H.M. TREASURY: Exchange of Information and the Draft Directive on Taxation Savings

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EXCHANGE OF INFORMATION AND THE DRAFT DIRECTIVE ON TAXATION OF SAVINGS

A paper by the United Kingdom

HM Treasury
Inland Revenue
February 2000

Introduction
Principle established by the Helsinki Conclusions
Advantages of exchange of information
The international context for exchange of information

The EU context
Current practice and the need to extend these arrangements
Conclusion

Annex: Making Better Use of the Anti-Money Laundering System

EXCHANGE OF INFORMATION AND THE DRAFT DIRECTIVE ON TAXATION OF SAVINGS

1. Introduction

1.1 The Helsinki European Council on 10-11 December 1999 called for further work on the taxation of savings income in the EU based on the principle that:

"All citizens resident in a Member State of the European Union should pay the tax due on all their savings income."

1.2 The European Council agreed that a High Level Group should consider specifically how this principle can be implemented most effectively, and as part of its work consider proposals put forward by the UK, including exchange of information. The Working Group is to take account of all decisions of the Council, including the approaches set out in the paper of 29 November 1999 (on Reinforced Tax Policy Co-operation) and to report to the Council with possible solutions.

1.3 This paper builds on the UK's paper of September 1999 on International Bonds and the draft Directive on Taxation of Savings. It sets the context for an approach based on exchange of information, consistent with the Helsinki conclusions.

2. Principle established by the Helsinki conclusions

2.1 The Helsinki European Council conclusions expressly provide for future work on the EU Savings Directive to include discussion of proposals on exchange of information. This also follows directly from the principle, established at Helsinki, that "all citizens resident in a Member State of the European Union should pay the tax due on all their savings income". This is a principle made up of three key elements. No single element can be divorced from the other two.

2.2 First, the principle provides that all citizens resident in a Member State of the EU 'should pay the tax due' on all their savings income. For a Member State to ensure that its residents pay the tax due (rather than some of the tax due) on their foreign source savings income, the Member State will need information from other tax authorities about the extent of their residents' income and whether any tax has been deducted at source.

2.3 Second, the principle provides for citizens resident in a Member State to pay the tax due 'on all their savings income'. This means that all types of savings income are to be covered, including bank interest, bond interest, and interest distributions from collective investment vehicles.

2.4 Third, 'all their savings income' also means that tax should be paid on all sources of savings income, wherever these arise. This includes savings income from all domestic and all foreign sources, whether received from a source in another EU Member State or not.

2.5 It follows that the information needed by a Member State to impose tax on the savings income of its residents cannot be confined simply to information from other Member States of the European Union. Exchange of information needs to be on as wide an international basis as possible, to ensure a level playing field across important financial centres, and to ensure that action in the EU is not frustrated by non-co-operation in important third countries.

2.6 This is also consistent with the ECOFIN Council Report of 29 November 1999 to the European Council on Reinforced Tax Policy Co-operation (referred to in the Helsinki conclusions) which established that any resolution of this Directive requires a sequence involving the implementation of "equivalent measures" in third countries and dependent or associated territories with important financial markets. The relevant section of paragraph 18 of the Report is set out below:

"It should also be noted that for certain Member States it is an essential condition for the adoption of the directive that equivalent measures are applied in third countries and dependent or associated territories with important financial markets. It is in this perspective that the Presidency has suggested a sequence in which Member States first seek agreement on the substantial content on the Directive. In this respect, the UK delegation made it clear that their position on these issues remains as set out in their paper on international bonds. And then, in cooperation with the Commission, Member States would pursue discussions to enhance implementation of equivalent measures in dependent or associated territories. The Presidency and the Commission would deliberate with third countries to enhance the implementation of equivalent measures in these countries, and the Council would decide on enforcement of the Directive once sufficient reassurances with regard to equivalent measures have been obtained."

2.7 The three elements of the Helsinki principle need to be taken together, as a package.

3. Advantages of exchange of information

3.1 Exchange of information to ensure effective taxation of cross-border interest offers a number of advantages over a "co-existence" approach. Some of these advantages were set out in Section IV of the UK paper of September 1999 ("International Bonds and the Draft Directive on Taxation of Savings"). The UK believes there are seven key advantages to exchange of information.

3.2 First, exchange of information allows for the right amount of tax due on the income from savings to be collected. For those countries which tax the savings income of their residents at the marginal rates which apply to income in general, a withholding tax is unlikely to be the marginal rate at which the investor should be paying tax in his state of residence.

3.3 Second, exchange of information allows savings income to be taxed in the right country - that is, the investor's state of residence rather than solely in the state of source for the investor's savings income. The "co-existence approach" does not allow for this and this is why several Member States have argued for revenue sharing.

3.4 Third, exchange of information encourages compliance with the tax system. It provides a deterrent to the non-declaration or under-declaration of income. In contrast a withholding system, without exchange of information, might appear to give the impression of legitimising tax evasion since it fails to deter non-declaration. Acceptance by the EU of the "co-existence" model in Community legislation might be interpreted by taxpayers as a signal that non-declaration to the taxpayer's state of residence will be tolerated.

3.5 Fourth, exchange of information helps wider compliance with the tax systems of Member States, including tackling the serious problem of cross-border "laundering" of the proceeds of tax evasion. Exchange of information will often draw the attention of the country of residence to the existence of an asset which may have been funded from income, profits or gains which have themselves been hidden from the tax authorities. In turn, these activities could now be taxed. Withholding conveys none of these advantages.

3.6 Fifth, exchange of information is easy and efficient. It would be sufficient to draw the attention of the country of residence to the existence of the income-producing asset - the tax authorities could then seek sufficient information from the investor to work out the tax liability. In contrast, applying withholding might in some circumstances require a financial institution to perform complex calculations not needed for its own purposes. In addition, a withholding system would require additional administrative costs in order to manage tax deductions or investor certification.

3.7 Sixth, exchange of information is good for the honest investor, since it does not lead to the cash flow disadvantages associated with a cross-border withholding tax system.

3.8 Seventh, exchange of information produces equity between Member States. It precludes the likelihood of capital flight from countries providing information to countries opting for withholding under "co-existence" arrangements. Dishonest investors determined to evade tax will generally prefer to suffer a (minimum) withholding tax rather than have information passed to their country of residence, and will choose where to invest their savings accordingly. This would lead to undesirable distortion of competition, by putting financial institutions in withholding countries at a tax-driven competitive advantage.

3.9 Exchange of information for tax purposes is consistent with the trend to greater international co-operation and transparency in international financial systems, encouraged by international initiatives in both tax and non-tax fields. Even if withholding arrangements were adopted by all countries globally, this would not provide an effective solution to evasion of tax on savings income. They would not allow Member States to collect the full amount of tax due on their residents' savings income, nor to deter and detect the "laundering" of the proceeds of tax evasion through investment abroad.

3.10 Exchange of information arrangements on a wide international basis is the only way in which an effective solution to the evasion of tax on savings income can ultimately be achieved. And it is the only way that the Helsinki European Council Conclusions can be delivered. Such an approach requires EU countries (as well as important third countries) to set aside those bank secrecy laws which are standing in the way of a solution to tax evasion based on exchange of information. This has already been recognised in a number of important initiatives on the international front aimed at tackling tax evasion, harmful tax competition and international financial crime.

4. The international context for exchange of information

4.1 Since its inception in 1963 the OECD Model Tax Convention has included provisions for exchange of information between the tax administrations of Contracting States. The OECD Model Article on exchange of information provides for information to be exchanged not only for the application of specific provisions of the Convention, but also for the implementation of the domestic laws of the Contracting States concerning those taxes covered by the Convention. ⁽¹⁾

4.2 However, if a Contracting State is not itself able to obtain information under its own internal laws and practices it is not required to obtain such information for the purposes of passing that information to the other Contracting State. Some countries expressly extend the right to refuse to supply information to information covered by domestic bank secrecy or confidentiality rules and practices. This can severely limit the effectiveness of exchange of information in combatting tax avoidance and evasion.

4.3 As part of its work programme directed at combatting tax avoidance and evasion, the OECD Committee on Fiscal Affairs has recently reviewed the current position of OECD Member countries on access to bank information for tax purposes and is now exploring solutions for improving such access. The Committee has required countries seeking accession to the OECD in recent years to have access to bank information for tax purposes.

4.4 The need to address the issue of access to bank information for tax purposes has also been identified in the OECD's initiative to address harmful tax competition. Its April 1998 Report Harmful Tax Competition An Emerging Global Issue(2) recommended that:

"in the context of counteracting harmful tax competition, countries should review their laws, regulations and practices which govern access to banking information with a view to removing impediments to the access to such information by tax authorities".

The report notes that:

"provisions which unduly restrict access by tax authorities to banking information required for the assessment of taxes are a serious impediment to

the fair and effective implementation of tax rules; and may distort the allocation of financial flows between countries by providing an unfair competitive advantage to those financial centres which operate such provisions."

4.5 More generally, the report identifies lack of effective exchange of information as a particularly harmful characteristic of a tax haven or harmful preferential tax regime. It points out that the most obvious consequence of the failure to provide information is that this facilitates tax evasion and money laundering.

4.6 The purpose of the OECD's harmful tax competition initiative is to encourage jurisdictions identified as tax havens or as operating harmful preferential tax regimes to re-examine their policies and to co-operate in removing those elements of their regimes which are judged to be harmful. As a result, the OECD is encouraging jurisdictions which appear to meet its tax haven criteria to put in place the means of effective information exchange. This includes the means to obtain access to bank information, where needed, for the purposes of detecting and preventing tax avoidance in an investor's state of residence as well as for curbing tax fraud.

4.7 Countries identified by the OECD as tax havens will quite properly expect EU and other OECD member countries to meet at least the same standards of effective exchange of information including access to, and exchange of bank information for, tax purposes, as they themselves are expected to meet under the Harmful Tax Competition initiative.

4.8 Many governments have also recognised that permitting tax authorities access to bank information for tax purposes has the potential to strengthen other law enforcement activities, for example by preventing the evasion of anti-money laundering systems. The Financial Action Task Force (FATF) has recently taken steps to address the issue of criminals attempting to avoid anti-money laundering measures by financial institutions by claiming to be evading taxes - the so-called "fiscal excuse". The FATF has recommended that suspicious transactions should be reported by financial institutions regardless of whether these are thought to involve tax offences.

4.9 The FATF is now working together with the OECD Committee on Fiscal Affairs to consider how the capacity of anti-money laundering systems to deal effectively with tax-related crimes can be enhanced. Their objectives are:

i. to ensure that obligations under anti-money laundering systems to report transactions relating to suspected criminal offences continue to apply even where such transactions are thought to involve tax offences;

ii. to permit money laundering authorities to the greatest extent possible to pass information to their tax authorities to support the investigation of tax-related crimes;

iii. to communicate such information to other jurisdictions in a way which would allow its use by their tax authorities, subject to appropriate safeguards; and

iv. to use such information for tax purposes in a way which does not undermine the effectiveness of anti-money laundering systems.

5. The EU context

5.1 EU Member States have participated in each of these international initiatives to promote exchange of taxpayer information to tackle cross-border tax evasion and avoidance. They have also adopted further measures in this area tailored to the special needs of the Community.

5.2 In December 1977 the Council adopted a Directive 77/799/EEC on Mutual Assistance between the competent authorities of the Member States in the field of direct taxation(3).

5.3 The scope of the Directive broadly follows that of Article 26 of the OECD Model, but in some respects the obligations to exchange information go wider. Notably the Directive requires a competent authority which does not have the information requested at its disposal to undertake all necessary enquiries within the limits set by its own legislation and administrative practice to meet a request for information made by another Member State. The Mutual Assistance Directive was the first provision of Community legislation adopted in the direct tax field, and for more than a decade was the only such legislation. This underlines the importance attached by the Member States to exchange of information in the tax field.

5.4 In 1989, the Commission brought forward a proposal to amend the Mutual Assistance Directive. In introducing its proposal, the Commission stated that:

"The exchange of information is currently inhibited by the fact that, under Council Directive 77/799/EEC of 19 December 1977, a competent authority is not required to look for, or to transmit to the competent authority of another Member State, information which it would be prevented by its laws or administrative practices from collecting or using for its own purposes.

"This provision is a particularly serious obstacle to the exchange of information in the case of income from capital, given the existence of very strict rules on banking secrecy in many Member States and of an even more restrictive administrative practice in some others."

5.5 This proposal to amend the Mutual Assistance Directive would both have strengthened co-operation between fellow members of the European Community and would also have provided a more level playing field within Europe for the European financial institutions competing for personal savings. But given a lack of unanimous support, it was later withdrawn by the Commission, at the same time as its 1989 withholding tax proposal was replaced with the current draft Directive on taxation of savings (presented on 9 June 1998).

6. Current practice and the need to extend these arrangements

6.1 Any effective direct tax system relies to some degree on taxpayers making a declaration of income or gains to their tax authorities. Such systems carry the risk that taxpayers can evade tax either by making false or incomplete declarations, or by failing to make a declaration at all.

6.2 The primary tool which tax authorities have for tackling evasion under direct tax systems is the power to obtain information, either from taxpayers directly, or from third parties. Information powers contribute directly to the collection of tax revenue, and also carry indirect benefits. They act as a powerful deterrent against non-disclosure of income and reinforce compliance with the tax system generally. The precise powers differ from country to country. A common feature in all countries is recognition of the need to balance these information powers with the legitimate rights of taxpayers, including the privacy and confidentiality of their personal affairs, and the competitive position of business.

6.3 Increased liberalisation and globalisation of trade and investment provides an increased challenge to tax authorities to obtain the information needed to tackle evasion - extending beyond the borders of their own country. Provisions for international exchange of information between tax authorities are a matter of national law and differ from country to country. However, as sections 4 and 5 of this paper make clear, there is a longstanding recognition of the need for international co-operation on the basis of common principles in the field of exchange of tax information.

6.4 A clear distinction needs to be drawn between those current arrangements which allow Member States to provide information only on a case by case basis (whether on request or spontaneously) and the arrangements necessary for effectively tackling tax evasion - the routine, automatic and comprehensive exchange of information.

6.5 Some information may currently be obtained by tax authorities on request. In a cross-border situation, this means that the tax authority where the investor is resident would request information relating to a named taxpayer from the tax authority of the country where the investment is made. For the request to be effective:

- the requested tax authority must have the power to enforce disclosure of information domestically; and

- the requesting authority must hold sufficient information on a taxpayer's investment in the first place to lead it to make a request.

6.6 Information in the possession of the tax authority of one Member State which appears to relate to the tax liability of a resident of another Member State may also be passed between tax authorities spontaneously. If all Member States extended the reporting obligations on financial institutions and agents under Money Laundering rules to cover "suspicious transaction reporting" of suspected tax offences (as in the UK), this would provide a possible basis for spontaneous exchanges of information in the most serious cases of suspected tax evasion. The Member State receiving this information would then be able to follow this up with a request for further information, if necessary, of the tax authority of the country in which the suspicious transaction has taken place. At the Helsinki European Council the UK put forward proposals for making better use of the anti-Money Laundering system to tackle tax evasion in the EU. These proposals are developed further in Annex A to this paper.

6.7 But there is an overwhelming case for exchange of information more routinely, to deter against evasion, and to assist compliance in the many cases in which the amount evaded or the circumstances of the evasion would not warrant the instigation of criminal proceedings. For such cases, tax authorities require automatic exchange of information. This involves the routine disclosure of information from payers of interest to their domestic tax authority, on a regular (annual) basis, and in bulk. The tax authority's systems will select from the information returned:

- the data to be used for its own taxpayer compliance enquiries, and

- the data to be passed to other tax authorities, in respect of their residents, on an automatic basis.

7. Conclusion

7.1 The UK Government is committed to tackling tax evasion. Its firm view is that the single most effective means of doing that is through exchange of information on as wide an international basis as possible. In the absence of any proposal for a Directive incorporating exchange of information, implemented on as wide an international basis as possible, the UK Government sees no other option but to stand firmly and fully on its paper on International Bonds of September 1999.

7.2 To implement the principle on taxation of savings income, agreed at Helsinki, requires the adoption of a solution based on exchange of information. It is the right way to collect the right amount of tax in the right country.

HM TREASURY
INLAND REVENUE
February 2000

Annex A

MAKING BETTER USE OF THE ANTI-MONEY LAUNDERING SYSTEM

1.1 This annex sets out in more detail the 5 point plan to tackle tax evasion proposed by the Chancellor of the Exchequer at the Helsinki ECOFIN Council.

1.2 Tax evasion is a serious international crime. To tackle it effectively we need to counter the problem that the proceeds of tax evasion committed in one Member State can be hidden in accounts held in another. This is an example of money laundering. Therefore, one way to address the problem at an EU level is to make use of the mechanisms which already exist - or which are being put in place - to tackle money laundering at an EU level. This note sets out how this could be done without placing substantial new burdens on the financial services sector. It also sets out additional steps which the UK is prepared to take, as part of this process, to extend the assistance it provides to our EU partners to improve the fight against tax evasion.

1.3 There are five elements which need to be in place before the anti-money laundering system can be made effective in countering tax crimes:

First, tax crimes need to be recognised as a predicate offence for money laundering in all member states. In other words, it needs to be made a criminal offence to launder the proceeds of tax evasion. The EU has already agreed - through Article 1(1)b of the Joint Action on Money Laundering, agreed on 3 December 1988 - to extend the crime of money laundering to a wide definition of serious offences(4). Our understanding is that this definition captures the main tax evasion offences in each Member State. This is already the position in the UK, where laundering the proceeds of any tax crime is considered a criminal offence.

Second, Member States need to institute a suspicious transaction reporting system which extends to tax offences. Under the Money Laundering Directive, financial institutions in Member States are obliged to report suspicions of drug money laundering. In line with other international commitments(5), all Member States have applied this obligation to a wider range of crimes. In the UK and some others, the obligation extends to all serious crimes, including tax crimes. This issue is currently being debated in the context of the proposed 2nd EU Money Laundering Directive. Most Member States are in favour of a reporting obligation that extends to all serious crimes. But the current Commission proposal would limit the obligation to a narrower range of offences(6) - excluding tax crimes and many other serious crimes (for example, financial frauds, corruption, market abuse and other offences which may not be associated with organised crime).

Third, we need to encourage deeper cooperation between Financial Intelligence Units, who receive intelligence from the financial sector on suspected crimes. This is on the point of being agreed through a third pillar Draft Decision(7).

Fourth, we need to ensure that intelligence relevant to tax evasion inquiries can be passed from the Financial Intelligence Units to the tax authorities. The OECD is, in cooperation with the Financial Action Task Force on money laundering, currently exploring ways in which cooperation between tax and money laundering authorities could be further extended. The approach taken in the UK is to appoint liaison officers from the tax authority to work within the Financial Intelligence Unit. A network of these liaison officers throughout the EU would be a powerful new response to the problem of international tax evasion.

Fifth, we need to ensure that suspicious transactions highlighted by this system can be properly investigated. This requires the 1977 Mutual Assistance Directive to be enforced effectively across the EU, supplemented by measures (in line with those currently under discussion in the OECD) to override bank secrecy in appropriate cases, and to exchange information at all stages of an investigation and prosecution.

1.4 In summary, Member States have already agreed elements of an effective EU-wide strategy to counter criminal tax fraud using the anti-money laundering system - but have yet to agree others. This strategy needs political authority to give it coherence, and to plug the remaining gaps. In Member States where elements of the strategy are already in place, it is generating results. For example, in the UK, these elements are helping investigations into serious tax evasion where hundred of millions of pounds of lost revenue is at stake.

1.5 The strategy offers a number of advantages as an element of the armoury against tax evasion:

it is targeted on suspicious transactions, and therefore allows law enforcement authorities to target their efforts on the most damaging examples of tax evasion, including those associated with very serious frauds;

it covers a wide definition of tax evasion, not simply the evasion of tax on interest payments;

it can help to develop links between the investigation of tax crimes and other serious crimes; for example by exploring the links between tax evasion and organised criminal groups, or between tax evasion and other forms of serious financial fraud;

it builds on existing, and well established systems to counter money laundering and therefore imposes no additional regulatory burden upon the financial sector. It does not require the financial sector to understand the tax system in other countries. The obligation to report is based on suspicious transactions. Usually these transactions cannot be related to a specific offence. Financial institutions are not required to act as detectives, but they should report transactions where they suspect criminal conduct of any description. This may include, for example, large transactions, or those which have no apparent economic purpose, or those which make use of offshore structures for suspicious reasons;

it helps to promote closer working between tax authorities and other law enforcement bodies involved in fighting financial crime. This meets the fifth point raised by the Chancellor of the Exchequer at the Helsinki ECOFIN Council, where he stressed the need for investigative cooperation to supplement exchange of information; and

it provides a framework for action beyond the borders of the EU. For example, the obligation to report suspicious transactions involving tax crimes is already an element of the anti-money laundering system in the US, the Isle of Man, the Channel Islands, Bermuda and in a number of Eastern European countries.

1.6 We propose that each Member State develop an action plan to make this strategy effective. To start this process, we have therefore considered what additional steps can be taken in the UK.

Proposed Steps by the United Kingdom

2.1 The UK's National Criminal Intelligence Service (NCIS) has received over 100,000 reports over the last 6 years, providing a very significant source of cumulative intelligence. Around 25 per cent of those reports have an overseas element, and a significant proportion are potentially of use to overseas tax authorities. In the past, the transmission of that intelligence to overseas tax authorities has been ad hoc. NCIS have passed intelligence to their counterparts in other Financial Intelligence Units, but there are generally restrictions on the onward disclosure of that information to tax authorities. And, in the past, the administrative and IT systems have not allowed routine transmission of the accumulated intelligence.

2.2 We propose to take the following five steps:

NCIS will allow intelligence from suspicious transaction reports to be passed to the tax authorities in other jurisdictions, for the purpose of initiating enquiries into tax evasion by their citizens(8). This will often mean these tax authorities receive more information on suspicious transactions in the UK than they do in respect of those that occur in their own financial sector.

NCIS will review the intelligence accumulated over the last 6 years, and provide intelligence packages which will be of use to tax authorities in other Member States.

We will invest in new computer technology to ensure that relevant information can be passed rapidly and routinely to overseas authorities.

We will work with the UK's Crown Dependencies to help them develop systems to pass on information on tax-related suspicious transactions that occur in those jurisdictions. This is a significant step. It builds on cooperation which the UK authorities are currently developing with the authorities in the Crown Dependencies, and would allow information on tax-related suspicious transactions to be passed to others within the EU.

The intelligence provided through this system will require an increase in the number of investigations conducted into accounts held in the UK. The UK already has a dedicated unit responsible for carrying out investigations in order to provide information to other tax authorities on request. The UK stands ready to provide additional investigative assistance to Member States.

1. 1 Switzerland has reserved its position on Article 26 of the OECD Model, proposing to limit its scope to information necessary for carrying out the provisions of the Convention.

2. Luxembourg and Switzerland abstained in the approval of the harmful tax competition report for reasons set out in Annex II of that report.

3. 3 The Directive was extended to value-added tax in December 1979 and to excise duties as of 1 January 1992.

4. "Offences which are punishable by deprivation of liberty or a detention order of a maximum of more than one year, or, as regards those States which have a minimum threshold for offences in their legal system, offences punishable by deprivation of liberty or a detention order of a minimum of more than six months".

5. Recommendation 15 of the Financial Action Task Force, of which all EU member states are a member, states that "if financial institutions suspect that funds stem from a criminal activity, they should be required to report promptly their suspicions to the competent authorities". An interpretative note to this recommendation, recently agreed by the FATF, ensures that this obligation continues to apply where tax matters are concerned.

6. The Commission proposal is to cover drug trafficking, "activities linked to organised crime", and "fraud, corruption and other illegal activities damaging or likely to damage the EC financial interests". Other offences can be added by member states, but they are not required to do so.

7. "Draft Decision concerning arrangements for co-operation between Financial Intelligence Units of the Member States in respect of exchanging information received under the provisions of the Council Directive on prevention of the use of the financial system for the purposes of money laundering."

8. Our preference is to pass such information from NCIS to other member states' Financial Intelligence Units, ideally to tax experts working in those units. In some cases there will legal constraints on the on-ward transmission of that intelligence to tax authorities. The OECD is considering how those barriers might be removed. In the meantime, in the case of member states where those barriers remain, we will explore other options which allow intelligence to pass from NCIS to other member states' tax authorities.