Information exchange

Gary Ashford outlines the new EU Savings Directive

On 1 July, with the introduction of the EU Savings Directive (2003/48/EC), EU member states will be a step nearer to the full exchange of banking information, the aim of which is to combat cross-border tax evasion.

The directive will force banks, and other financial institutions that make interest payments to individuals, to collect information on savings income paid to individual account holders. This information will then have to be provided to the relevant tax authority.

UK financial institutions have, for some time, had to submit reports to the Inland Revenue (now HM Revenue & Customs (HMRC)), and so, to some extent, the collection of information to meet the terms of the directive will be achieved simply by enhancing and extending their ongoing procedures. However, the obligatory information exchange is a new development.

Background

The origins of the directive date back to discussions held at the Helsinki European Council in December 1999. Considering ways to combat both harmful tax practices and tax fraud, the principle was borne that all citizens resident in EU member states should pay the tax due on all their savings income. The Council took the view that, to achieve this:

• member states needed information from other tax authorities about the extent of their residents’ income
• all types of savings income should be covered, including bank interest, bond interest and interest distributions from collective investment vehicles, and
• all sources of savings income should be taken into account (including both domestic and foreign sources, whether received from a source in another EU member state or not).

The European Council’s views were mirrored to a certain extent by the Organisation for Economic Co-operation and Development (OECD), whose Committee for Fiscal Affairs identified the failure of tax havens to provide information as a particularly harmful characteristic that facilitated tax evasion and money laundering.

The best way to achieve the stated aims was then debated - specifically whether to introduce a system of withholding taxes or a system of exchange of information.

Member states eventually agreed on information exchange; however, to be fully effective; they recognised that reciprocal agreements with as many other countries as possible were needed.

The directive was signed on 3 June 2003. However, some member states (Belgium, Luxembourg and Austria) were originally unwilling to sign up to the immediate exchange of information unless key financial centres also agreed to exchange information. They therefore negotiated transitional periods during which they would withhold tax as opposed to exchanging information.

Transitional arrangements

The transitional arrangements will remain in place for as long as key financial centres (Switzerland, Liechtenstein, Monaco, San Marino, Andorra and the US) are not participating in information exchange.

For the first three years, the withholding tax will be levied at 15%, with a 20% levy for the following three years and 35% thereafter. (The country withholding tax will transfer 75% of its revenue from the withholding tax to the investor’s country of residence).

As a step towards the eventual exchange of information, agreements were signed in late 2004 with financial centres, which provided four important elements:

• withholding tax, similar to the EU transitional system - i.e. 15% first three years, 20% for the subsequent three years and 35% thereafter
• voluntary disclosure of information (so the withholding tax should not be applied)
• exchange of information on request in cases of fraud, and
• a clause to review the terms of the agreement to take account of international developments.

The UK’s associated territories, including the Channel Islands and the Isle of Man, also agreed to implement similar transitional arrangements, and regulations were recently issued as a result of bilateral agreements signed with the UK Government.

Crackdown on offshore fraud

The timing of the directive will be very welcome to HMRC, which has for several years been gearing itself up for a fully-fledged drive against offshore tax fraud.

An Offshore Fraud Project Group was set up in 2002 with the aim of identifying bank and credit card accounts held offshore containing untaxed income and assets. In serious cases, they will open investigations and will, in some cases, consider prosecution.

HMRC has benefited from experiences shared by the US Internal Revenue Service (IRS), provided through its joint intelligence sharing relationship with the US, Australia and Canada, known as the Joint International Tax Shelter Information Centre (JITSIC). The Offshore Fraud Project Group has also for some time been applying its formal powers to obtain information about offshore accounts from various financial institutions.

HMRC has set up an Offshore Arrangements Project Group looking at companies with links to tax havens. In the past couple of years, it has identified approximately 30,000 companies for potential investigation.

In addition, HMRC is now receiving money laundering reports from the National Criminal Intelligence Service (NCIS) and has been briefed by the UK Government to take a leading role in identifying and prosecuting money laundering offences where tax evasion is the primary offence.

How will the withholding tax regime work in practice?

Undoubtedly, those involved in tax evasion will continue to invest in countries where withholding taxes are applied, as opposed to a system of information exchange.

The withholding tax regimes have been agreed, and the ultimate aim of the directive is to achieve full-scale information exchange. Having achieved implementation of the directive, it seems likely that the member states will continue to negotiate for full-scale exchange, having committed themselves to tackling evasion.

Undoubtedly, there is a limit to the number of enquiries which HMRC can mount at any given time. However, it will simply work its way through the list of those due to be investigated. With the spotlight rapidly falling on tax evasion, those who undertake it must be clear that the net is closing in.

Gary Ashford is senior manager, tax investigations, at Grant Thornton UK LLP.