Directive: directing the way ahead for savers

Wednesday September 20th 2006

Samantha Barrett

The EU savings tax directive has far-reaching implications. The directive, introduced in July 2005 after years of wrangling and postponements, is designed to ensure that tax on savings within the EU is paid to the correct country?s tax authority. It gives savers two options when it comes to how their savings tax is handled.

First, savers can elect to exchange information. This means the bank or building society will pass savers? details on to the tax authority in their country of residence. This option allows them to continue receiving interest gross, but, as was the case before July, they will need to submit a tax return and pay any tax.

If you don?t choose to exchange information, you will pay a 15% retention, or withholding, tax where the account is held. This will be levied automatically on any interest. The proceeds are then split between the tax authority of the country where your savings account is based, which receives 25%, and the tax authority where you are resident, which receives the remaining 75%.

?In the three months to July we sent out a lot of literature explaining the changes and the options open to our customers. We also offered our customers tax planning sessions with financial advisers if they wanted to review their savings and investments, although . . . most people kept their money in cash,? says Fiona Passey, director of offshore banking at Derbyshire (Isle of Man).

Michael Chaytor, head of sales and service at Bank of Scotland International, says: ?It was a fairly equal split between those who told us they wanted to exchange information and people paying retention tax, although I do expect more people to elect to exchange information as we move forward.?

Switching between the two regimes is easy. However, some institutions and tax authorities are more flexible than others. ?Customers will have to wait until the end of the tax year if they want to switch between the two tax treatments,? Chaytor adds. ?Although if there has been a change in your tax position and you have a statement from the tax authority, a mid-year switch will be possible.?

As well as a healthy take-up of the information exchange option, predictions that savers would shift their cash to more exotic climes such as Singapore and Hong Kong, outside the reach of the directive, failed to materialise. ?We did have some outflow of money in July and August, but it wasn?t on the scale that was expected and it may just have been because the communication exercise prompted people to review their finances,? says Passey.

Chaytor believes that this is because tax avoidance isn?t the primary objective of most offshore banking customers. ?In the run-up to the introduction of the directive, tax advisers were recommending all sorts of far-flung places where you could invest your savings without incurring tax. But the majority of our customers are UK expatriates who don?t necessarily trust these areas to look after their savings,? he says, adding that from the customer?s perspective the directive is tax-neutral.
?There has always been a requirement to pay tax on our accounts. The directive simply makes it easier for tax authorities to catch the people who aren?t declaring tax.?

The directive has helped banks and building societies get a better picture of their customers. ?People have come back to us to let us know they?re no longer resident in the EU or they?re resident in a different country. This has enabled us to offer them different products that may be more suitable to their circumstances,? says Alan Bougourd, managing director of Skipton Guernsey.

The institutions have been developing products that suit the new tax requirements. The Derbyshire (Isle of Man) launched a tax planning savings account that allows customers to defer interest. Interest accumulates on a daily basis but it isn?t paid until the account closes. This means savers can leave it rolling up until their tax position is more advantageous: for instance, if they retire or move to a country with lower taxes.

Investments start at 10,000 (about $17,550) on the account and customers can hold up to 2m (about $3.5m) in an account. Interest rates start at 4.45% and rise to 4.6%. Other savings institutions that offer deferred interest accounts include Alliance & Leicester International, Bradford & Bingley International, Britannia International and Nationwide International.

Products that are exempt from the directive have proved popular. Bank of Scotland International has had a lot of interest in its capital guaranteed savings bond, which allows customers to defer tax. Because it is based on a derivative, this five-year savings contract is exempt from the requirements of the directive. Tax is payable, but not until maturity, so you could set this up to mature in line with a change to your tax position.

There has also been an increase in product development activity. Skipton Guernsey launched its three-year ?step-up bond?, which pays an increasing rate of interest each year. Although interest isn?t deferred, this gives an option to take advantage of higher interest rates when your tax position may be more advantageous.

Further switching to exchange of information is expected. The first trigger point will be when statements containing details of the retention tax are sent to customers. The second key dates will be when the tax rises ? to 20% from July 2008 and to 35% from July 2011.

Money Observer

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