European Union Withholding Tax

The European Union withholding tax, more commonly known as the EU withholding tax is a withholding tax which is deducted from interest earned by European Union residents on bank accounts in participating countries. The purpose of this withholding tax is to ensure that the EU resident does not avoid taxation by depositing funds in tax havens (EU ones or countries cooperating with the EU) with bank secrecy laws. The rate of tax is currently at 15% of the interest earned. The tax is withheld at source and passed on to the EU Countries without any disclosure as to who was actually the beneficial owner of the bank account receiving the interest. Of course if the person filed a return that showed he or she was entitled to a refund of this withheld money there would be no practical way for them to show that it was in fact paid since the government in question only receives a lump sum payment. This could be one reason why the Swiss banks do not like to pay interest on their accounts.

Date of introduction

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

Objective of the EU Savings Directive

The original intent of the EUSD was that all counties 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.

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 EU that no further attempt would be made to commence negotiations regarding bank secrecy rules for at least 7 years WARNING: Guess what these countries intend to do in seven years, in return for which individual account holders could, if they so wished, voluntarily elect to waive bank secrecy and authorize disclosure. Those individuals who did not make any election would see a withholding tax deducted from their bank and bond interest. If they made full disclosure to their home government then they would presumably just file tax returns at the end of the year. 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.

Countries affected

The EU withholding tax currently applies to the residents of the 25 European Union Member States as shown below:

Together with their dates of accession, the 25 current members of the European Union are:

Austria (1995)  Belgium (founding member: 1952/58)  Cyprus (2004)  Czech Republic (2004)  Denmark (1973)  Estonia (2004)  Finland (1995)  France (founding member: 1952/58)  Germany (founding member: 1952/58)  Greece (1981)  Hungary (2004)  Ireland (1973)  Italy (founding member: 1952/58)

Latvia (2004)  Lithuania (2004)  Luxembourg (founding member: 1952/58)  Malta (2004)  Netherlands (founding member: 1952/58)  Poland (2004)  Portugal (1986)  Slovakia (2004)  Slovenia (2004)  Spain (1986)  Sweden (1995)  United Kingdom (1973)

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-avoidance – More Bad News

Certain anti-avoidance 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.

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, or to capital gains and other profits realized 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. Maybe this is why Swiss Attorneys buy hundreds of Panama Corporations each month.

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.

The transitory provisions of the Withholding Tax – It gets much worse over time!

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 (1.7.2005 – 30.6.2008),
• 20% in the next three years (1.7.2008 – 30.6.2011), and
• 35% after 1.7.2011.

Countries providing for the exchange of information

All EU Member States with the exception of Belgium , Luxembourg , and Austria have agreed to exchange information with each other. This would include account holder information specifically, which means zero privacy and no secrecy.

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.