Originally published October 28 2005


The European Savings Tax Directive (STD) is one of three elements of the EU Tax Package. The other two measures are the EU Directive on interest and royalties and the Code of Conduct for Business Taxation. This article is only concerned with the STD.

The history and politics of the STD are well known. Suffice it to say that the STD started out as a measure designed to flush out residents of Member States with very high marginal rates of personal tax who were not declaring savings income earned in other Member States. The draft STD aimed to deal with this problem by introducing an "information exchange regime" across the European Union ("EU") whereby each Member State would report the payment of interest on savings paid to a citizen of another Member State to that citizen’s tax authorities. This simple idea came up against implacable resistance from Austria, Belgium and Luxembourg who prided themselves on a high degree of client confidentiality and, hence, the concept of a withholding tax as an alternative to information exchange came into being. It was then realized that the introduction of either regime within the EU might cause a mass flight of capital to financial centres outside the EU, including Dependant or Overseas Territories of EU Member States. Hence, the extension of the STD to, inter alios, Overseas Territories of the United Kingdom, including the Turks and Caicos Islands (TCI).

After much debate and delay, the STD came into effect in the EU, the Dependant and Overseas Territories of EU Members States, and in certain third countries, on 1st July 2005.

Of course, the STD does not have universal application but only applies to individuals (natural persons) who are resident in a Member State or one of the Crown Dependencies of the UK, where such an individual has savings income held in his own name in another Member State or Overseas Territory to which the STD applies.

Retention Tax Ordinance

The TCI government implemented the STD on 1st July 2005 by the introduction of the Retention Tax Ordinance 2005 (RTO). The TCI government has chosen the withholding tax regime in preference to the information exchange regime.

Put broadly, the RTO requires paying agents (e.g. banks and other financial institutions) to deduct a retention tax from any interest payments to be made to a resident of a Member State.

The following interest payments are caught by the RTO:

  • Interest paid out on debt-claims or credited to accounts;
  • Interest rolled-up and paid out when a debt-claim is repaid or sold;
  • Distributions made by certain unit trusts and other collective investments funds which have invested more than 15% in debt-claims and;
  • Accumulated income paid out when units in certain collective investments funds, which have invested more than 40% of their investments in debt-claims, are redeemed or sold.

The RTO captures interest on bank deposits as well as interest which is included in the proceeds of the sale or redemption of certain bonds and income from certain kinds of investment fund, mainly, open ended money market retail funds.

The RTO does not apply to dividends on shares from companies. Nor does it apply to pensions or rents even where they are derived from investments. The RTO does not apply to interests paid to a beneficial owner in respect of a contract entered into prior to 1st July 2005.

A paying agent is required to establish the residence of every beneficial owner it deals with, although the information required depends on whether the interest relates to a contract entered into before 1st July 2005. In such a case, it is sufficient for the paying agent to rely on any information it already holds in compliance with the TCI anti-money laundering regime. In the case of all other beneficial owners, the paying agent must establish identity by reference to a passport or official identity card issued by a Member State. Where the passport or an official identity card is not that of the Member State in which the beneficial owner claims to be resident, the paying agent must establish the residence of the beneficial owner by reference to a tax residence certificate or some equivalent document issued by the authorities of the country in which the beneficial owner claims to be resident. Where there is no such evidence, certificate or other document, the paying agent must treat the beneficial owner as resident in the Member State which issued the passport or identity document proferred by him.

Having established that a particular beneficial owner is resident in a Member State, the paying agent is obliged to levy a retention tax on all interest payments to be made to such a beneficial owner. The rate of retention tax to be levied under the RTO escalates from 15% for the period 1st July 2005 to 31st December 2007 to 20% for the period 1st January 2008 to 31st December 2010 and to 35% from 1st January 2011.

The TCI government retains 25% of the aggregate retention tax to defray the expenses of operating the arrangements, and the balance is transmitted to the relevant tax authorities of the Member States of the beneficial owners concerned.

The RTO provides for the retention tax arrangement to cease on the introduction of an information exchange regime agreed between the TCI Government and the 25 Member States.


By opting for the withholding tax regime, the TCI has helped to preserve the confidentiality of residents of Member States who have relevant savings in TCI.

Clearly, EU residents who are affected by the RTO will have to decide whether the escalating amount of tax snatched by their countries of residence is a price worth paying for continued confidentiality. Perhaps some may will decide that they will move their investments to financial centres outside Europe and the Overseas Territories notably, to those in Asia.

Given that the RTO (and the STD) only apply to individuals (i.e. natural persons) those individuals who are affected may choose to transfer their investments into the name of corporations. This would enable them to maintain the confidentiality of their financial affairs and to avoid the retention tax. Anecdotal evidence suggests that most of the foreign residents with interest bearing investments in the TCI are not residents of the EU so the impact of the RTO may be slight. Only time will tell. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.