Europe's Investors Flee Tax Directive

by Ulrika Lomas, for LawAndTax-News.com, Brussels

27 October 2005

As expected, wealthy investors are finding it easy to circumvent the EU's Savings Tax Directive: in August alone nearly EUR7bn poured out of Swiss accounts into Luxembourg Sicav II bonds, which are outside the scope of the Directive.

The Directive, which came into force on 1st July this year, applies to certain types of income from savings if paid to individuals. In most EU countries, such income is reported to the investor's home tax authority, but in Luxembourg, Switzerland, Jersey, Guernsey, the IOM and some other jurisdictions, there is a withholding tax of 15% (20% from 2008).

Evidently, payments to companies are exempt, as are various types of bonds. Investment providers, including banks and insurance companies, have been busy developing products such as offshore-bond wraps and deferred interest accounts which escape the tax.

In Luxembourg, the Directive applies to interest on bank deposits, and returns on many types of bonds. Funds are included if they are UCITS (ie, they can be marketed throughout Europe under the EU UCITS Directive) and if they satisfy certain other criteria. Not all UCITS funds are covered.

Luxembourg offers a wide range of vehicles for investment funds, including the SICAV (Societe d'investissement a capital variable), an open-ended vehicle having a variable capital which is always equal to the net asset value of the fund, the SICAF (Societe d'investissement a capital fixte), which is a closed-end fund normally used for private placements, and the SICAR (Société d’Investissement en Capital à Risque), which offers an alternative to the traditional limited partnership structure which works well for fund managers and investors in countries such as the United Kingdom, but can pose problems for fund managers in continental Europe.

Continental investors seeking tax transparency may opt for a SICAR in the form of a limited partnership (SeCS). An SeCS is not liable to corporate income tax or net wealth tax. SeCS are exempt from the municipal business tax; income from the partnership and capital gains realized on units by non-resident partners is not taxed in Luxembourg.

Swiss banks such as UBS and Credit Suisse with lots of anglo-saxon investors have launched a series of SICAV II funds in recent months, which are outside the scope of the Directive, but are not UCITS funds. Therefore they cannot be widely marketed, and are most often used by private or institutional investors. However, they are ideal for the banks' well-heeled clients, and it is these funds that have seen a tidal wave of money fleeing the Directive since July.

Recommended