The EU’s attempts to make offshore savers pay tax are forcing banks to devise some innovative strategies to protect this sizeable and lucrative market, reports Michael Imeson.

Banks are developing new strategies to mitigate the adverse effects of the EU’s Savings Tax Directive on their offshore retail savings business. They are concerned about the number of clients who may move their money to jurisdictions outside the scope of the directive – to places such as Singapore, Hong Kong and the Bahamas – to avoid disclosing details of their savings income to EU tax authorities or having tax deducted at source.

Offshore savings is such big business that banks have a duty to shareholders to think of ways to protect it, but it is a sensitive issue. Six of the nine banks contacted by The Banker refused to talk about the subject (SCH, Crédit Agricole, Deutsche, BNPP, Credit Suisse and ABN AMRO), and the other three (Barclays, UBS and JPMorgan) said little.

This reticence is understandable given the political sensitivity of tax planning and avoidance, and the fact that no bank, quite rightly, wants to be seen to be condoning or assisting tax evasion; nor do they wish to give anything away to competitors.

Unknown quantity

No-one knows the size of the offshore market worldwide. Sterling retail deposits held in the Channel Islands and Isle of Man are estimated to be about £250bn, a third of total onshore UK retail deposits.

“The directive is the biggest threat to banks’ offshore retail deposit business,” says Steve Blizzard, a director of KPMG’s financial services advisory practice. These deposits are a big feature of private banking services, as well as representing an important low-cost source of funding for banks; on the margin their cost is 0.75% lower than onshore deposit accounts.

Customers basically fall into two categories: “non-disclosers” and legitimate “tax avoiders”. Non-disclosers are the target of the legislation; these balances will decline. The legitimate tax avoiders can be valuable customers – typically non-EU residents, or EU residents who do not have to pay tax on non-EU income – and generally they will not be affected by the directive.

“On balance, most forecasters do not expect the directive to herald a fundamental decline in the market because banks are devising strategies to help them adjust to the changes,” says Mr Blizzard.

The new rules

The directive, due to come into effect this July, will compel banks to provide information about savings interest paid to residents of other EU states to the tax authorities in which the accounts are held, which will then be forwarded to the tax authorities of the states in which the customers reside. This is known as automatic exchange of information. The aim is to ensure that EU residents pay the right amount of tax on the interest they earn in other states, thus removing harmful tax competition.

However, three EU states (Austria, Belgium and Luxembourg) have chosen to apply an alternative arrangement, which is a withholding tax. Under this arrangement, banks will deduct tax from the interest earned by EU residents on savings held in other EU states. The tax will start at 15%, rising to 20% in 2008 and 35% in 2011.

The directive will also be implemented in UK Crown Dependencies (Channel Islands and Isle of Man), UK Overseas Territories (such as the Cayman Islands), the Dependent Territories of the Netherlands and certain other third countries (Andorra, Liechtenstein, Monaco, San Marino and Switzerland – though there is a possibility that the Swiss will reject it, in which case it might be delayed throughout the EU).

Strategies to consider

Banks are looking at two broad strategies to deal with the impact of the directive and minimise the number of clients who will move their savings to offshore centres where the directive will not apply.

First, they will encourage many customers to leave their offshore savings where they are, actively marketing legitimate customers – mainly non-EU residents, or EU residents who do not have to pay tax on non-EU income – for a broader range of financial services, such as mutual funds, wealth management and structured finance.

Second, banks will help customers who no longer want to keep their money offshore to repatriate it to onshore accounts. “Banks will need to consider this as a defensive measure to prevent their existing customers being enticed away by other banks’ onshore products, and as an offensive measure to encourage other banks’ customers to switch to them,” says Mr Blizzard.

Advice for clients

So what do the banks have to say? Not much in public, for fear of antagonising EU governments and tax authorities, but they have started advising their clients in private.

UBS admits that some EU clients will move their money to countries “outside the scope” of the directive but it claims that the amounts will be small. Most will leave their savings in Swiss and other European accounts, as tax is not the only issue that affects them and they prefer to keep their savings geographically close in financial centres that are safe and offer the most professional services, says a UBS spokesman.

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