UK: EU Taxation: The Way Forward After The Withholding Tax Furore

Last Updated: 13 December 1999

by David Evans (Director, International Tax, KPMG London)

Fingers are being pointed at the UK for blocking the so-called ‘withholding tax’ on savings. We are accused of being a bad European but in fact by blocking the proposals, the UK has saved the EU from trying to adopt a fortress Europe approach which would have pulled up the drawbridge but left the back door wide open. Germany and others wish to stop their residents from keeping savings in other Member States where the interest is paid gross, rather than net.

The background to the dispute

The problem is that not all such interest is then declared on individuals’ tax returns. The German government believes an EU-wide withholding tax would stop such a problem. This is a poor argument. German investors may like investing in Luxembourg banks because Luxembourg is an easy drive from Germany but so is Switzerland! There is no indication that Switzerland is going to apply such a withholding tax. And increasingly, investors are happy to invest further afield.

In proposing the withholding tax, Germany is clearly defending its national interest, but it is only right that the UK should do the same. It appears UK individuals are comparatively good when it comes to declaring such income, so we see no overriding reason for a such a blunt instrument as a withholding tax. The UK agrees with Germany’s aims; tax evasion is something to be stopped. But more appropriate tools would be to loosen bank secrecy rules to increase detection rates or, better still, to lower tax rates so people are not so averse to paying in the first place.

Difficulties with the proposed withholding tax

A blanket withholding tax which damages the EU’s growing international bond market cannot be the right approach. Neither is exchange of information, the principal alternative put forward. This would increase bureaucracy and costs in a low-margin (though high-volume) business. Any incremental cost hike in such a market would inevitably drive it elsewhere.

There is also the thorny problem of revenue-sharing: the member state which would collect the withholding tax is not necessarily the state to which that tax is due. This issue is far from being resolved.

For the time being though the threat to the City of London is receding. The government has made it clear that it will not be sacrificing the City at the Helsinki Council meeting on 10/11 December.

The 3-part tax package

The UK’s concerns at the withholding tax were highlighted when we signed up to a 3-part tax package in December 1997. Perhaps because the Member States recognised the UK fears as genuine, the withholding tax proposal was lumped in with two other measures which arguably the UK stood to benefit from. But there has been a serious misjudgement of the relative benefits and disadvantages of the overall package to the UK - the withholding tax would simply never be acceptable to the City.

So what are the other two parts of the tax package that will be lost along with the withholding tax Directive at Helsinki? The most important are the measures to abolish harmful tax regimes which a working group chaired by the UK’s own Dawn Primarolo have identified - these would have been relatively useful to the UK because after considering over 200 such special tax concessions to particular industries in various Member states, the 60-odd that remained are reported as containing not a single UK case. Other countries were not so lucky and regimes were targeted in Belgium, the Netherlands and Luxembourg, amongst others, which are used by companies for generating low taxed income.

The second issue was the interest and royalties Directive would have enabled multinationals to pay interest and royalties between group companies without having to account for withholding taxes, which seems rather ironic. This proposal would have been of benefit to say UK companies investing in Europe into those countries where such taxes are not already reduced to nil by double tax treaties.

The way forward

So where do we go from here? It appears another Commission effort at tax harmonisation is doomed to fail. The last successful direct tax proposals, back in 1992, were directed at corporate taxes and improving the business tax environment in the single market. Surely this is where the Commission should direct its efforts now? The single market should give European companies the domestic market they need to build themselves to compete in the global arena.

But, from a tax point of view, the market remains fragmented into the fifteen Member States. Companies are unable to restructure or use their resources in an effective manner without suffering sometimes huge tax charges. In the meantime global competitors are able to enter the single market and to structure their operations to take advantage of it. The Commission needs to renew its efforts to make the single market work better for business and so must the Member States.

And where EU countries’ tax rules are obstacles to providing services or establishing businesses in other Member States then the Commission should be far more active in taking those countries to the European Court of Justice (ECJ) to have the obstacle removed. In the landmark ICI v Colmer case last year the ECJ directed that UK law on group relief discriminated against non-UK companies and since then there have been cases involving the direct tax systems of Greece, Germany, France and Sweden in which taxpayers have won some stunning victories. The ECJ is taking the lead in tax harmonisation matters and the Commission will have to catch up.

For further information, speak to your usual KPMG tax contact.

This article is intended to provide a general guide to the subject matter and should not be regarded as a basis for ascertaining the liability to tax or determining investment strategy in specific circumstances. In such instances separate advice should be taken.

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