Another little job

Any solicitor with clients who have income arising out of their country of residence should be aware of the EU Savings Directive

The Journal, June 2006, page 23

There are so many bits of legislation, directive and direction that flow from the European Union that it is very difficult to keep track of those which appear to have an obvious impact on your day to day business without having to search for the less obvious challenges. One example of the latter is the European Union Savings Directive (EUSD), which came into force on 1 July 2005.

At first blush this appears to impact on banks, building societies and other financial institutions, and possibly ring alarm bells for individuals who have money in foreign jurisdictions party to the directive. Indeed that is its main thrust. The directive is designed to aid and increase the exchange of information between participating countries with the stated intent of countering the tax evasion that is believed to be prevalent where individuals have assets generating income outside their country of residence.

This may be a laudable intent, but as usual the burden created by the mechanics of gathering this type of information is laid on the backs of businesses trying to make a living without being unpaid tax collectors, information gatherers etc for the state. So to a list that already includes PAYE responsibilities, CSA order enforcement and POCA obligations we now add the EUSD.

The payer and the income

The EUSD seeks to have information gathered by payers of “savings income” to individuals not resident in the payer’s country of business but resident in one of the “prescribed territories”. Once gathered, in the prescribed form, the information must be sent to the local fiscal authorities for onward dissemination to the fiscal authorities of the “prescribed territories”.

The key initial matters that have to be established by solicitors in business in Scotland are twofold:

1. Are you a “paying agent”?

2. What is “savings income”?

The directive goes into some detail in defining these terms exactly, but there are two simple and broad definitions which suffice for our purposes:

1. A “paying agent” is a person who in the course of their business makes payments of “savings income”. (Interest paid on normal trade debts paid late is not “savings income”.)

2. “Savings income” includes any interest arising on money debts.

Practising solicitors are persons in business, and if you ever hold clients’ money and pay interest on it you are paying “savings income”. As soon as you are a “paying agent” paying “savings income” you are caught within the terms of the directive.

HMRC expects

The HMRC guidance on implementation indicates that it will be taking something of a “prove a negative” stance for persons making payments of savings income. HMRC will expect any person making payments of savings income to individuals to be able to demonstrate that they have procedures in place whereby they have identified the residence position of every individual to whom such payments are made, and satisfied themselves that the individual in question is not within the directive or else have included the payments to that person in their EUSD return to HMRC.

For all individuals to whom payments of “savings income” are made, you will have to have on file evidence of the details on which you have based a decision on whether or not the payment is one which should be returned. These details are different depending on when your relationship with the client started. The differential date is 1 January 2004.

For contractual client relationships commenced before 1 January 2004 the details required are:

name;

address;

country of residence.

For contractual client relationships commenced on or after 1 January 2004, and client relationships not governed by contract, the details required are more extensive:

name;

address;

country of residence;

    date and place of birth, or alternatively for residents of EU member states, tax identification number if available.

You must also retain copies of the documents on which you based your acceptance of the client details you are using.

The country of residence is taken as being where the individual has their permanent address unless the individual has a passport or an official identity card issued by an EU member state, in which case the country of residence is where the passport or identity card is from, unless they can provide a certificate of tax residence from the country in which they have their permanent address.

The key checklist

So the questions are as follows:

• Do I make or am I ever likely to make payments of “savings income” to any individuals? If not, cheer! (NB Am I sure I understand the definition of “savings income”?)
• Can I identify every payment of “savings income” made to any individual since 1 July 2005?
• Can I demonstrate the residence position of each individual to whom I make payments of “savings income” irrespective of whether they are resident in a “prescribed territory” or not?
• Can I sort all the payments of savings income made to individuals on a territory by territory basis?
• Have I notified HMRC by 19 April 2006 that I am a paying agent; or by 19 April following the end of the tax year in which I make the first relevant payment?
• Will I be able to get the return required to HMRC by 30 June 2006?

As ever with HMRC there are penalties for failure to comply with their requirements. A paying agent who fails to notify HMRC that they have made reportable “savings income” payments may be charged a penalty of up to £3,000. A paying agent who fails to make a report after having been issued with a notice may be liable to a penalty of up to £300 and up to £60 per day for each day the report remains outstanding after the initial penalty is imposed. A paying agent who fraudulently or negligently makes an incorrect report may be charged a penalty of up to £3,000. The first notification date of 19 April 2006 has now passed. I believe it is unlikely that HMRC will seek to impose large penalties in this first year of operation. This will almost certainly be the case where the failure is rectified as soon as possible and returns are made on time.

Sadly, there is no de minimis limit on reporting and your systems must be adequate to demonstrably ensure compliance, no matter how small a percentage of your clients are individuals caught by the directive.

Foreign income of UK clients

The second area in which this new directive may impact on legal practitioners is in information that Her Majesty’s Revenue and Customs may come into possession of in relation to clients resident in the UK. From this year HMRC will be receiving details of “savings income” payments to UK residents made in over 30 different states or territories.

The intent of the directive is to counter tax loss through evasion occasioned by non-declaration of offshore sources of investment income. It would be disingenuous to suggest that HMRC imagine they will only be pursuing investment income: they will, and indeed are expecting to net leads into substantial amounts of undeclared UK taxable business income which has been deposited outside the UK.

The other things that this directive will generate are mainly twofold.

Perfectly legitimate UK resident but non-domiciled taxpayers will be asked to explain “savings income” arising offshore. Enquiries from HMRC, even when they result in no tax being payable, do carry a cost in terms of time, hassle and professional costs.

UK resident taxpayers who are declaring non-UK source income in their tax returns will find that in certain countries the banks are withholding tax from their interest. While it is true that they will be able to claim credit for the tax withheld, they will face a cash flow disadvantage of up to 22 months. For example, with an interest credit into an offshore account on 6 April 2006, under the previous system tax would have been paid on the gross interest received on 31 January 2008. Under the new system the bank will withhold tax on the date of the credit, 6 April 2006, and the foreign tax credit will not be effective until the 2006-07 tax return is lodged and processed. This is likely to be some time after 31 January 2008. In some cases the time cost of the interest loss could be considerable.

This state of affairs arises because some of the parties to the EUSD do not wish to divulge account details. Amongst these are Luxembourg and Austria, who claim that their bank secrecy laws prohibit such disclosure and it will take a number of years to alter those laws. There are others such as the Channel Islands and Switzerland who are concerned that detailed disclosure will jeopardise their attractive position as financial centres.

Better to disclose

To meet such concerns a compromise has been agreed. A number of participants have agreed that they will make a withholding tax effective from the date of payment, and 75% of the tax withheld from “savings income” payments to residents of each country will be paid over to the home authorities. The authorities in the country whose paying agents are withholding the tax will retain 25% of the withheld tax as an effective “administration fee”. The withholding tax rate is starting at 15% but will escalate to 35% by 2011. The theory is that for many non-compliant taxpayers it would be as well for them to disclose and retain the cash flow advantages, rather than pay 35% in tax, lose the cash flow advantages and retain the risk of discovery with the attendant problems of interest and penalty charges.

There is however an option for the account holder specifically to authorise full disclosure to the local fiscal authority for onward transmittal to HMRC. In such cases no withholding tax will be applied. Clients wishing to retain the benefits of receiving interest gross should consider authorising disclosure without delay.

This directive is another tightening of the net round tax evaders. As the quality of information in the hands of HMRC improves, so the chance of evaders being found out increases. As ever the risk-reward equation will be being considered by some clients. As ever with HMRC it is always better to go to them than have them come to get you. Unfortunately, as with many attacks on the non-compliant taxpayer, there is collateral damage for the compliant both in business and individual terms.