POSSIBLE COMPROMISE MEASURES
187. Negotiations on the proposal for a co-existence
model have been looking for amendments which might mitigate the
perceived adverse effects of the Directive without losing the
benefits which some judge it to have. In particular, it has been
vigorously argued that some sort of exemption should be made for
Eurobonds under the withholding tax option. This would not be
easy, not least because, as the Bank of England pointed out, it
is hard nowadays to define Eurobonds: the market is increasingly
fused with the domestic bond market (Q 67). However, the search
continues for a compromise, which would need to address both the
short-term and the long-term effects.
188. In the short-term, there is agreed to be a transitional
problem because the withholding tax could trigger the call-in
of existing Eurobonds, though there are differences of view as
to how extensive the problem is. It has been suggested that it
could be resolved by "grandfathering" (that is, allowing
interest to continue to be paid gross on existing Eurobonds[115]).
This would have the disadvantage of creating a temporary two-tier
market, and (as the Corporation of London noted) it would not
deal with the problem of "discounted" or "zero"
bonds, where any tax due is not payable until the end of the bond's
life, and it is not clear who would then be liable (Q 123). Deutsche
Bank suggested that it might be more appropriate to limit any
exemption to those issues specifically affected by the problem
of the tax-redemption clause, which it estimated as being "well
below 10 per cent of existing Eurobonds" - or even further,
to those payments which would otherwise actually trigger gross-up
clauses and tax calls (p 75).
189. The idea of a short-term exemption of some kind
seems to have won fairly broad acceptance. For example, the Irish
Government commented that "the position of existing debt
instruments which have been issued on the basis that no withholding
tax will apply will have to be dealt with through satisfactory
transitional provisions" (p 175), and M le Floc'h-Louboutin
said that the French Government was "open to discussion on
this subject" (Q 254). It can however be argued that there
is no justification for exempting existing issues[116].
Lannoo and Gros[117]
suggest that there is no reason in principle why an ex post
transfer to borrowers should be undesirable. As for the argument
that doubts would be cast on the trustworthiness of the market,
they maintain that: "It is up to borrowers to decide whether
they want to use [for their own benefit] a clause inserted to
protect investors … and thus lose the trust of savers"
(p 177).
190. Even if some form of grandfathering were accepted,
it would not solve the perceived longer term problem of business
moving outside the EU. Possible solutions to this problem
can be approached from two angles: by carving out exemptions for
the most vulnerable sectors of the market, or by ensuring that
similar measures are introduced in the non-EU countries which
might be competing for the business.
191. The Commission recognises the importance of
Eurobonds to the City of London - and thus, said Commissioner
Monti to the EU as a whole, because "with your permission
… we regard the City of London as an important asset for
the whole of the European Union" (Q 231). But to carve out
Eurobonds entirely would go counter to the objective of levelling
the playing field, and to devise exemptions would create loopholes.
M le Floc'h-Louboutin suggested that the French Government was
not alone "in saying that the idea of a total ad hoc
exemption for Eurobonds would be very difficult to swallow"
(Q 254). The German Government maintained that to exempt Eurobonds
altogether "would lead to large gaps in the Directive's terms
of application and would therefore not be acceptable in the opinion
of the majority of Member States and the Commission" (p 67).
192. Nevertheless, the Commission had persuaded other
Member States to look at compromise solutions, and the United
Kingdom Government has been invited to put forward suggestions.
Julian Reed of the Inland Revenue confirmed that the Government
was looking at "whether a revised form of Directive could
be devised that would be acceptable to the United Kingdom but
also to other Member States". There had been a suggestion
from the City of London that this might be achieved by continuing
to exempt "wholesale" holdings of Eurobonds, but charging
withholding tax on "retail" holdings (perhaps below
40,000 euro). But this could obviously be evaded by individuals
joining together to bring their holding above the limit (QQ 164
and 172). However, although there have been widespread press speculation
on the nature of a possible carve-out the Government's proposal
had still not come forward by the time we finalised this Report.
This delay was a source of disappointment to Dr Kieschke from
the German Ministry of Finance, who chairs the relevant Council
Working Group (Q 197). The Paymaster General told us that consultation
with the City was "very detailed, complex and taking some
time … We rely very heavily on City representatives and different
organisations to make sure that we are aware of their detailed
views on the subject. Whilst we are making progress, it is not
easy. We would rather get it right than do it quickly" (Q
434)[118].
193. It has therefore been suggested that this proposal
should be accepted only if it can be applied outside as well as
inside the European Union "to prevent an outpouring of capital"
(Luxembourg Minister of Justice and the Budget[119]).
Barclays Bank considered that "to the extent that at the
moment people are evading their obligations [to report to the
tax authorities interest paid to them gross], they will merely
continue to do so but will just do it in a different location"
(Q 16). Many witnesses suggested that the adoption of such a measure
should be deferred until similar proposals were adopted elsewhere.
While this might seem an attractive way forward, it would not
satisfy Commissioner Monti, who claimed that further delay was
not an option, when a political commitment to take action had
been made as long as 11 years ago (Q 231). The German Government
noted (p 67) that the Troika[120]
was engaged in exploratory talks with some non-Member States,
though the Paymaster General made clear that no agreement reached
in such talks could be binding on Member States (Q 444).
In any case, most witnesses considered that the main hope of progress
in this direction lay with the OECD.
194. Our evidence from Jeffrey Owens left us convinced
that the OECD was trying to move in the right direction, but less
convinced that it could hope to achieve much, at least in the
short term. He explained that its secretariat believed "that
in the long run exchange of information is the answer, and this
is the way that you counter most effectively international tax
evasion and avoidance" (Q 262). He thought that if the withholding
tax were adopted in the EU, this would encourage debate among
other OECD members as to how they should react (Q 273) - but he
held out no hope of a early solution.
195. It was further suggested that the game was simply
not worth the candle, because there would be only negligible benefits
to be set against the costs generated by the Directive. The British
Bankers' Association suggested that the Directive would only create
the ability "to levy a withholding tax on interest paid to
a handful of cross-border investors who have not moved their holding
outside the EU net" (p 10). The Corporation of London pointed
to the absence of an evaluation report by the Commission (p 31).
The Treasury judged that, whether the effect of the Directive
was simply that new issues would be set up with paying agents
outside the EU or that issuance and trading also left London,
the problem of tax evasion would not thereby be solved (p 41).
196. The Paymaster General said: "The bottom
line is that we shall not agree with anything that we believe
causes serious damage to financial markets in the European Union,
in particular the City of London, or forces the United Kingdom
to impose a withholding tax. We need to have a mechanism to deal
with the issue identified in the first place: cross border tax
evasion … If the Directive does not deal with the issue it
is for us to demonstrate why and then move on to next business
which does address the issue of tackling international tax evasion:
exchange of information" (QQ 436 and 443).
197. In relation to the
short term effects if the proposal were to go ahead, we note the
view that problems arising from private sector contracts, voluntarily
assumed, should not be allowed to affect public policy decisions.
Nevertheless, we can see that there is an argument for the adoption
of a "grandfathering" arrangement (allowing interest
on existing Eurobonds to continue to be paid gross) to avoid massive
disruption of the market.
198.
Looking at the longer term effects of the proposal, we note
that the OECD is seeking a solution on a broader basis than simply
the European Union, but we cannot see what small tax-haven countries
outside the EU would gain from taking part in such an arrangement.
It follows that if the proposal were adopted the danger of driving
the Eurobond market out of the City of London - and indeed out
of the European Union - would remain. We agree that this potential
cost exists, and that the benefits from the Directive to set against
those costs might be limited, but we have no basis on which to
quantify either.
