Anyone concerned about the effects of the EC's proposed directive on the taxation of interest payments, to ensure a minimum of taxation of savings income, would do well to read a report issued by the Edmond Israel Foundation*.
The report looks at the wider issues of glo-balisation of markets, but also addresses di-rectly the impact on the eurobonds market, should the directive be approved as planned, while suggesting away forward. As the report says: Of all the aspects of the proposal that deserve to be reviewed, the most controversial ones have to do with the implications of the proposed withholding tax on wholesale capital market activities and notably on euromarkets.
"The ECOFIN Council has given clear instructions not to impose the withholding tax on institutional investors, yet this has not been seen as implying that the euro markets should benefit from an exemption, as had been the case in previous direc-tives.This part of the proposed directive has been prepared with quite a remarkable lack of consultation.
"These very liquid markets, on which close to $1trn have been raised through more than 5,000 issues in 1998 alone, are based in Europe, very important to European sovereign and corporate borrowers as a large and efficient source of funds, and global in nature in terms of the financial institutions, currencies and market infrastructures involved."
It is pointed out that job losses are ex-pected to be around 11,000 in London and another 1,400 in the custody and paying agent activities in Luxembourg and London. "But what will also be lost is the position of the EU as gateway in that $1trn market". The report then quotes Lombard Street Research: "On a worst case basis, the EU will lose the largest fixed income market in the world, and London will lose its role as the leading international finance centre".
It goes on to say: "The directive does not take into account how the overall global market structure will evolve and whether this will reinforce or weaken the role and in-fluence of Europe on global finance. This is highly surprising at the very moment when the union has taken the radical and bold step to increase its role in global finance (through the euro)."
The report does not see any easy solution: "There are powerful reasons why the EC does not exclude euromarkets from the proposed directive, including the number of individual investors holding euro-securities and the eurobonds are held in bearer form, which limits control. In doing so, however, the EC finds itself, even partially, in the role of de facto regulator for a market which has developed around the absence of regulation. The paying agent approach chosen by ECOFIN does not provide the clear-cut protection from tax collection interference in the wholesale markets because the paying agent can only determine at the last minute and through complex procedures, whether the money is being paid to an individual or an institutional investor. A white line of reporting, control and record keeping must therefore be in place. Meeting this requirement will imply costs in the order of 20 basis points." On the issue of tax evasion, the report points out that wealthy investors have the possibility to create a corporate vehicle to hold these securities and thus escape tax. "Promoting an OECD-wide code of conduct regarding bearer bonds - possibly an outright ban - is necessary if one does not want the proposed directive to be read by non-EU countries as a standing invitation to capture business." The way forward, it sees is that: "The emphasis should be on the following features that can already be considered as necessary for the directive to be less costly to administer and more in line with European integration dynamics: r The withholding tax should be so final as to make it simple and also European in inspiration rather than defensive; r It should be set at a level low enough to compensate for the bias in today's national tax systems, towards keeping savings at home; r A perspective should be open for an evolution towards a VAT type structure, with agreed levels of withholding tax for certain types of investment. Differentiated tax level would facilitate the funding of pensions in ways comparable to what members states do at home, with the possibility of zero-level withholding tax for the type of pension-re-lated investments that are (or will become) tax exempt in each state; r It should include a 'post-euro' set of guidelines to separate retail from wholesale activities, exempting, the latter entirely. This in turn calls for in-depth work and some re-organisation of placement activities by financial firms themselves." The OECD is mentioned by almost all market participants, says the report, as the logical forum for any meaningful debate and decision on a withholding tax that could stand a chance of not turning into a major cause of lost investment and financial market activity for the EU. "There is something surprising (then) in the EC's view that going alone is good for Europe, to show the way and be followed quickly by an OECD-wide consensus; once liquidity is lost, it does not come back easily, as it is in the nature of liquidity to feed on liquidity."
*The Proposed Directive on Harmonisation of Taxation of Interest Payments - The Edmond Israel Foundation; Tel: +352-44 99 26 040."