EU Savings Tax Directive

I have a savings account in Jersey, as well as two investment funds - both sterling bond funds - in the Channel Islands. I have heard rumblings that interest from my savings, as well as the interest from the bonds, will be taxed at source at 15% from next year. Why is this happening all of a sudden, and how can I control where to pay the tax due on my savings and investments?

From July 2005, new arrangements will come into force across the whole of Europe which will make an impact on all individuals who have interest-bearing bank accounts and investments. This topic has been ongoing for about 15 years now, and I see it as a necessary conclusion to what should have been put in place many years ago.

Back in the late 1980s, the Organisation for Economic Co-operation and Development (OECD) tried to tackle tax avoidance from savings and investments, but without success. As a result, EU finance ministers at the time agreed on joint action across Europe to eliminate what they deemed "harmful tax practices" by reducing the opportunities for tax evasion.

This resulted in the EU Savings Tax Directive, which requires all EU states to exchange information on interest payments received on savings and investment income of non-resident private individuals so that they can be taxed at the appropriate rates in their home country. The majority of EU countries will adopt this method of exchange of information.

However, Luxembourg, Austria and Belgium have elected to deduct a withholding tax at source instead. Switzerland, the Isle of Man and the Channel Islands will also be adopting the withholding tax option, even though they are not EU members.

In practice, this means that for the countries adopting the exchange of information route, on an annual basis, details of interest earned from private bank accounts and investments will be passed to the account holder's home country, i.e. Malta. Interest will therefore be taxed in Malta as it always should have been.

In the case of accounts/investments in the likes of Jersey and the Isle of Man, there will be no automatic exchange of information. Tax will instead be charged and deducted at source at 15%. This rate will however rise to 20% in 2008 and 35% in 2011.

The Jersey/IOM government will retain 25% of the tax revenue and 75% is passed to the account holder's home country, i.e. Malta. This tax revenue will be passed in bulk, i.e. no naming of individuals will be made. This is a very important point as these countries, especially Switzerland, rely on client confidentiality.

Any bank deposits that pay interest, as well as investment income that is generated from fixed interest securities (government and corporate bonds) will be affected, if they are held in the name of the individual. Very importantly however, trusts and life insurance-based products are excluded from the Directive and therefore offer a legitimate means of tax planning.

Interest bearing deposits and investments can therefore be held in legitimate insurance bonds without any automatic exchange of information or withholding tax. For example, your two sterling bond funds can be transferred into an insurance bond. However, if tax is due, then one must pay it, although certain investments do allow legitimate tax planning opportunities, where you can control when tax is paid.

I have been following the impact of the EU directive for more than five years now and the results are not surprising. Investing 'offshore' will, from July next year, certainly take a new direction.

It is critical therefore that one reviews any offshore investments held to ensure they still meet one's objectives. Such a review/consultation can be arranged by contacting one's investment adviser.

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 (office hours) or e-mail mh@hollingsworth-int.com.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.