If you value your tax privacy, there are some shocking changes about to take place in the European Union that we must bring to your attention immediately. 

Beginning July 1, 2005, the “European Savings Tax Directive” will come into effect. It calls for EU member states to pass details of interest payments to EU nationals to their respective tax authorities. In order to preserve their bank secrecy rules, Austria, Belgium and Luxembourg “opted out” of the information exchange, and will instead impose a withholding tax on interest payments to EU nationals. In addition, the 10 newest EU members—Cyprus, Malta, Poland, etc.—will not be subject to these requirements until 2007. 

As the directive is still not in effect, details of exactly how it will operate are only now coming into view. And there is one “shocker:” tax collecting authorities in EU countries have been advised that there are no legal barriers at an EU level to prevent them from requiring banks and other interest-payers to provide information on interest earnings in previous years. The rumor in the European banking industry is that this period may extend as far back as 10 years.

In late February, I had lunch with a high-level official in the Austrian tax ministry. He confirmed this position, but added that Austria would not participate in this effort, as it is one of the three EU countries that have opted out of the information exchange.

If you live in one of the EU countries that will be exchanging data pursuant to the directive, and have at anytime during the past 10 years had a bank account in another “data exchange” EU country, and did not pay tax on the interest from this account, you could face a serious problem. If you face this situation, I recommend that you consult with a tax advisor immediately to determine your options. 

Another consequence of this directive will be to make it more difficult for EU nationals who no longer live in the EU to maintain bank accounts there without having tax deducted or information exchanged. For instance, if you are a U.K. passport-holder, but no longer live in the United Kingdom, you must prove that you are tax resident in another country to avoid having tax deducted or information exchanged. If you live in Dubai or another country that doesn’t have an income tax, you may not find it easy to obtain a certificate of tax residence. There may also be problems if you move from one country to another. In all cases, the default position of the EU financial institution paying interest to you will be to withhold tax, or to send information to the country from which you hold a passport.

Incidentally, overseas territories and dependencies of EU members are subject to the directive, including Andorra, Aruba, the British Virgin Islands, the Cayman Islands, Gibraltar, Guernsey, the Isle of Man, Jersey, Monaco, San Marino and the Turks & Caicos Islands. (Bermuda, however, is exempt.) All of these overseas territories and dependencies will withhold taxes rather than participate in information exchange. Several non-EU jurisdictions, particularly Switzerland and Liechtenstein, will withhold tax as well. The United States is also enforcing the directive, but the Bush administration has blocked its implementation.