RE: Implementing the Savings Taxation Directive in Hungary
1 / 17
Budapest, 22 February 2006
RE: Implementing the Savings Taxation Directive in Hungary
The implementation of the Savings Taxation Directive concerns the arrangements for the exchange of fiscal information and for withholding tax procedures. The implementation of the directive in a member state cannot be successful unless efficiency in these arrangements can be achieved. In the following, the experience Hungary has collected in implementing the directive will be discussed.
1. Community law background
(i) Policy considerations
The Interest Savings Directive is rather a reporting than a tax directive and, in this sense, it resembles the money laundering directives. The methods are similar: the member states are obliged to maintain a system enabling the exchange of information on certain matters in order to help the operation of the internal market. The exchange of information seems to be unavoidable because of the differences amongst the taxation systems of the member states, and because of the lack of motivations to deepen the integration in this realm of the internal market. This lack of motivation persistsdespite the fact that there is a consensus on the harmfulness of the competition in taxation. Nonetheless the vast majority of the member states insist on their sovereignty in tax matters. Not surprisingly, these member states comprise first of all of the new ones, which either hope for acquiring some benefit from the tax competition or are reluctant to give up more of their sovereignty.
The Savings Taxation Directive focuses on the effective taxation of the savings income derived by individuals in their residence country. Thus, it does not concentrate on the elimination of double taxation. It provides for the foreign tax credit granted by the residence country with special regard only to the transitional withholding tax suffered in the source country. Under the normal regime as provided for by the directive, the source country is not prevented by the directive from levying withholding tax on interest. Instead, it is still prohibited from applying zero or low tax without the exchange of information. The power of the residence country to tax interest is not affected by the directive either. The elimination of the international double taxation of the interest income derived by individuals is to be secured by way of double tax treaties. Alternatively, an independent EC directive has been adopted to eliminate the international double taxation of inter-company interest payments.
The foreign tax credit to be granted for the transitional withholding tax may even exceed ordinary credit because the excess amount of the transitional withholding tax over the national tax shall be refunded to the taxpayer. The reason for this rule is that taxpayers are discouraged from preferring the transitional withholding tax to the normal tax applicable by the residence country. This measure on full credit as envisaged by the directive cannot be seen as that distorting decisions whether invest in a member state or in a third country. The only function of the full credit rule is to provide fiscal disincentive in respect of the member states transitorily applying low withholding taxes without providing the exchange of information. This rule has thus been part of the package adopted by the EC Council in terms of the Savings Taxation Directive.
The comprehensive and automatic exchange of information in the field of the savings taxation of individuals can be justified by combating harmful tax competition. Harmonization is still limited first of all by the principles of the specific conferment of power and subsidiarity, enshrined in the EC Treaty. The tradition of the eighteenth hundred’s enlightenment that law is to be developed within the framework of statutory national legal systems may also cause an obstacle to going ahead with direct tax harmonization, at least in structural issues. Where necessary discrepancies between national legislative measures or national restrictions must be eliminated by way of harmonization EC-wide. The Savings Taxation Directive has not been the last step in this process. Interestingly, the withholding tax procedures are for the time being fraught with the serious burden of national disparities or restrictions.
The Savings Taxation Directive is applicable to the taxation of income, in respect of which it is the established norm in almost all jurisdictions to apply foreign tax credit, instead of exemption. The incentive of low taxes to be applied by the source countries cannot be neutralized in the residence country unless the latter is provided with relevant information of the income derived abroad and reported domestically. The directive contributes to the more efficient operation of the residence country taxation by providing for the exchange of relevant and automatic information. Although the source country is allowed to apply low taxes while efficiently providing information, the weakness of this fiscal policy incentive may be apparent due to the introduction of the directive.
The directive lays significant burden on the paying agent to provide information while in the treaty law it is the taxpayer who is expected to prove residence and beneficial ownership before the competent authority of the source country, in order to reduce the tax payable in the source country. Indeed, the legal status of the paying agent is a key to the operation of the directive. This is because the purpose of the directive is profoundly different from that of a double tax convention. This directive is not targeted not only at the elimination of international double taxation, but even at combating international tax avoidance either. Instead, the directive is aimed at the co-operation between the member states with a view to contributing to the efficient operation of the single market. For this reason, the directive seeks to eliminate the features of national fiscal policies detrimental to free competition. The directive is thus addressed to the national fiscal legislation of a member state instead of domestic or foreign resident taxpayers or competent tax authorities.
The scope of the directive is determined by reference to interest payment. It is, of course, crucial to have clarity concerning this definition. Despite this fact the directive is fraught with uncertainties. In fact, Article 6 on the definition of interest payment contains disperse provisions. The hesitation in legislating the directive can be explained first by the fact that the member states were not able to come to a political compromise exhaustive enough as to what scope the directive should cover precisely. Secondly, due to the recent innovations in the financial markets, it is all the more difficult to carve out of hybrid investment schemes debt instruments. Given these difficulties, a less coherent style of an Article 6 might probably be more efficient.
(ii) Beneficial owners and paying agents
According to the Savings Taxation Directive, a “beneficial owner” means, roughly speaking, any individual who receives an interest payment or any individual for whom an interest payment is secured. However, where no interest payment is received or secured for the benefit of the recipient, the intermediary cannot be treated as a beneficial owner. According to the directive, those cannot thus be considered as beneficial owners [Article 2 (1)] who
- act as paying agents;
- act on behalf of en entity subject to profit tax under the general arrangements for business taxation; or
- act on behalf of another individual who is the beneficial owner.
A “paying agent” is an economic operator who pays interest to, or secures the payment of interest for the immediate benefit of, the beneficial owner [Article 4 (1)]. An entity, not being subject to profit tax under the general arrangements for business taxation, to which interest is paid or for which interest is secured for the benefit of the beneficial owner shall also be considered a paying agent upon such payment or securing of such payment [Article 4 (2)]. It is clear from the directive’s provisions on beneficial owners and paying agents that fiscally transparent entities cannot be considered, but paying agents.
Interestingly, the term of “beneficial owner” is under treaty law interpreted quite strictly. Treaty benefits should not be available when an intermediary, such as an agent, is interposed between the beneficiary and the payer. Beneficial owners are those who are free to decide
- whether or not the capital or other assets should be used or made available for use by others (the right to decide whether or not a yield should be realized);
- on how the yields therefrom should be used (the right to dispose of the yield); or
Even if an individual (a paying agent) for whom an interest payment is secured can be recognized as a beneficial owner, this person should be authorized to decide either for the realization of the yield to the capital invested or to dispose of the yield. Otherwise beneficial owners will be those who stand behind the paying agent.
Under the Sixth VAT Directive, where taxable transactions are effected by taxpayers resident in another member state, arrangements can be adopted whereby tax is payable by someone other than that taxpayer. A tax representative may be designated to arrange for the liability to pay tax in the destination member state [Article 21 (1)(a), Article 28g (1)(c), 28g (2)]. A paying agent as covered by the Savings Taxation Directive and the tax representative as regulated by the Sixth VAT Directive are the positions held by economic operators that are very similar to each other.
According to the first Giovannini report, the need to use a local agent or to appoint a local representative in the discharge of withholding obligations represents a significant extra cost for foreign intermediaries relative to local providers. To ensure a level playing field in the provision of withholding tax services in the context of an integrated EU financial system, it should be possible for all financial intermediaries established within the EU to act as a withholding agent in all member states. Not to mention that explicit harmonization or the conclusion of international conventions could be useful for the purpose of removing the barriers from tax withholding services, the restrictions on the handling of withholding taxes offered by non-local paying agents can clearly be challenged in the light of fundamental EC freedoms as well.
The directive imposes greater obligations as regards financial institutions operating cross-border payments of interest. There is a risk that purely domestic institutions with domestic customers will not be subject to this regime and therefore may have a competitive advantage over their pan-European competitors. To the extent that the directive works to the disadvantage of pan-European institutions it must be seen as having an adverse effect on the development of the single market. This is one side of the coin. On the other side, currently, tax discrimination is believed to be holding back the European investment fund market. More transparent information on savings by individuals should prevent the different EU tax administrations from justifying such discrimination.
Apart from the urging necessity of eliminating the obstacles foreign service-providers have to face, a few notes can be made below on economic operators:
- Commercial agency services and fiscal agency services are strictly to be distinguished. The first case concerns the right of establishment or the freedom to provide services, the latter one may, however, be subject to exceptional rules due to the exercise of official (tax) authority. Restrictions on the fundamental freedoms as enshrined by the EC Treaty can in this respect be legitimised, even though the Community-wide assistance in the assessment of tax liability and in the recovery of tax claims has been consolidated in the recent years.
- Some countries require the appointment of fiscal agents established in the country of investment in order to satisfy domestic fiscal law requirements. Although this is the solution preferred by the Savings Taxation Directive and the institution of tax representatives as regulated by the Sixth and Eighth VAT Directives has also been proliferated within the EU, there are member states (including Hungary), which have not yet been inclined to introduce into their national law the requirement that foreigners appoint a fiscal agent in the country of investment.
- Direct and indirect schemes of investment can be conceived where the liability to deduct tax rests with the paying agent acting for the issuer of securities or, exceptionally, with the local custodian. In the latter case, the paying agent makes a payment in gross to the domestic custodian and it is the custodian to whom the responsibility of tax deduction is allocated. Nevertheless such a situation cannot occur in certain countries (including Hungary). This is because – in the absence of recognized intermediaries -- once someone deemed to be a paying agent for tax purposes is inserted, he or she is immediately liable to deduct tax.
(iii) Procedures of claiming for treaty benefits
Under the Savings Taxation Directive, for the purpose of eliminating double taxation resulting from the imposition of the transitional withholding tax referred to in Article 11, the residence state is obliged to grant a credit. A repayment of the excess amount of the tax withheld to the beneficial owner is still possible [Article 14 (2)]. The tax credit mechanism can be replaced by a refund of the withholding tax [Article 14 (3)]. The subsequent repayment or refund of the tax paid does surely not suit for removing the administrative barriers from the settlement of securities transactions. The procedure of the repayment or refund of tax is regulated more in detail in favour of taxpayers under the Inter-company Interest and Royalties Directive [Article 1 (15)-(16)]. Accordingly,
- there is a deadline for dealing with the taxpayer’s application; and
- late payment interest is payable on the tax not duly refunded.
In the treaty practice, most continental countries follow the “retain and refund” procedure according to which withholding tax is first retained in full, and the difference between the tax withheld and that due under the respective treaty rate is not refunded to the taxpayer until the latter has submitted a claim for it. In contrast, common law countries prefer the certification system according to which the payer applies the reduced rate when withholding tax, provided that the requirements in regard to the furnishing of proof are met. Both the “retain and refund” system and the requirement of a certification even prior to the payment may well contravene the wording of a double tax convention. Where a treaty merely indicates that the rate of withholding tax be reduced, this means technically that the withholding agent should from the outset withhold no more than the reduced amount of tax. The rule, being “lex specialis”, should take precedence over domestic provisions governing the withholding procedure and related formalities.
As a rule of thumb, the Savings Taxation Directive provides for an exchange of information system, being an alternative to withholding taxation. It could still be used for the purpose of harmonizing procedures of tax withholding in respect of securities transactions to the extent that a certification system is to be substantiated by an efficient system of the exchange of information. The system of the exchange of information as provided for by the Savings Taxation Directive is to be complemented by the Mutual Assistance Directive with the exception that the limits on the exchange of information as regulated by the Mutual Assistance Directive do not apply to cases covered by the Savings Taxation Directive. In addition, the system of the exchange of information as regulated by the Savings Taxation Directive is enhanced by the activity carried on by the paying agent as well who is subject to comprehensive reporting obligations (Article 8).
The treaty law argument for “lex specialis”, prevailing over the domestic provisions on tax retain and refund, is likely not well accepted on the European continent. Even if immediate treaty reductions cannot be used in a harmonized procedure immediately, it would be crucial to provide for a strictly regulated procedure for the refund of tax with a view to improving the taxpayer protection. The task of achieving harmonization in the withholding tax procedure does not seem to be less important than that of having introduced a VAT refund procedure, as the case is with the Eights Directive.
In regard to the proposed tax relief model of the Group of Thirty, the main items of tax relief arrangements are to be reproduced as follows:
- completion of tax declarations;
- release of certificates of residence and related documents (e.g., certificate of beneficial ownership);
- possible upfront agreements of treaty eligibility for certain types of investors (e.g., investment funds);
- segregation of assets into various tax rate pools (following the US practice) or one single asset pool with tax rate breakdown;
- tax relief at source arrangements (following common law countries);
- authorization of financial intermediaries and review of authorized intermediaries; and
- a backup tax reclaim system applicable for cases where for any reason the relief at source system does not operate.
2. Overview: taxation of interest income in Hungary
(i) Hungarian implementation of the directive in general
Hungary has duly implemented the Council Directive 2003/48 on the taxation of savings in terms of introducing a separate annex to the Taxation Order Act [Annex 7 to Taxation Order Act in conjunction with Sec. 52 (12) of Taxation Order Act]. This annex refers to the key concepts of the directive (interest, beneficial owner, paying agent, the scope of the exchange of information, etc.). However, the rights and obligations as envisaged in the directive have been built in the effective Hungarian system of tax administration. This concerns, in particular, the liability to register, to disclose tax-related information and the enforcement of treaty relief.
The Hungarian tax authority is obliged to transfer information to the competent tax authority of another member state through the Hungarian Central Liaison Office. This means that the Hungarian law does not provide for an independent procedure on the transformation of information by the Hungarian tax authority to the competent tax authority of another member state. Instead, it relies on the Assistance Directive, the Recovery Directive and the related Community law measures on tax administration. The competent authority is considered in the EC co-operation in fiscal matters always the Central Liaison Office [Sec. 56 (1) of Taxation Order Act].
In implementing the directive, the tax administration has established