Select Committee on European Communities Report


Letter from Lord Tordoff, Chairman of the Committee, to Mrs Dawn Primarolo MP, Financial Secretary, HM Treasury

  Sub-Committee A (Economic and Financial Affairs, Trade and External Relations) considered this proposal for the first time at its meeting on 14 July. The Sub-Committee was concerned that the Treasury's Explanatory Memorandum on this important proposal is unhelpfully brief. It therefore agreed that I should write to ask you for a detailed memorandum containing further information on the following points:

    (i)  the effect of this proposal on the City, and whether it would be likely to discourage investors;

    (ii)  HMG's stance on the details of the proposal—the Explanatory Memorandum states (paragraph 7) that "work is needed on the details of the draft Directive" without divulging the Treasury's thinking on these details;

    (iii)  whilst noting that the proposal is made under Article 100 (and therefore requires unanimity), what is the attitude of other Member States, including Austria and Luxembourg, to the proposal.

  It would also be helpful to know the Government's timetable for the discussions which it is currently holding with interested parties, and when the "fuller assessment" referred to in paragraph 9 of the Explanatory Memorandum is likely to be published.

  If time allows, the Sub-Committee has indicated that it may think it appropriate to take evidence on this proposal, and on fiscal harmonisation generally, later in the year. It has therefore also asked me to ask you to keep the Committee informed of any other EU taxation proposals which are due to be published.

  The Sub-Committee wishes to maintain the scrutiny reserve for the time being.

15 July 1998

Letter from Dawn Primarolo, Financial Secretary to the Treasury, to Lord Tordoff, Chairman of the Committee

  Thank you for your letter of 15 July asking for further information about the European Commission's draft Directive on the taxation of savings. Since discussions in the Community on this proposal are still at an early stage, and our own research into the likely implications of the proposal is not complete, the amount of extra information I can give at present is necessarily limited. However, I thought the Committee would appreciate a response before the recess.

  I have annexed to this letter a note setting out our understanding, article by article of how the Directive as drafted would work. I hope the Committee will find this helpful.

  The Committee asks about the effect of the proposal on the City. As you know, many City institutions have expressed grave concerns about the effect which the directive might have on the financial markets, in particular on Eurobonds for which London is the leading centre. My officials are in close touch with a representative group of interested bodies in the City, and a series of meetings and much research work have already taken place. The aim of these discussions is to identify exactly which sections of the market would be most likely to be affected and to what extent. It is essential that whatever stance the Government takes in the forthcoming discussions in Europe can be supported by firm evidence. However, it is as yet too early for me to say what the outcome of the research will be. We hope to be able to use it to develop our position, as well as provide a fuller formal assessment of the business impact of the proposals, by the autumn.

  Our stance on the detail of the proposed Directive does, of course, also depend to some extent on the outcome of our discussions with the financial sector. However, we have already said that in our view exchange of information about interest payments between Member States is preferable in principle to the coexistence model proposed in the draft Directive. The Directive as drafted is technically defective in a number of ways, and much work will be needed to get it into a workable form. Areas of concern are likely to include the scope of the Directive, the definition of interest, the "paying agent principle", under which the obligation to withhold or provide information attaches to the last paying agent in the chain, and the interaction of the Directive with double taxation agreements.

  The Committee also asks about the attitude of other Member States. Discussions at European level are only just beginning, but the evidence so far is that most Member States are broadly in favour of the proposals in principle, though many have reservations about the detail and not all are unambiguously in favour of the coexistence model (which has been devised as a system which would have some chance of being acceptable to those States which retain strict banking secrecy laws which would not allow them to exchange information about investors' holdings). The Austrian presidency has signalled its desire to make progress on the issue, and we expect the momentum to be maintained under their German successors. Many states, including Luxembourg, have indicated that they will want to raise a number of technical points on the proposal. There seems to be a general recognition of the need to avoid risking a flight of capital outside the Community, but most States also feel that it should be possible to find a balanced solution which is reasonably effective against tax evasion while avoiding serious damage to the financial markets. That will be one of the many issues for discussion in the months to come.

  Undertakings to consider Directives on Taxation of Savings and on Interest and Royalties (COM(98)67) comprise two of the three parts of the EU package on tackling harmful tax competition which was agreed by the Ecofin Council on 1 December 1997. The third was the Code of Conduct for business taxation. It may be helpful to let you know what progress has been made on that front.

  You will recall that the Code of Conduct is a non-legally-binding agreement whereby Member States committed themselves not to introduce new tax measures which are harmful within the meaning of the Code, and to re-examine existing laws and practices with a view to eliminating any harmful measures. A Code of Conduct Group, which I chair, has been set up. It comprises representatives from each Member State and from the Commission. It will review measures which are potentially harmful within the meaning of the Code.

  The Group has met twice and has agreed an ambitious work programme which includes a provisional report to Ecofin in December 1998, a further report in Summer 1999, and a full report by the end of that year. The Commission has drawn up a list of potentially harmful tax measures for the Group's consideration. It is an initial list which will be refined and added to over the Summer.

  The process of assessing whether potentially harmful measures on the list are considered actually harmful will be started by two sub-groups which will start work in the Autumn and report back to the main Group. The output from the Group will consist of reports to Ecofin which will reflect the full range of views within the Group. The Ecofin Council will decide whether the Group's reports are published.

  I enclose a copy of a Press Statement issued after the latest meeting of the Group on 16 July.

24 July 1998



  At the end of the meeting of the Code of Conduct (Business Taxation) Group, held today in Brussels, the Chairwoman of the Group, Dawn Primarolo, UK Financial Secretary to the Treasury, said:

    "The Code of Conduct Group (Business Taxation) met for the second time today. It was a useful meeting at which member states reaffirmed their commitment to the principles of the Code we agreed last December.

    We discussed our work programme and set a timetable to enable us to present our initial report to ECOFIN in December. Our next meeting will be in October.

    We noted that the initial indicative list of potentially harmful business tax measures which might fall under the scope of the code of conduct for business taxation. This list was compiled by the Commission on the basis of information provided by member states and information based on earlier discussions in the tax policy group, as well as publicly available information.

    The Group emphasised that the list was not exhaustive, and that inclusion of a measure on the list did not necessarily mean that it was, in fact, harmful.

    We have decided to evaluate measures category by category on a cross-country basis. We agreed today to divide the measures into five categories: intra-group regimes, financial and off-shore companies, other sector-specific regimes, regional incentives, and other measures.

    We decided to establish two sub-groups which will undertake an initial examination of measures related to intra-group regimes, and the financial and off-shore companies respectively. The three other categories will be examined subsequently. I will chair the first and Mr Nolz, Director-General of the Austrian Ministry of Finances, will chair the second subgroup".



Summary of explanatory memorandum

  1.  Paragraphs 1-4 set the draft in the context of the wider package announced in November last year to tackle harmful tax competition. They make it clear that this Directive is intended to further all three objectives of the package (reducing distortions in the internal market, preventing loss of tax revenue and hence rebalancing tax structures so as to reduce taxes on employment) by countering evasion of tax on savings. It is noted also (Paragraph 3) that the start of the single currency makes achieving this objective more urgent.

  2.  Paragraphs 5-11 discuss the "coexistence" model, explaining that giving Member States a choice between two options is seen as increasing the chances of the Directive's adoption (ie States with strict banking secrecy laws would be able to opt for withholding, but information exchange provisions already in place could be continued or extended). Individuals resident in States opting for withholding would be able to avoid withholding, without compromising banking secrecy, via the certification procedure provided for by Article 9.

  3.  Paragraphs 9-10 discusses the choice of a rate for withholding, explaining the tension between the need to achieve the objective of the Directive (to ensure a minimum of effective taxation) and the need to avoid causing a capital flight by setting too high a rate.

  4.  Paragraph 11 says that it is possible for the beneficial owner to ensure that he is taxed exclusively in the State where he is resident by providing a certificate issued by his own tax authority to the paying agent, who would then not have to withhold tax.

  5.  Paragraphs 12-14 discuss the "paying agent principle", explaining that the paying agent is in practice best placed to implement the Directive's requirements. It points out that this has the effect of including payments from debtors outside the EC (if they make them via an EC paying agent), and says that this mitigates the effect on EC borrowers in comparison with borrowers outside the EC.

  6.  Paragraph 14 says that the impact on the Eurobond market is thought to be limited by:

    —  the "paying agent principle" (and in particular the fact that an issuer resident in the EC is not placed at a disadvantage in comparison with an issuer outside the EC);

    —  restriction of the Directive to individual recipients within the EC (because, it is thought, most investors in Eurobonds are either companies or individuals outside the EC).

  7.  Paragraph 15 discusses the need for wider international measures. It proposes that the Community should negotiate with its commercial partners to achieve this, and requires Member States, so far as it is constitutionally in their power, to ensure that equivalent provisions are applied in their dependent territories to the extent that these do not fall directly within the Directive's scope (for us, only Gibraltar is directly covered).

Article 1

  Sets out the aim of the Directive, providing that Member States are to take the "necessary" measures to ensure a minimum of tax on interest payments going to individuals resident in other Member States. Paragraph 2 introduces the "paying agent principle", making MSs responsible for ensuring that paying agents established in their country comply with the obligations imposed by the Directive. It specifies that the place of establishment of the debtor itself is to be disregarded for this purpose.

Article 2

  Sets out the "coexistence model". Paragraph 1 provides that Member States are to operate either the "information system" or the "withholding tax system" (both described in later articles). The intention of paragraph 2 is that Member States should have to adopt either one system or the other for all relevant payments.

Article 3

  Defines the terms "beneficial owner", "paying agent", "residence for tax purposes" and "competent authority" for the purposes of the Directive.

  The "beneficial owner" is defined as the person (who must be an individual not a company) who receives the payment "for his own benefit".

  The "paying agent" means, for the purpose of the Directive, the last link in the payment chain. Thus, if the payment to the beneficial owner is made directly by the debtor, the latter is the paying agent. Or, if the payment passes through one or more intermediaries, the last one is the paying agent. This is the case even if the last intermediary was appointed by the beneficial owner himself, so that for the purpose of the Directive the term "paying agent" includes what we would call collecting agents.

  "Residence for tax purposes" This term is used in the Directive for establishing which "beneficial owners" are to be covered. The beneficial owner is to be deemed resident in the Member State:

    —  where he has his permanent home;

    —  if he has a permanent home in more than one Member State, in the one which is his "centre of vital interest" (described as the one "with which his economic and personal links are closest");

    —  if neither of these work, where he "usually resides";

    —  if he usually resides in no or several Member States, in the Member State of his nationality.

  If none of the above work to establish residence, the Member States concerned are to agree "within a reasonable period of time" where the beneficial owner is to be deemed to be resident. This structure follows the standard "tie-breaker" tests used under double taxation conventions to decide questions of residence as between two States.

  The term "competent authority" is used in Article 7 (the authorities who are to transmit/receive information where the information system is chosen) and in Article 8 (authorities who are to provide certificates authorising gross payment where the withholding tax system is chosen). The definitions used are in the Mutual Assistance Directive, for Britain: "The Commissioners of Inland Revenue or an authorised representative".

Article 4

  Requires Member States to adopt whatever procedures are necessary to allow the paying agent to identify the beneficial owner and his residence, using the definitions in Article 3. The paying agent needs to be able to do this to allow him to ascertain whether the Directive is applicable to the payment and, if the information system is being operated, to pass the information to the authorities to allow them to pass it on to the recipient's State.

Article 5

  This defines "interest" for the purposes of the directive. The four categories listed are, broadly:

    —  income from debts;

    —  increase in value of debts;

    —  income from collective investments vehicles investing in securities;

    —  increase in value of units in the latter.

Article 6

  This article defines the territorial scope of the draft Directive. It is to apply only to payments by paying agents (as defined) which are "established within" the EU.

Article 7

  Describes the "information system" option. Where this is chosen, the paying agent's Member State must convey (automatically, ie without being asked) to the beneficial owner's Member State the information which is "necessary to establish the amount of the beneficial owner's tax liability". Paragraph 2 sets out the minimum which must be given: amount, date of payment, identity and declared residence of beneficial owner. The information would have to be provided within 6 months of the end of the calendar year during which payment was made.

Article 8

  Describes the withholding tax system option. Where this was chosen, tax would have to be withheld at a minimum 20 per cent, except where the recipient produced a certificate with details of the payment issued by the relevant authorities of his Member State (in which case tax would only be withheld from any uncertificated amount). This article needs to be read in conjunction with Article 10 which sets out how the taxed payment would have to be dealt with in the recipient's State.

Article 9

  Sets out the certification procedure for the purpose of Article 8. For withholding to be avoided, the recipient's Member State must issue a certificate within two months on request by the recipient, showing the beneficial owner's identity, the paying agent's identity and the amount and date of the payment.

Article 10

  This Article contains the main measures to deal with the consequentials of withholding tax ie accounting for it in the recipient Member State and avoiding double taxation. Paragraph 1 states, in a general way, that Member States are to take the "necessary measures" to eliminate double taxation on income covered by the Directive. Paragraph 2 provides for the recipient's State to give a tax credit corresponding to the tax withheld at source. If the credit exceeds the tax due in the recipient's State, the excess is repayable by the State which withheld tax from the payment. The aim of paragraph 3 is to make similar provision to ensure that credit is also given for underlying tax on collective investment vehicles covered by the Directive. And Paragraph 4, dealing with payments originating outside the EU, provides for withholding tax under the Directive to be reduced by any non-refundable tax which has already been withheld before the payment reaches the paying agent's Member State.

Article 11

  Provides for the Community to negotiate with its "main third country commercial partners" to ensure effective taxation of income which comes via paying agents outside the EU.

Article 12

  Gives a timetable for the Directive. It is to be adopted and published by Member States by 1 January 2000, and applied by 1 January 2001.

Article 13

  Provides for the Commission to review the operation of the Directive and report to the Council on it by1 January 2004.

Article 14

  Provides for the entry into force of the Directive (20 days after publication in the Official Journal of the European Communities).

Article 15

  Addresses the Directive to the Member States.

Letter from Lord Tordoff, Chairman of the Committee, to Dawn Primarolo MP, Financial Secretary, HM Treasury

  Thank you for your helpful and informative letter of 24 July giving further information about this draft Directive, which was considered by Sub-Committee A (Economic and Financial Affairs, Trade and External Relations) at its meeting on 10 November. The Sub-Committee is still considering whether to take evidence on this proposal, and on fiscal harmonisation generally, and therefore wishes to maintain the scrutiny reserve for the time being.

15 July 1998

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