The latest tax proposals from Commissioner Mario Monti could severely affect the offshore funds industry as we know it. Richard Newell reports.

Tax harmonisation across Europe is something most of us have difficulty imagining. But dealing with seemingly intractable situations is not something that deters the European Commission. It has pursued the concept of fiscal 'smoothing' since agreement was reached last December with members states on a package of measures to ensure a minimum of taxation of savings income with the union".

While Commissioner Mario Monti recognises "certain positive aspects of tax competition," he put forward a proposal to the ECOFIN council on 5 June that would, if implemented, mean each member state would have to apply either a withholding tax of at least 20% or provide information to other member states on interest income from savings.

The proposed directive does not seek total harmonisation of the taxation of interest income within the EU. The proposal only covers the taxation of cross-border savings income in the form of interest paid in one member State to individuals who are resident in other member states. Monti states that he has no plans to attempt to harmonise overall rates of taxation of capital across the EU.

Implementation of the proposed measures would rely on the co-operation of market operators which directly pay out the interest. The paying agent, normally a bank, would be obliged either to provide the information or to levy the withholding tax. This presents some fundamental problems for a state such as Luxembourg which holds banking secrecy as sacrosanct.

Luxembourg currently levies no withholding tax on income distributed domestically or to non-residents. The Luxembourg banking community has always sternly resisted any attempts to impose a Europe-wide withholding tax. Similarly the funds industry in Dublin is concerned not to have its competitive position threatened by attempts to to remove certain tax advantages.

Although Luxembourg is certainly one of the main targets of these proposals, on the basisof the huge inflows of money from Germany and Belgium, Dublin's investment industry could also be hit. A level playing field in Europe would simply encourage investment to move outside the EU. Last year, Prime

Minister Jean-Claude Juncker of Luxembourg went on record stating that Luxembourg would introduce withholding taxes as long as they applied across all OECD nations, including Switzerland and the Channel Islands. In response to the new directive proposal, he is sticking to this line, adding that he wants the proposal extended to companies and that even if all these conditions are met, Luxembourg will not accept a withholding tax rate of 20%.

Is this a case of the irresistible force meeting the immovable object? Luxembourg is expecting a lot in return for its compliance. A level playing field might actually be to its advantage. Marie-Jeanne Chevremont at Coopers & Lybrand in Luxembourg comments: "It is not going to affect Luxembourg adversely because it will also affect other financial centres and may actually provide opportunities for Luxembourg."

The variety of issues contained in the Commission's proposal is almost certain to meet resistance from other member states. The UK has come out

against it because, among other things, there is a requirement that member states with dependent territories should ensure that equivalent provisions are introduced in those territories. If harmonisation in Europe drives investment out of Europe, who is going to agree to it? John Pauly at Banque Internationale a Luxembourg says, "tax evasion is not going to rely purely on the existence of Luxembourg. If we are going to talk about a level playing field, it has to be OECD-wide."

The proposed directive is intended as a first step towards effective taxation of savings income throughout the EU. The Commission would report on the operation of the Directive three years after it enteredinto force, to determine what extent further progress could be made.

The 1 December 1997 Finance Council held a wide-ranging debate on coordinated action at EU level to tackle harmful tax competition on the

basis of the Commission Communication of 5 November 1997. Three areas were particularly highlighted: business taxation, taxation of savings income and the issue of withholding taxes on cross-border interest and royalty payments between companies. Following the debate, the Council adopted a resolution on a code of conduct for business taxation, approved a basis for a proposal for a Directive on savings taxation and is pushing ahead with a Directive "remove a significant distortion in the Single Market"."