Common tax on capital moves closer

Date: 18/02/1999

By Tim Jones

A DECADE since the idea was first floated, the EU is closer than it has ever been to establishing a common system for taxing capital income.

Admittedly, the stop-start history of pan-European energy levies should make everyone wary of making predictions, but it is now probable rather than possible that a savings tax regime will be approved in principle by the end of this year.

The key to unlocking a deal is the utterly changed political climate since the European Commission first suggested withholding tax on all interest at a common rate of 15&percent; back in 1989. The idea, though supported by the Franco-German juggernaut, ran into a British-Luxembourg stonewall.

The Conservative government in the UK felt it had gone far enough in harmonising indirect taxes to make way for the single market and feared that a tax on capital income paid in the City of London to non-British nationals would drive a major source of income to New York.

Successive Luxembourg governments, first under Jacques Santer and then Jean-Claude Juncker, have levied no taxes at all on capital income either for domestic savers or foreigners. This has made the Grand Duchy a massive and exceedingly convenient tax haven for the German, Belgian and Dutch middle classes.

Luxembourg is not alone. The Austrian Research Institute estimates that €200 billion in tax revenues is waiting to be tapped in Europe's various tax havens, including Andorra, San Marino, Monaco, Liechtenstein and the Channel Islands.

The 1989 proposal aroused excitement, then disappeared. When the Belgians took over the presidency of the Union in 1993, they attempted to breathe life into the corpse, as did the Germans six months later. Promises to negotiate equivalent savings-tax agreements with Switzerland, the tiny tax havens and - within the Organisation for Economic Cooperation and Development - with the US, fell on deaf ears.

On taking office in January 1995, Internal Market Commissioner Mario Monti decided to revive the idea but in an entirely different form. Having prepared the ground with his arguments against “harmful tax competition” and following the election of a left-leaning government in the UK, the Italian Commissioner came forward with a stripped down withholding-tax plan in May 1998.

This time round, to meet the French halfway, the Commission proposed a 20&percent; tax on capital income but specified that this should only be withheld from interest paid to EU nationals who were not resident for fiscal purposes in the country of payment. This would, Monti's team hoped, concentrate the efforts of the EU on the cross-border impact of varied tax regimes and address the problem of widespread evasion and avoidance.

In addition, to meet the concerns of governments - particularly the British - which would never consider levying tax from foreign nationals, the Commission offered a 'co-existence' model. This would allow member states to choose between either setting a tax or obliging their banks and paying agents to provide interest payment details to a non-resident saver's home tax authority.

In the meantime, Monti had been careful to offer the Luxembourghers a carrot in the form of an attack on predatory corporate taxation and was hopeful that the new UK Labour administration would be receptive to his war on tax evasion. After all, London had just launched a public inquiry into its own offshore centres on the Channel Islands and the Isle of Man.

“We are convinced that there are only four freedoms in the single market,” Monti told the European Parliament last year. “These are free movement of capital, goods, services and people; and not a fifth freedom to use these other freedoms to evade taxes.”

The puritanical British Finance Minister Gordon Brown appreciated the rhetoric. However, he had already made it clear, six months before the Monti proposal saw the light of day, that he wanted an exemption from the tax for interest 'coupons' from debt instruments denominated in a currency other than that of the issuer (eurobonds).

British negotiators have not budged a centimetre on this issue since talks began last spring, forcing Monti to despatch his staff to the City of London in search of a compromise arrangement.

Banking agents and the 'custodians' who hold bonds for large institutional investors want to cut the costs of the scheme, while eurobond-market players claim the imposition of a tax would trigger contract clauses which would effectively transfer €4 billion from bond-holders to issuers.

Nobody is saying it out loud for fear of spooking this €3-trillion market, but nearly everyone is expecting a 'grandfather clause' to be drafted. This would specify that the tax or information-sharing provisions would only apply to bonds issued after the directive came into force.

The new German presidency is taking the negotiations slowly. Bonn knows it will get nowhere until elections are out of the way in Luxembourg in June but officials are convinced that, once it is isolated within the euro zone, the Grand-Duchy will bite the tax bullet.