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The so-called European Union withholding tax is a withholding tax which is deducted from interest earned by European Union residents on their investments made in another member state, by the state in which the investment is held. (The European Union has no taxation powers, so the name is strictly a misnomer). The aim of the tax is to ensure that citizens of one member state do not evade taxation by depositing funds outside the jurisdiction of residence and so distort the single market. The tax is withheld at source and passed on to the EU Country of residence. All but three member states disclose the recipient of the interest concerned. (Most EU states already apply a withholding tax to savings and investment income earned by their nationals on deposits and investments in their own states. The Directive seeks to bring inter-state income into the same arrangement, under the Single Market policy).

Contents

Date of introduction

The tax was introduced at the time of the introduction of the European Union Savings Directive (EUSD), a directive on the taxation of interest income from savings within the European Union. This came into effect on the 1st July 2005.

Objective of the EU Savings Directive

The original aim of the EUSD was that all countries would freely disclose interest earned by a resident of an EU country in order to ensure that the interest was fully declared in his country of residence. The plan was that non-EU countries would also agree to disclose information about the interest earned by EU residents. Many non-EU states and countries agreed to introduce similar measures. These countries included most tax havens and dependent territories of the EU countries. Countries such as Jersey, Guernsey, Cayman Islands, Andorra, Turks & Caicos, British Virgin Islands, Monaco, Switzerland, and many others thus agreed to implement similar or transitional arrangements (see below). The transitional arrangements involved the payment of a withholding tax whilst bank secrecy remained protected.

Maintenance of bank secrecy laws and the EU withholding tax

Some countries agreed to fully comply with the EU Savings Directive by disclosing the names of their account holders and the interest that they earned. However, several other EU and non-EU countries, such as Switzerland, objected to the disclosure of account holders' names on the grounds that such a disclosure would be contrary to their bank secrecy laws. Bank secrecy laws prevent the disclosure of information about account holders, their assets, and their interest or other income.

Finally an agreement was struck with the objecting countries. The objecting countries achieved agreement from the EC that no further attempt would be made to commence negotiations regarding bank secrecy rules for at least 7 years, in return for which individual account holders could, if they so wished, voluntarily elect to waive bank secrecy and authorise disclosure. Those individuals who did not make any election would see a withholding tax deducted from their bank and bond interest. To avoid the withholding tax, certain types of individuals could also prove that they were exempt from taxation in their country of residence. Exempt individuals include certain diplomats and others with a special tax status in their country of residence.

Accordingly, in order to guarantee privacy and bank secrecy for EU residents who have accounts within certain territories such as Switzerland, a withholding tax of 20% is being levied on the interest earned by those EU residents. This withholding tax, which applies only to certain interest, such as bank deposit interest and bond interest, is passed on anonymously to the EU countries concerned, and is known informally as the EU Withholding Tax.

Countries affected

The EU withholding tax currently applies to the residents of the 27 European Union Member States as shown below:

Together with their dates of accession, the 27 current members of the European Union are:

Income on which the EU tax is deducted

The EU withholding tax applies only to bank interest, bond interest, and analogous income, such as income from bond funds, money-market funds, loans, and mortgages.

Anti-evasion

Certain anti-evasion measures exist, for example, to levy the tax where interest has been converted to some form of capital gain. Typically this would apply where, for example, a zero coupon bond has been bought and sold at a profit, or where a bond fund, or a money-market fund, does not pay out its interest and the fund is subsequently sold at a profit. The rules define how much of the fund's assets must be in bonds for it to be classified as "interest earning".

Initial reports as to the amounts of funds raised by the withholding tax suggest that the anti-avoidance measures have not been particularly effective.[1]

Income gains and profits which are not taxed

The EU withholding tax is not levied on any other forms of income such as employment income, trading profits, commercial activities, royalties, annuities and similar income. Also, the EU withholding tax does not apply to dividends from shares, nor to capital gains and other profits realised on investments. All these types of income and profits are described as being "out of scope".

Individuals and accounts which are not affected

The EU withholding tax is levied only on individuals and not on companies, discretionary trusts, foundations, stiftungs, anstalts, investment funds, etc., except in very special circumstances, e.g. a "bare trust".

The EU withholding tax is not deducted from individuals who reside outside the European Union. Thus, for example, a resident of Jersey or of Switzerland, would not pay the tax, even though these countries have signed the agreement with the EU. Neither Jersey nor Switzerland is in the European Union.

Companies

The EU withholding tax does not apply to interest paid to companies. A separate EU directive, the Interest and Royalties Directive, applies to interest (or royalties) paid by a company in one member state to an associated company in another member state.[1] Such interest is exempt from withholding tax, although in many cases interest paid is in any event exempt from withholding tax under the terms of double tax treaties between member states.

UK resident but not UK domiciled individuals

In the UK such individuals have a special tax status which limits them to paying tax on income and gains from UK sources, and on foreign income and gains which are remitted to the UK. A similar status can be accorded to individuals in some other European countries (e.g. Belgium and the Netherlands), because they are only temporarily resident for the purpose of employment. Certain countries such as Jersey and Switzerland accept that these individuals may be exempt from tax on income earned and retained overseas, and are thus not subject to any retention. Needless to say, the exemption needs to be proven.

Beckham Law

Spain has introduced a similar concept to the UK non-domiciled rule above, known as the Beckham law. The law gained its nick-name after the footballer David Beckham became one of the first foreigners to take advantage of it. However the law is aimed at all foreign workers (particularly the wealthier ones) living in Spain. Upon application and acceptance such individuals are only liable for Spanish taxes on their Spanish source income and assets. As with the UK non-domiciled individuals, exemption from tax on foreign income must be proven to the financial institution to avoid the EU Savings Tax deduction.

The transitory provisions of the Withholding Tax

The Countries that would be applying the transitory provisions, instead of exchanging information will retain withholding tax as follows:

  • 15% in the first three years (2005-07-01 – 2008-06-30),
  • 20% in the next three years (2008-07-01 – 2011-06-30), and
  • 35% after 2011-07-01.

With regard to the distribution of their withholding tax, the Directive provides that all Countries that are withholding it will retain 25% of all receipts at their end and will transfer the remaining 75% to the Member State where the beneficiary owner is resident.

With regard to double taxation, the Directive provides that the Member State where the beneficiary owner is resident, and therefore where he normally pays his tax dues, should ensure that tax is not paid more than once when applying the withholding tax rates.

Countries providing for the exchange of information

All EU Member States with the exception of Belgium and Austria have agreed to exchange information with each other.

In Luxembourg clients can choose between exchange of information and withholding tax retention.

Gibraltar is deemed to be part of the UK for the purposes of the EU Savings Directive and thus will exchange information with other EU countries such as Spain and the UK. Residents of Gibraltar will either suffer withholding tax on interest arising overseas, or have that income reported to the UK who will pass it on to Gibraltar authorities.

Among the third countries signatories there are also, Anguilla, Cayman Islands, Montserrat and Aruba who have agreed to exchanging information.

Countries providing for the withholding tax retention under the Transitory Provisions

The following countries maintain bank secrecy and will deduct the withholding tax from interest:

From among the EU Member States, the following countries maintain bank secrecy:

Other countries (Not EU member states), (the following countries also maintain bank secrecy):

Countries who did not sign any agreement

Singapore, Hong Kong, Bermuda and Barbados did not sign any agreement.

External links to legislation, guidelines and commentary

See also

References

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