Urs Kapelle explains the intricacies of the EU's Savings Tax Directive and the problems that Switzerland's financial services are facing during implementation
For months now the Swiss financial services industry has been working overtime to prepare for the introduction of a withholding tax from 1 July 2005, according to the agreement Switzerland signed with the European Union (EU) to help the EU close a potential loophole in its Taxation of Savings Income Directive. Switzerland has always made it clear it will fulfil its obligations under this agreement both in terms of timing and implementation.
The first step Switzerland had to take was to prepare the legal foundations for the withholding tax. Switzerland signed the agreement with the EU on 26 October 2004 and the necessary domestic legislation (the so-called 'Zinsbesteuerungsgesetz' or 'Taxation of Interest Law') was subsequently passed by the Swiss parliament with an overwhelming majority during its winter session. Already in October 2004, the Swiss Federal Tax Administration (FTA) issued its first draft guidelines for levying the withholding tax.
Looking around the rest of Europe it is clear that Switzerland is at present further ahead than most countries. Of the 40-odd countries and dependent territories due to introduce the EU Directive or implement equivalent measures, Switzerland was one of the first to issue 'secondary regulation' governing national implementation. It was essential to have this regulation in place at an early stage as it forms the basis for the work that has to be done in terms of programming IT systems by banks and other paying agents.
An obsession with interest
You may well ask why the introduction of a simple withholding tax - at an initial rate of 15% - poses a problem in this age of sophisticated software. The answer lies in the special nature of the EU's Taxation of Savings Income Directive. The EU itself intentionally designed the directive to be very selective and specific. The directive specifically targets interest earnings, but no other capital income such as dividends or capital gains. Furthermore, it only applies to natural persons, such as individual private human beings; legal persons such as companies and corporations fall outside the scope of the directive. And it only applies to cross-border interest payments to those natural persons who are liable for tax in an EU member state.
Tax and IT experts in banks across Europe have to program their systems to identify those interest payments that fall with the scope of the directive from those that do not. The vast majority of the approximately 340 banks in Switzerland have not outsourced their IT systems. This means that every single bank has to examine and analyse its software applications and, where necessary, make adjustments. There is work not only for the bank's back office and IT people, but also for the front office in terms of advising clients, opening new accounts and developing financial products. The Swiss Bankers Association estimates the work involved to get ready for 1 July 2005 will cost Swiss banks around 300m Swiss francs (approximately £135m).
Besides relying on the international treaty between Switzerland and the EU and the Taxation of Interest Law, Swiss computer programmers and tax specialists are using the FTA's Guidelines as their Bible. The guidelines were forged by a working group consisting of representatives of the FTA, the Swiss Bankers Association, the Swiss Funds Association and the Swiss Fiduciaries Association.
The guidelines contain all the details necessary for practical implementation. For example, they spell out which investment products are affected and describe the practicalities of taxing the interest. They also contain regulations governing other duties of the paying agent, such as identifying clients who fall within the scope of the directive, calculating the amount of tax to be withheld and informing clients who choose to divulge information about their interest payments voluntarily to their respective home tax authorities.
Will everybody be ready?
In Switzerland it is somewhat astonishing to see that a substantial number of EU members states, including Luxembourg, Italy and Greece, have not yet even passed the necessary legislation (primary regulation) for the national implementation of the Directive. For reasons explained earlier, even more important is 'secondary regulation' in the form of detailed guidelines from the tax authorities. Among Switzerland's immediate neighbours, only Germany has published such guidelines. A recent survey by the European Banking Federation discovered that Austria, France, Italy, Luxembourg, Belgium, the Netherlands, Spain, Portugal, Sweden, Finland, Greece and all the new EU members states have not yet produced or even drafted such implementation guidelines.
Switzerland is surely justified in asking how the authorities in these countries plan to supervise the implementation of the directive from 1 July 2005 if they cannot manage to issue guidelines before that date. It is even more difficult to judge how far paying agents in the countries mentioned above have got with their practical preparations. Switzerland took the issue very seriously from the beginning and always reassured the EU that it would not allow EU taxpayers to circumvent the directive simply by using a paying agent on Swiss soil. However, while Switzerland should not implement a 'light' form of the directive, it should on the other hand not go overboard and implement it more strictly that EU member states themselves. Great care is needed here, because tiny discrepancies in the detailed regulations could, in practice, result in competitive disadvantages. For example, structured investment products are of crucial importance to the asset management and new issues business. In this area, Switzerland is following the original intention of the EU and is largely excluding pure derivative products from the taxation of interest. If this had not been done, Swiss banks would have been at a competitive disadvantage in their private banking business compared with other countries.
Problems with investment funds
There are similar problems with investment funds. Investment funds are affected by the directive if, in their investments, they cross percentage thresholds in the proportion of interest-earning products held. Who knows how the EU decided on the rules determining these thresholds and how it will decide on their practical implementation. If the regulations were to be implemented literally, virtually all funds would fall outside the scope of the directive. If, on the other hand, the regulations were to be implemented in the spirit of the EU's original intention and purpose, then a much larger number of funds would be affected. Established and up-and-coming fund centres such as Luxembourg and Ireland are, not surprisingly, tending to apply the literal interpretation, thereby undermining the very purpose of the directive. The EU Commission should really step in here and make things clear. Switzerland will decide on a course of action only when it knows what the other countries will be doing.
1 July 2005 is fast approaching. It is to be hoped that EU member states, together with their dependent territories and other non-EU financial centres, can succeed in turning into reality something they have long striven for: namely, a level playing field.
Switzerland is at present further ahead than most EU countries in its preparations for the directive.
Switzerland is following the original intention of the EU and is largely excluding pure derivative products from the taxation of interest.
Switzerland will decide on a direct course of action only when it knows what the other countries will be doing
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