What did the EU decide on taxation of income that is earned from savings?
Some 14 years after EU countries first set out to deal with this issue, an agreement appears finally to have been reached. The issue at stake relates to people who deposit their savings abroad and earn income on these savings. They normally do so if they think that they can earn higher interest or if they think that they can avoid paying taxes on what they earn.
But, of course, this practice costs national treasuries in the country of residence of the depositor a lot of money in lost tax revenue. For example, in Malta we pay a withholding tax of 15 per cent on interest that we earn from our bank deposits held in Maltese banks.
But those of us who deposited their savings abroad, do not pay tax in Malta on interest earned abroad, unless they declare the income here. This costs the Maltese treasury money in lost revenue. And this explains why last year the Maltese government operated a scheme to give an incentive to those holding money abroad to repatriate it against payment of a minimal registration tax.
Much the same applies in other countries which have a vested interest in seeing such moneys declared for tax purposes. But from the other side of the coin, this issue is also of interest to countries that have benefited hugely from such deposits made by non-residents. The classic case is Switzerland. But others include Luxembourg, Monaco, Andorra, San Marino as well as British dependencies such as the Channel Islands, the Isle of Man and its other territories in the Caribbean.
Malta too has attracted business in private banking, although this is not considered to be the main pillar of our financial services industry. EU countries have long wanted to act on this issue and different proposals have been on the table for more than a decade. Just that tax decisions require unanimous approval in the EU and no agreement could be reached. Until last month, when an outline agreement was reached in the EU council of ministers.
In the main, the EU proposal seeks to curtail tax avoidance by introducing a system of automatic exchange of information between tax authorities. This means that tax authorities would be able to obtain information on the income earned by their residents abroad - in other words this would do away with the banking secrecy behind which depositors have been hiding.
A previous proposal to introduce a common withholding tax on savings income earned by non-residents was shot down by the British. The system of withholding tax does not hit confidentiality. But, of course, it reduces significantly the main incentive for a person to take the hassle of depositing his money in another country.
The main concern among some EU countries, such as Luxembourg, was that any law adopted by the EU could lead to a flight of capital out of the EU and into non-EU countries such as Switzerland and the rest. Therefore, it argued, for any EU law to be acceptable to Luxembourg, it has to be "obeyed" in substance by non-EU countries as well. Until this happened, Luxembourg would not agree to play ball.
This explains why, over the past year or so, the EU has been engaged in negotiations with Switzerland to get the Swiss to accept "equivalent measures" and agree to introduce exchange of information.
The basis of the agreement with Switzerland, although yet to be finalised, would see this country getting away with full removal of banking secrecy. But at a price.
Switzerland would accept to reduce its attractiveness as a private banking centre by imposing a new withholding (or retention) tax on deposits held in Switzerland by non-residents. The tax will start to apply in Switzerland from 2004 at a rate of 15 per cent going up to 20 per cent in 2007 and 35 per cent from 2010.
As EU Commissioner Bolkestein pointed out, if the saver does not want to declare his or her revenue to their State of residence then, "there has to be a penalty".
Significantly, Switzerland agreed to share the tax that it collects with the country of residence of the depositor. The tax revenue will be shared on the basis of 75/25. Switzerland will keep 25 per cent of the tax collected whereas the country of residence of the depositor will net 75 per cent.
This means that, if an Italian resident holds an account in Switzerland, the interest he earns will start to be taxed at the above rates in Switzerland. But Switzerland would then pass on three quarters of that tax to the Italian treasury. Switzerland also agreed to keep the tax at 35 per cent even after it starts to apply exchange of information on OECD standards. Switzerland also agreed to grant exchange of information on request for all criminal and civil cases of fraud or similar misbehaviour on the part of the taxpayers.
On the basis of the expected agreement with Switzerland, the EU will conclude similar agreements with other non-EU countries, such as Liechtenstein, Monaco, Andorra and San Marino. Offshore centres that are dependent or associated territories of EU countries, such as the Channel Islands, the Isle of Man and Britain's dependent or associated territories in the Caribbean, will also comply.
New EU countries, including Malta, will also be asked to adopt this law.
All these centres must now take stock of the situation and develop their business on the clear understanding that full exchange of information is the ultimate objective.
As far as EU countries themselves are concerned, automatic exchange of information will start to apply from 2004. On the other hand, Luxembourg, Belgium and Austria will retain a withholding tax system on the same basis as Switzerland. Even here however, it is a postponement, not an exclusion, of exchange of information.
The new law will not affect the interest or other income that you earn in Malta or the rate of withholding tax that you pay on interest on your bank deposits in Malta (currently at 15 per cent). It merely applies to non-residents. Taxation of savings income of Maltese residents in Malta remains up to Malta.
Malta-EU Information Centre: Tel: 25909192; Fax: 21227580; E-mail address: euinfo.mic@magnet.mt; Website: www.mic.org.mt
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