The proposed Council Directive on savings income was circulated by the European Commission on June 4 1998. Its rationale is the perceived scope for tax avoidance created by a lack of coordination of national systems for the taxation of interest payments on savings. It will also tax interest on public debt securities and bonds.
The objective is to tax interest received in a member state for a resident of another member state regardless of where the issuer of the debt securities is established. It has material implications for the Eurobond market and the development of a European high yield bond market.
Under the withholding tax proposals paying agents will be required to either withhold 20% from the interest due on investments they hold or alternatively to ensure that the beneficiary's interest payment details are passed back to the tax authority in the other member state. Each member state can decide which approach to adopt. There is a mechanism for a beneficiary to avoid a withholding by proving it has advised its local tax authority of the interest it is to receive. It is proposed that local laws are adopted by member states to give effect to the Directive from January 1 2001. The effect of the proposals is not yet totally clear (and they may change) but some issues are as follows:
- certain holders of Eurobonds potentially lose the cash flow advantage of receiving interest gross;
- the gross-up clauses in typical Eurobonds (maturing after 2001) may be triggered giving the issuer the right to redeem;
- further consideration will need to be given to taxation clauses in future Eurobond issues;
- potentially onerous obligations on paying agents may be imposed causing paying agents to leave member states;
- certain member states, particularly Belgium and Luxembourg, may take the opportunity to elect for the withholding tax to gain a considerable extra source of revenue; and
- UK resident banks and fund managers which are beneficiaries for the purposes of the Directive may take their Eurobond holdings outside a member state.