Opinion of the Economic and Social Committee on the "Proposal for a Council Directive to ensure a minimum of effective taxation of savings income in the form of interest payments within the Community"(1)

(1999/C 116/05)

On 3 July 1998 the Council decided to consult the Economic and Social Committee, under Article 100 of the Treaty establishing the European Community, on the above-mentioned proposal.

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 8 February 1999. The rapporteur was Mr Geuenich.

At its 361st plenary session on 24 and 25 February (meeting of 24 February 1999), the Economic and Social Committee adopted the following opinion by 93 votes to 22, with 15 abstentions.

1. Introduction

1.1. Commission objectives

The proposal for a directive is intended to ensure a minimum of effective taxation of savings income in the form of interest paid to natural persons who are resident for tax purposes in another EU Member State. The Commission is aiming to achieve a pragmatic, minimalist solution in order to avoid complications as far as possible. Issues relating to taxation of pensions and insurance payments will be considered separately with a view to drawing up specific proposals for legislation.

Taxation of investment income earned by corporations likewise falls into a different legal category than that covered by the present proposal for a directive.

1.2. Content of the Commission proposal

1.2.1. To ensure minimum taxation of interest payments to natural persons resident in the Community, the Member States can introduce either a withholding tax on interest payments to beneficiaries resident in another Member State ("withholding-tax system") or a system whereby information is communicated to the home Member State of the interest beneficiary ("information system"). This possibility of choosing between two different systems is referred to as the "coexistence model". The model applies to interest payments made through a paying agent in the EU (the "paying agent principle"). The place of establishment of the debtor is irrelevant.

1.2.2. The minimum rate of withholding tax is set at 20 %, though this does not preclude Member States from having a higher rate if they so wish. The sole function of the tax is to ensure that tax is collected once (minimum taxation of interest). It should therefore not be levied if the interest beneficiary presents to the paying agent a certificate from the tax authority of the Member State of residence confirming that this tax authority has been informed of the amount of interest to be paid. If the amount of interest paid exceeds the amount recorded on the certificate, withholding tax is charged on the difference.

1.2.3. The certificate must identify the interest beneficiary and the paying agent, and specify the amount of interest due and the payment date. The certificate is issued to the interest beneficiary within two months of application. According to the Commission, further details concerning the certificate remain to be discussed.

1.2.4. Revenues from withholding tax remain in the country where the tax is collected. In cases where a certificate is received from the tax authority of the Member State of residence, as described in the previous point, that country obviously receives the revenues from the taxation of interest payments.

1.2.5. In its proposal for a Directive of 10 February 1989(2) the Commission considered excluding eurobonds from the scope of the directive. This is not the case in the present proposal for a Directive, under which interest on eurobonds would be subject to the same taxation procedure as other forms of interest.

1.2.6. The Community undertakes to enter into negotiations with its main trading partners with the aim of also ensuring effective taxation of interest paid by paying agents in third countries to beneficiaries resident in the Community.

1.2.7. The Commission recommends that the representatives of the Member State governments meeting within the Council adopt the following decision: "Member States which have dependent or associated territories or which have special responsibilities or taxation prerogatives in respect of other territories are committed to taking appropriate measures, where appropriate within the framework of their constitutional arrangements, to ensure that provisions concerning interest payments to Community residents, equivalent to those contained in the Directive once adopted, may be applied in those territories."

1.2.8. The Member States are due to adopt and publish the necessary legal and administrative provisions by 31 December 1999 at the latest, so that the directive can be applied from 1 January 2001.

The Commission will report to the Council on the functioning of the directive by 1 January 2004. On the basis of this report, the Commission will if necessary propose to the Council amendments to the directive designed to improve the system of taxing interest payments and to eliminate any undesirable distortion of competition.

2. Risk of tax avoidance

2.1. Introducing withholding tax or an obligation to report cross-border interest payments in the European Union could encourage tax avoidance by moving funds to low-tax countries outside the EU. The ESC would make the following points on major instances of this practice.

2.2. Switzerland would not profit from any additional large influx of tax avoidance funds from the EU countries, as this would put further upward pressure on the exchange rate of the overvalued Swiss franc. The current overvaluation is already having a considerable effect on Switzerland's international competitiveness. Switzerland might be obliged in its own interests to take measures to prevent a further big influx of tax avoidance funds.

With the above in mind, it must also be considered that Switzerland relies on a system of bilateral agreements with the EU to avoid any disadvantages that might arise from not being an EU member. In this context there is every reason to hope that Switzerland and the EU will be able to reach a mutually satisfactory agreement in relation to the objectives of the proposal for a directive to guarantee a minimum of effective taxation of savings income in the form of interest payments within the Community.

2.3. In addition to all the big names in world finance, the Cayman Islands are host to some 28000 off-shore holding companies (27640 as at 6 November 1998) and as many trusts, which are attracted by zero taxation and increasing confidence in the islands' domestic stability.

It is an open secret that large-scale money-laundering takes place in the Cayman Islands, for instance. If there is any surveillance of this money-laundering, it is conducted only by the authorities of the Cayman Islands themselves, without the involvement of any foreign authority. If a foreign authority wishes to obtain the cooperation of the local authorities, this has to be approved first by a local court. No cases of this happening are known to date.

The right forum for dealing with the problem of a potential increase in tax avoidance using tax havens would presumably be the International Monetary Fund (IMF). If appropriate, negotiations between the EU and the OECD, involving the United States, could play a complementary or supportive role. Specifically, the IMF could block access to the international system of interbank transfers for all those banks that did not exercise a minimum degree of discipline.

However, it is hardly acceptable that the tax environment in the Cayman Islands, which are a British protectorate, should in the long run obstruct the objective of achieving a minimum of effective taxation of savings income in the form of interest payments within the Community.

2.4. The Cayman Islands have also been referred to as the "Liechtenstein of the Caribbean", which says something about the position of that other tax haven. However, the Liechtenstein issue is quite different from that of the Cayman Islands, if only because Liechtenstein is, like Norway, a member of the European Economic Area (EEA).

2.5. The Committee notes that the process of solving the problem of tax avoidance is well under way. It refers to Article 11 of the proposal for a directive, in which the Community is to be required to initiate either bilateral or multilateral negotiations with its main third-country trading partners in order to ensure that effective taxation of interest payments is possible.

The Committee is pleased to note that the European Council has stated its firm intention to meet this requirement. The conclusions of the European Council of 11 and 12 December 1998 in Vienna say the following about tax policy:

"The European Council welcomes the report of the Council on reinforced tax policy cooperation and emphasizes the need to combat harmful tax competition. Cooperation in the tax policy area is not aiming at uniform tax rates and is not inconsistent with fair tax competition but is called for to reduce the continuing distortions in the single market, to prevent excessive losses of tax revenue or to get tax structures to develop in a more employment-friendly way.

Specifically, the European Council:

- invites the Council [of Ministers] to pursue work on the proposals for a directive on taxation of savings and for a directive on interest and royalties with a view to reaching agreement before the Helsinki European Council;

- welcomes the intention of the Commission and the Council to begin talks with third countries on problems concerning the taxation of interest income."

2.6. A political process to resolve the problem of tax avoidance is also under way for Member States with dependent or associated territories or with special responsibilities or tax rights in such territories. An example is the joint statement of Tony Blair and Chancellor Gerhard Schröder of 10 December 1998, which was forwarded to the Austrian Chancellor, Viktor Klima, and all the other EU heads of state and government and the European Commission President, Jacques Santer, in which they say:

- "We fully support the need for enhanced cooperation in the fight against tax abuse and evasion".(3)

2.7. It should be borne in mind that the more "exotic" the country, the riskier a capital investment motivated by the desire to avoid tax is likely to be. Internal economic stability and an economy sound enough to make foreign capital secure are particularly relevant considerations here. There is also a limit to the extent to which above-average risk on capital investment can be covered by higher risk premiums, since any interest, including the risk premium, must ultimately be earned on the market. Thus the capital market automatically sets limits on tax avoidance in high-risk countries.

2.8. Finally, the Committee points out that the possibility of tax avoidance has not prevented any EU Member State from taxing interest earned by residents. This thorough taxation must now be supplemented by minimum taxation of interest paid to savers in another EU Member State.

3. ESC recommendations

3.1. The Committee has already stated its views on the question of taxing cross-border interest payments in the EU in its opinions entitled "Direct and indirect taxation"(4) and "Taxation in the European Union - Report on the development of tax systems"(5), and refers back to these documents.

3.2. The Committee welcomes the proposal for a directive because, once fully implemented by the Member States, it should curtail improper tax competition, and help to provide resources for job creation and (through the requirement to conduct productive negotiations with major trading partners) to prevent the European Union being put at a disadvantage on international capital markets.

The OECD has traditionally advocated the exchange of information on taxation between its members. It can be assumed that the OECD has been waiting for action to establish a minimum level of effective taxation of interest payments within the Community, now taken by the European Commission with this proposal for a directive, before introducing complementary measures.

3.3. As the Commission proposes a system which includes a choice between a withholding-tax system and an information system instead of only one common system, the following problem will arise.

The countries that choose the withholding-tax system will keep the taxes from interest incomes while those with an information system inform other countries of their respective nationals' interest incomes and thereby export this tax base. To prevent such a redistribution the Commission proposal needs to be amplified with a rule which eliminates the impact on the tax base created by the "co-existence" model.

3.4. The Committee notes that ensuring minimum taxation of cross-border interest payments does not prevent individual Member States from helping small savers by providing tax exemptions, for example. The Committee also endorses this approach.

3.5. Since collection of withholding tax does not discharge the beneficiary's tax liability, but could do so de facto if the beneficiary did not declare the interest received in the country of residence, the Committee points out that the "information system" is a particularly effective way of ensuring that interest is taxed at the beneficiary's personal tax rate.

However, the Committee is also aware that fair account must be taken of the legal situation in each EU Member State. In Luxembourg, for instance, an "information system" would be constitutionally impossible.

3.6. The Committee assumes that there can be no problem with administering the "information system" in this age of advanced electronic communications technology.

The introduction of other systems in addition to the "coexistence model", i.e. alongside the parallel "information" and "withholding tax" systems would make the situation progressively more unmanageable.

3.7. The Committee welcomes the Commission proposal that the Council should adopt a decision on negotiations to bring the position of EU exclaves and "off-shore" centres into line.

3.8. The Committee recommends that the minimum taxation of interest should be extended to financial products, which can be considered virtually equivalent to fixed-interest investments. The inclusion or non-inclusion of eurobonds in the scope of the directive is a major problem. The eurobond market is very significant in volume terms and has particular features that call for special evaluation of its tax treatment. It should be noted that many investors in this market are not resident in the European Union. The eurobond market is highly concentrated, and the vast majority of issues take place in London.

The Committee is aware how important this matter is, and for the following reasons is inclined to agree with the Commission's view, as expressed in the proposal.

Excluding eurobonds would substantially restrict the scope of the proposed directive. It would also give this type of investment a further advantage over other types of capital investment.

It should also be pointed out that eurobonds represent a significant percentage of the issues market in the United Kingdom. Not applying the taxation system set out in the Commission's proposal to eurobonds would virtually amount to excluding the United Kingdom from the scope of the directive. This is therefore an extremely delicate political problem for which a solution needs to be proposed that is likely to be supported by the required majority in the Council.

Brussels, 24 February 1999.

The President

of the Economic and Social Committee

Beatrice RANGONI MACHIAVELLI

(1) OJ C 212, 8.7.1998, p. 13.

(2) COM(89) 60 final, OJ C 141, 7.6.1989, p. 5.

(3) From Agence Europe No 7361 (General News),11.12.1998, p. 7.

(4) OJ C 82, 19.3.1996 .

(5) OJ C 296, 29.9.1997.

APPENDIX

to the opinion of the Economic and Social Committee

(Rule 47(3) of the Rules of Procedure)

The following amendments, which were supported by over a quarter of votes cast, were defeated during the course of the debate:

Amendment tabled by Mr Levitt and Mr Walker

Replace the entire text by the following:

"1.1. While accepting in principle the idea of a unified withholding tax in the EU, the ESC considers that the Commission's present proposals are ill-timed and ill-conceived.

1.2. In the absence of any agreement with countries outside the EU, there is the near certainty that such a measure, applied unilaterally within the EU, would result in massive outflows of capital to countries with more favourable tax regimes, including lower compliance costs. This has happened in the past when an individual Member State attempted to introduce similar legislation and it will happen again on a much larger scale if this proposal becomes law at this time. There is evidence that banks are already making contingency plans to switch funds to Switzerland, Liechtenstein and other European tax havens and these countries will welcome such inflows enthusiastically.

1.2.1. The ESC therefore believes that negotiations with external nations should precede the introduction of such legislation, if only because the prior enactment of this legislation would leave the negotiating teams with no lever with which to negotiate.

1.3. The extension of such legislation to include existing Eurobonds would have disastrous consequences for the Eurobond market. In many cases, bond holders are guaranteed a specified return after tax and the effect would be to force the bond issuers to increase the gross rate of interest paid in order to leave them with the same net return. This would increase the cost of capital, which would, in turn, reduce the prospects for employment. Where the terms of the issue permitted the bond issuers to redeem the bonds at an earlier date, they would do so and replace them by new issues at lower rates of interest. This would induce a massive capital transfer to issuers from bondholders including pension funds.

1.3.1. The net effect of this would be to place EU-based capital markets at a disadvantage with their competitors in other countries, which would create additional unemployment.

1.4. In any case, the legislation is unlikely to do much to achieve its declared aim of reducing tax evasion. Where a Member State imposed a withholding tax, it would receive this tax into its exchequer; on the other hand, if it opted to inform the Member State where the taxpayer was domiciled, the tax would be collected by that Member State. In these circumstances, all Member States will naturally elect to impose a withholding tax and none will choose the option to inform. The 'co-existence' is, therefore, a myth.

1.4.1. The result of this is that the minimum tax of 20 % will also be the maximum tax, since Member States in which the taxpayers are resident will continue to be ignorant of the existence of the transactions, which will consequently escape the higher rates of tax which would, in most cases, have been levied if the information method had been used."

Reason

Self-explanatory

Result of the vote

Against: 72; for: 40; abstentions: 7.