Global Policy Forum

By Tom Buerkle

The European Union reached a landmark agreement Monday to combat the evasion of taxes on interest income, effectively settling an issue that has been a cause of bitter dispute over the past decade. The agreement aims to prevent investors from avoiding taxes by stashing their savings abroad. It requires member countries either to impose a withholding tax on interest income earned by foreigners or to provide information about foreigners' interest income to their national tax authorities.

If it is fully implemented over a seven-year transition period beginning next year, the deal will effectively bring an end to banking secrecy within the EU. The deal, which was reached at a meeting of EU finance ministers in Brussels, followed an accord in principle reached in June. At that time, EU leaders agreed to rely on exchanging information, rather than an EU-wide withholding tax, to combat tax evasion. The success of the plan remains speculative, because the deal requires non EU countries - including Switzerland, the United States and such offshore banking centers as the Channel Islands and Cayman Islands - to also agree to exchange information on savings held by nonresidents.

Notwithstanding that caveat, EU officials warmly welcomed the accord. "It had been on the table for the last 12 years," said a spokeswoman for Laurent Fabius, the French finance minister who was the chairman of the meeting. "It was time for Europe to go forward." The net effect of the package will mean that by the end of this decade, the spokeswoman said, "tax evasion within Europe is virtually finished." Britain also welcomed the decision to rely on exchanging information among tax authorities rather than imposing a Union-wide withholding tax, which countries like France and Germany had sought for years. Britain wanted to safeguard the interests of the London-based Eurobond market, which argued that it would have been devastated by a mandatory withholding tax. "We always said we would not accept a withholding tax imposed on the City of London," the chancellor of the Exchequer, Gordon Brown, said. "There will be no withholding tax in Britain."

Germany, France and other EU countries contend that tax evasion is a substantial and growing problem, with many investors putting funds in bank accounts in places like Luxembourg and Austria - which have strict banking secrecy laws - and not reporting their interest income to tax authorities. Under the agreement, 12 of the 15 EU countries have agreed to exchange information to curb tax evasion. The remaining three countries - Luxembourg, Austria and Belgium - will impose a withholding tax of 15 percent as of March on interest income paid to accounts held by nonresidents from other EU countries. For four years starting in 2004, that tax will increase to 20 percent.

At the end of the seven-year period, the agreement envisions that all EU countries will exchange tax information. But for that to come into effect, the accord requires that non-EU countries commit themselves to similar information exchanges by the end of 2002. That condition aims to ensure that EU tax measures do not end up simply pushing tax evasion to other financial centers like Switzerland or the Channel Islands.

Luxembourg, whose big international banking and mutual fund industry could suffer from international competition, stressed that condition in backing the accord. "I'm not so sure we'll go to information exchange," Treasury Minister Luc Frieden said. "Luxembourg will carefully monitor what Liechtenstein, Switzerland, the Channel Islands and Dutch Antilles do." Many analysts regard the prospect of a broad international agreement among tax authorities to exchange information on savings as a long shot, especially if Governor George W. Bush of Texas becomes the next U.S. president. "You have to be fairly cynical about it getting off the ground," Alison Cottrell of UBS Warburg said.

But EU and French officials pointed out that the United States has worked actively in the Organization for Economic Cooperation and Development to combat offshore tax evasion. "The wind of change is blowing hard through these financial centers," a European Commission spokesman said. "It is no longer regarded as acceptable not to cooperate in the fight against tax evasion and money laundering." It was a reflection of the long-running nature of the dispute that the agreement did not cover investments in equities, the fastest-growing part of the European markets. Germany has focused exclusively on interest income because of the traditional German preference for investing in bonds, and the country's 1992 withholding tax only applies to interest income.