directive needs the adherence of the associated territories and third countries that initially concluded agreements with the EU or with their Member States. The Commission has already agreed with Liechtenstein on such a new agreement. Member States have so far not yet mandated the Commission for new negotiations with Switzerland, and the position of the US is not clear. Worldwide level playing field considerations also need to take into account the booming Private Banking sector in South-East Asia.

The current standard on a worldwide level is clearly the exchange of information on request (OECD model of 2005). With the majority of Member States having opted for an automatic exchange of information, the EU seems to want to act as a new standard setter in this context. The above-mentioned proposal for a Directive on administrative cooperation in the field of taxation (intended to replace the Directive of 1997 on mutual assistance in tax matters) shows that the Commission is committed to the objective of automatic exchange of information. The scope of this proposal does, in fact, cover all kinds of taxes (including wealth and Inheritance tax) and proposes to proceed to an automatic exchange of information. Despite previous claims to the contrary, more recent statements seem to indicate that the OECD is now also favouring an automatic exchange.

It needs to be seen whether a worldwide level playing field may be achieved on this basis. But such a world-wide level playing field, as well as the consideration of all the elements of the above-mentioned “package”, are certainly prerequisites with which Luxembourg will enter forthcoming negotiations at EU level.

A final word on data protection and the fundamental human right to privacy: Recent decisions of a Member State’s Constitutional Court seem to indicate that at least in one EU country an automatic exchange of information may not be allowed for constitutional reasons at a purely domestic level. An automatic exchange of information that only applies at cross-border level within the EU and covers all kinds of taxes (see the new proposal on mutual assistance) may certainly be questioned under the aspect of the proportionality of such a measure.

Article by Rüdiger Jung,
Member of the ABBL Executive Committee

(Article from the Luxembourg Banking Quarterly - 3/2009)

1. Or in associated territories or third countries (e.g. Switzerland) having concluded an agreement with the EU / its Member States applying the rules of the Savings Directive.

2. Defined, according to the introductory phrase of Annex III to the proposed Directive, as the “place of residence / establishment of the person who primarily holds legal title and primarily manages the asset producing Interest” ; in case of a trust, this means at the place, where the trustee is established (legal person) or resident (natural person).

3. Effective taxation = tax rate > zero percent

4. Maltese proposal, justified by the statute of limitation in (administrative) tax matters.