Investment conditions over the last few years have encouraged many investors to move into cash. Many will still wish to retain a significant cash holding and portfolio bond products can be useful vehicles as they enable individuals to move back into equity-backed investments within the life wrapper and without the added complications brought about by the savings tax directive.
The aim of the directive is to ensure the effective taxation of savings income of individuals resident in other EU states. It proposes to do this chiefly by exchange of information between member states.
Article 6.1(a) of the directive principally defines savings income as an interest payment. It is “interest paid or credited to an account, relating to debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits, and in particular income from government securities and income from bonds or debentures; penalty charges for late payments shall not be regarded as interest payments”.
Examples of savings income include bank and building society account interest, UK National Savings interest, interest on cash Isas and Premium Bond prizes if received by a resident of another EU or EEA state.
You should note that it also includes income paid out or reinvested in new units or added to existing units in a collective investment scheme where the scheme has invested 15 per cent or more of the fund in debt claims.
Examples of non-reportable payments include insurance policies and payments from them, shares in Oeics and units in unit trusts (subject to the limits on the fund’s investment into debt claims), personal pensions and purchased life annuities. Also excluded are ordinary and preference shares and dividends from them, winnings from betting including the National, European and other lotteries (but note that UK Premium Bond prizes do arise from debt claims) and rents from real property.
The directive only applies to beneficial owners if they are resident in another EU state or a related territory. The beneficial owner is defined as being “any individual who receives an interest payment or any individual for whom an interest payment is secured”.
It applies to all EU member states and Gibraltar, the related territories of the Channel Islands and the Isle of Man and the British and Dutch Caribbean dependencies.
Will they all exchange information? No. Austria, Belgium, and Luxemburg have opted to take off withholding tax from interest payments instead of exchanging information. The Isle of Man and the Channel Islands have also decided to go the withholding tax route. It seems that they have almost agreed on a model form for use in the agreements which they will need to set up with each member state.
Bermuda, although a British dependency, is not subject to the directive as it is not in the Caribbean. It will be interesting to see if it conforms voluntarily.
The rate of withholding tax will be 15 per cent for the first three years, then 20 per cent for next three years and 35 per cent after that. Arrangements will need to be put in place so that investors who would prefer reporting can receive their interest gross. To achieve this, investors will probably need a certificate from the authorities in the state where they are resident for production to the person making the interest payment.
Why is this directive of interest to you? The key reason is that insurance policies are not within the scope of the directive. Therefore, none of their deposit-type funds will be subject to any new tax charge and, of course, as the insurer owns the unit-linked fund assets, there is no new reporting duty.
You will all be aware of the need to know your client and the source of funds. At the same time, it is likely that there will be many clients who will be concerned to ensure that their affairs and status are clearly legitimate. They will see the use of a portfolio bond as a suitable vehicle for some of their wealth.
In summary, the effect of this directive is to give advisers an opportunity to add value to their clients’ planning.