Compromise at hand in eurobond tax deal

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The Independent Online
A DEAL to introduce an EU-wide tax at source on interest income on eurobonds will be finalised in time for a 17 April meeting of European finance ministers. Britain has agreed not to veto the withholding tax proposal despite fears that it poses a threat to the City of London, the EU's main centre for the eurobond market.

A compromise deal is expected to give member governments the option of either levying the tax on interest paid to EU residents or of providing information on the interest payments to other member states. As the UK already has a reporting system in place, Gordon Brown has concluded the new tax would not severely damage the City. The Chancellor dropped a strong hint that a deal along these "co-existence" lines was likely in his recent evidence to the Treasury Committee. He told MPs: "We will take whatever action is necessary. I have said before that we are not prepared to introduce the withholding tax in Britain and we favour the exchange of information as the basis of moving forward on these matters."

The Chancellor refused to say, in reply to repeated questions, that he would exercise the British veto on the withholding tax. The Treasury has started to liaise with the City on the proposals. But as part of the deal the EU will seek an agreement with non-members, such as Switzerland, to close a loophole whereby bond issuers could avoid the tax or reporting requirements by paying interest through a non-EU agent.

As a further concession to concerns raised by market participants in Frankfurt and London, some existing eurobonds will be exempt from the tax. But the "grandfathering" - exemption of bonds in issue before a cut-off date - might not be as widespread as rumour suggests.

The planned tax posed a particular problem for about 5 to 7 per cent of the $2.8bn (pounds 1.7bn) eurobonds outstanding, as these have clauses obliging the issuer either to gross up interest payments to offset the impact of any new tax or to call the bond at par - that is, redeem it for its face value.

With many bonds trading above par at present, most of the issuers affected would choose the second option, equivalent to an estimated $5bn windfall transfer to them from investors.

The financial markets have ignored this problem, assuming that all pre- existing bonds will be exempt from the new tax. However, as this would create a eurobond market split between old and new issues, the authorities are trying to draft an exemption that would apply only to the minority of existing issues subject to the tax clause.

The possibility of a compromise on the withholding tax arose with the departure of Oskar Lafontaine, the confrontational former German finance minister. The British and German governments have agreed to settle the issue before Germany's EU presidency ends this summer in order to lift the uncertainty hanging over the financial markets.

The proposal for a pan-EU savings tax was first put forward in December 1997. Eurobonds are bearer bonds that can be cashed anywhere, and are used by retail investors in some European countries as a means of tax evasion. Retail investors are thought to account for 10 to 20 per cent of the market.

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