The shifting sands of tax reform in Europe
EU members prepare to stem the loss of tax revenues.
By Chris Blampied, Royal Bank of Canada (Channel Islands) Limited, Jersey
RESIDENTS OF THE EUROPEAN Union (EU) should take note of the forthcoming EU Savings Directive. Scheduled to take effect on January 1, 2005, the Savings Directive will generally require EU member states to exchange information on interest generated by the savings income of EU residents.
Austria, Belgium, and Luxembourg will be permitted to levy a withholding tax on interest rather than disclose information (please see the sidebar on Page 2 for an explanation of how tax revenues will be allocated). In certain circumstances, you may be able to reclaim it upon tax filing.
The goal of the directive is to defend the tax revenues of the EU member states. At present, there is not a broad exchange of tax information among the EU nations, although some of the individual EU countries do apply withholding tax.
Subject to scrutiny
The Savings Directive is expected to cover four different categories of interest payments:
- Interest payments on debts, including cash deposits, corporate and government bonds, and debentures;
- Interest realised on the sale, refund or redemption of certain instruments such as interestbearing securities, zero-coupon and discounted bonds;
- Income distributed by certain funds, where the income of the fund is derived from interest payments; and
- Income realised on the sale, refund or redemption of shares in certain funds, where the funds have invested more than 40% of their assets (25% after January 1, 2011) in debt claims.
The Savings Directive is expected to apply to payments received by EU residents in certain non-EU offshore jurisdictions as well as in other EU nations (see below).
Who’s affected
The EU Savings Directive is meant to apply only to individual EU residents.
The Savings Directive does not appear to apply to companies and probably will not apply to discretionary trusts. It is not yet clear whether it will apply to bare trusts, which are trusts where trustees have no powers other than to pass the trust assets to the beneficiaries at their request. As the Directive progresses these issues will become clearer.
Clients who have trust structures will need to obtain professional advice from a knowledgeable lawyer in the appropriate jurisdiction.
Details not yet final
We are closely monitoring the progress of the EU Savings Directive and the bilateral agreements, and will keep you informed as further details become known.
European offshore centres and their perspective
THE EU SAVINGS DIRECTIVE is expected to apply to you if you are an EU resident with an included form of savings in one of the following jurisdictions: Andorra, Gibraltar, Guernsey, Isle of Man, Jersey, Liechtenstein, Monaco, San Marino, Switzerland.
Although these jurisdictions are not members of the EU, they have substantial commercial links with the EU and have agreed to comply with the terms of the EU Savings Directive.
Bilateral agreements still to come
In order for the EU Savings Directive to be implemented, these jurisdictions must enter into bilateral agreements with each of the EU members that set out exactly how the Savings Directive will operate. The agreements will provide clarification on the outstanding issues, such as how trusts will be treated and what the requirements are for application of the rules.
RBC has a presence in a number of offshore jurisdictions that may be affected by these changes. For example, Switzerland has chosen to apply a withholding tax instead so that client confidentiality is fully guaranteed. As well, Jersey and Guernsey have arranged to take a common position on the agreements — their intention is to allow clients a choice between disclosing information and paying a withholding tax. The British dependent territories, such as the Cayman Islands, may also be affected and we are monitoring the situation.
Choosing between tax and disclosure
If the EU Savings Directive applies to you, you may need to decide whether you want the withholding tax provisions or the disclosure provisions to apply to your savings. Withholding tax is planned to be implemented according to the following schedule:
January 1, 2005 – December 31, 2007 . . . . . . 15%
January 1, 2008 – December 31, 2010 . . . . . . 20%
January 1, 2011 – Onwards . . . . . . . . . . . . . 35%
The jurisdiction where the payments originate will retain 25% of the tax revenues; 75% will be remitted to the EU country where you live.
The withholding provisions are expected to apply automatically unless you notify your financial institution that you prefer disclosure. In that case, the financial institution will be required to report the payments to the local tax authority.
Leaving on a jet plane
I travel frequently and need a means of transportation that’s flexible and convenient. Does it make economic sense to use a private jet rather than commercial airlines?
DEPENDING ON YOUR NEEDS and how you structure your use of the jet, it may be to your advantage to forego commercial travel.
The simplest arrangement is to hire a jet as needed from a local charter service. This can make economic sense in a number of situations, such as when you’re travelling with a group of people and gain the benefits of a lower cost per person. In addition, if you are travelling on short notice, commercial carriers will usually charge their highest fare. In those situations, private jet travel can be surprisingly cost-effective, especially for shorter-haul regional travel.
If you fly frequently over longer distances (cross-continent or overseas), then jet ownership becomes a more compelling option.
Sole ownership of an aircraft is typically arranged through a cash purchase or leasing arrangement. With sole ownership, you gain the flexibility of being able to travel where and when you want — in a style that’s tailored to your needs. These intangible benefits usually drive the decision to purchase an aircraft, as the fixed costs associated with ownership (the purchase price plus ongoing costs for flight crew, insurance, storage, and maintenance) make a purchase difficult to justify from a purely economic standpoint.
“There may be ownership structures that can be beneficial from an estate planning viewpoint,” offers Nick Cawley, Managing Director, Royal Bank of Canada Trust Company (International) Limited. These may involve structuring the ownership of your plane through preferential offshore jurisdictions. Professional advice specific to your circumstances is essential if you are considering this.
Shared ownership can be an excellent alternative to sole ownership, providing many of the same intangible benefits (style, convenience, flexibility) but at a much lower cost.
This type of ownership can take a number of different forms, from two or more groups buying a single aircraft, to a fractional interest in a fleet of aircraft.
For example, a U.S.-based company that ranked highly in the 2002 Aviation Research Group ownership experience survey uses the fractional ownership business model. Each of its clients buys a certain number of hours on a jet. The hours can be used at any time over the course of the contract. In many ways, it’s similar to a timeshare.
No matter how the shared ownership arrangement is structured, careful advance planning is essential before entering into it, to ensure that the arrangement is cost-effective and that liability risks are properly managed.
Tax considerations will play a key role in the lease-versus-buy decision. The deductibility of costs and payments varies by jurisdiction, so be sure to consult a professional advisor before making an ownership decision.
The world of private equity funds
Part of a series of articles featuring the managers of our investments.
MICHELE KINNER IS THE Manager of Private Equity Fund Investments for RBC Capital Partners. She manages the private equity commitments of RBC Capital Markets and develops private equity fund opportunities offered to investors by the RBC Financial Group.
In this interview, she describes how private equity funds operate and the role they can play in an investment portfolio.
What is a private equity fund?
A private equity fund is a pool of capital invested in companies that are not typically publicly traded. The investors in a private equity fund agree to make contributions of capital over a specified time period. The manager of the fund calls on the investors’ commitment as the funds are needed.
There are a number of strategies that private equity funds use. They may be involved in leveraged buyouts or management buyouts of existing, mature companies. They may provide venture capital financing to start-up companies, or to companies that have not yet had an initial public offering. They may provide mezzanine or subordinated debt financing, either when the owners of a company want to limit dilution of ownership, or when a company is in financial difficulty.
Individual private equity funds sometimes focus on a specific industry, such as life sciences, but often broaden their scope to several industry specialisations. Generally, they require a minimum investor commitment of US$5 million to US$10 million.
What are the benefits and pitfalls of private equity funds?
Private equity funds have historically provided a greater return on investment than investments in public companies. In addition, returns are not highly correlated to the stock market, so they provide useful diversification.
While returns are not guaranteed, the 20-year average is currently about 14% to 15% per year. In the early years, however, an investment return is likely to appear negative while cash contributions are made to the private companies before they achieve measurable results.
The main drawback is the length of commitment. Investors who choose a private equity fund should be prepared for a commitment of 10 to 12 years. The commitment is irrevocable: there is no organised secondary market for private equity funds and there are no withdrawal windows.
What type of investor should consider private equity funds? Private equity funds are suitable for patient investors who understand the investment’s long-term nature and who can afford to let their capital develop over a few years without seeing any initial return on investment. Whether it is an appropriate investment depends on the individual investor’s tolerance for risk and level of investable assets.
One of the best ways to reduce investment risk in this category is through a “fund of funds” approach. A fund of private equity funds invests in 10 or more private equity funds in different industries, creating a more diversified portfolio. In addition, it provides the investor with professional fund management, including access to investment data that may be unavailable to individual investors. It is also a more affordable way to properly diversify an investment in private equity funds.
What role should private equity funds play in an investor’s portfolio?
Investors should always focus on their overall investment goals and should consider how a private equity fund will interact with the other investments in their portfolio. It’s important to recognise that an investment in private equity funds will be the longest-term portion of an investment portfolio.
Private equity funds typically represent 5% to 10% of a wealthy investor’s portfolio, although investors who are themselves entrepreneurs may be comfortable with a greater share of their portfolio in private equity funds, including investments in the equity of their own companies.
Reviewed your financial plan lately?
HAVING A PLAN is an essential part of achieving your financial goals. Unfortunately, many people forget to review their plan regularly to ensure that it still meets their needs — and reflects any recent life changes.
Acknowledge the past
An annual review will help ensure that your plan reflects the following:
- Changes in your personal life. Marriage, divorce, the
birth of a child, receiving an inheritance — events
like these may necessitate amendments to your plan. You
should also take into account any increase or decrease
in your short-term cash flow requirements, or your long-term
savings needs.
- Performance of your current holdings. If you were aggressive in setting your annual return targets, you may need to adjust your financial expectations. For example, if you based your financial plan on double-digit annual returns and you have fallen short of this target, you may need to adjust your asset mix, invest a greater amount, or increase the timeline for achieving your financial goals.
- Financial goals you have attained. If you have recently finished paying for a major expense, such as the purchase of a business or property, you should consider allocating this increased cash flow strategically to achieve other financial goals.
Prepare for the future
Reviewing your financial plan also means anticipating future financial events so that you can take advantage of any opportunities they may present.
For example, if your job requires you to move to another jurisdiction and the tax rates in that jurisdiction are lower than where you currently live, you may be able to time your move to take full advantage of the lower rates for your current year’s income.
Of course, if you are moving to a jurisdiction with higher tax rates, you will want to time your move to minimise any adverse tax impact.
Talk to your Relationship Manager
Year-end is a good time to review your financial plan to ensure that it still reflects your goals and personal circumstances.
Your Relationship Manager can help you update your financial goals and make any necessary adjustments to your long-term strategy.
Internet bank scams on the rise
The Internet has opened up a new world for criminals who want to gain access to your savings. Here’s an example of a current bank scam. An email is sent that claims to be from a bank. The email states that the bank has lost the recipient’s Online banking user name and password. It directs the recipient to click on a link to a Website, which asks him or her to enter the supposedly misplaced user name and password. The scam artist then uses this information to access the victim’s bank account.
This particular scam hits doubly hard because visiting the Website also surreptitiously downloads a program into your computer which can be used to gain control of it.
If you receive such an email, do not respond to it. It is important to be very cautious about what financial information you provide online, and ensure that you are dealing only with reputable financial institutions.
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