Banks' Swiss watch on tax haven rules

European Union tax changes are prompting some investors to move their offshore investments in banks, building societies, unit trusts and open-ended investment companies (Oeics) from traditional tax havens to the Far East, possibly Singapore.

Steve Travis, international overseas manager at adviser Wilfred T Fry, says: 'Anecdotally we are hearing about this and clients are expressing interest. We hear from banks that they are gearing up to handle such moves, particularly banks with branches in offshore centres and the Far East.'

The new withholding tax - part of the European Savings Directive, in force from January 2005 - means some offshore countries will have to start deducting tax at source instead of paying interest or dividends gross.

Even savers with simple deposit accounts in Jersey, Guernsey or the Isle of Man will be affected. UK investors with money in offshore accounts pay UK income tax sooner or later, but can delay payment if they receive gross interest. Non-taxpayers do not have the bother of reclaiming tax automatically deducted. But some people do use offshore accounts to avoid or evade tax.

Geoff Browne, of Bradford & Bingley in the Isle of Man, says: 'We take it that our customers are making proper declarations already, in which case there is no need for them to take the money away from the Isle of Man or Channel Islands.'

Originally the EU wanted to force withholding tax on all member states so they could no longer pay tax gross on offshore investments. Chancellor Gordon Brown persuaded them to include the alternative of disclosing information. Instead of deducting tax, the offshore country passes details of the investments and interest or dividends paid to the saver's own tax authority.

Each country can choose which route it prefers and 12 EU states, including the UK, France and Germany, have decided not to deduct tax but to disclose investors' details. Austria, Belgium and Luxembourg will only deduct tax, with no option to exchange information.

Jersey, Guernsey and the Isle of Man, although outside the EU, have agreed to apply the new tax rules. They have decided to deduct a withholding tax but also to allow savers to choose disclosure instead. So far, they are the only states doing this.

Switzerland is also outside the EU but, as a significant offshore area with a history of banking secrecy, its actions affect the rest. The EU needs Switzerland's co-operation, otherwise billions of pounds in the states which do clamp down on tax evasion will see their business shift to Switzerland, according to Travis. 'If Switzerland opts not to take part,' he says, 'the other participants will think there is no point if the major player isn't on the field with us.'

Browne agrees: 'Switzerland's steps will be relevant because clearly everybody wants a level playing field.'

Switzerland intends to hold a referendum on this early next summer. This leaves little time for other countries to meet the January 2005 start date.

Before the tax can be implemented, bilateral agreements have to be signed by each member state with the various dependent territories, so everyone can move to the new tax arrangements at the same time. Browne explains: 'It will require legislation to be enacted here on the island. That hasn't happened yet. Like other jurisdictions, the Isle of Man is waiting to see what happens in other places. That makes it very difficult for the banks on the island to plan ahead.'

Each country that deducts withholding tax will charge the same rate. This starts at 15 per cent in 2005 and will rise to 35 per cent by 2011. 'Initially it won't be too bad,' says Travis, 'but eventually it will become very painful.'

Taxpayers will not be taxed twice on the same money, and non-taxpayers can reclaim any withholding tax. Where it is deducted, 75 per cent goes to the country where the investment is held and 25 per cent to the investors' country of residence.

That adds complications, according to Travis: 'Many offshore investors have PO box or 'care of' addresses or do not live at the address shown in their correspondence, so banks don't know the individuals' country of residence. My understanding is they are going to pass it on to the country of nationality.'

HSBC, which has interests in Hong Kong, Singapore, Isle of Man, Jersey and Guernsey and faces the prospect of different tax rules in different parts of its empire, says it will advise international clients on the options available when it knows if the proposed timescales will be met.