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August 30, 1991
TO: INTERNATIONAL COMMITTEE NO. 21-91
RE: EUROPEAN DEVELOPMENTS IN MUTUAL FUND TAXATION
__________________________________________________________
This memorandum summarizes recent tax developments in
Europe regarding mutual fund taxation.
1. German Supreme Court Decision Will Force Review of
Germany's System for Taxing Investment Income
The German Supreme Court has ruled that Germany's system
for taxing investment income is unconstitutional because
investors receive different tax treatment depending on whether or
not they voluntarily report income paid to them on securities
held in bearer form. Since no mechanism exists in Germany for
reporting to the German government the income paid to investors
holding securities in bearer form, the only investors taxed on
this income are those who voluntarily report it. German
investors who hold their German mutual fund shares in bearer form
can receive their fund distributions in cash by presenting the
bearer shares for payment at the fund distributor's office, such
as a bank's local branch.
The court's decision requires that the German government
take some action before January 1, 1993 to provide a modified
taxation system for investment income that provides comparable
treatment for all taxpayers. At the present time, it is not
clear when the German government might act or what the proposed
system might be. Opposition has already developed to any
proposed reintroduction of a German withholding tax, which was
effective for only six months in 1989, before being repealed to
stop the outflow of capital that was triggered by the tax.
2. United Kingdom High Court Disallows Nonresident's Claim for
Interest on Tax Refund
1
*/ The claim for refund was based on the U.S.-U.K. income tax
treaty, which apparently applied because the income was
attributable to certain loans made by the U.K. branch to U.S.
businesses.
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The United Kingdom's high court has disallowed a claim by
Commerzbank AG, a German bank with a U.K. branch, for interest on
a tax refund.*/1 The U.K. Inland Revenue concluded, and the U.K.
court agreed, that nonresidents are not entitled under U.K. law
to repayment supplements (interest) on excess tax payments (tax
refunds), even when they have a branch in the U.K.
The court also rejected the bank's argument that denial of
interest to a non-U.K. EC resident unfairly discriminates against
non-U.K. taxpayers in violation of the European Economic
Community Treaty (the Treaty of Rome). However, recognizing the
importance of the issue, the U.K. court invited the European
Court of Justice to rule.
U.S. taxpayers would not be directly affected by any ruling
of the European Court of Justice, which would affect only
taxpayers resident in European Community countries. Any change
in the U.K. position that U.S. taxpayers are not entitled to
interest, a position that the U.K. maintained throughout the
negotiations that recently led to refunds of excess tax payments
to funds organized as Massachusetts Business Trusts, would have
to be made either unilaterally by Inland Revenue or bilaterally
pursuant to treaty negotiations with the U.S.
3. Irish Finance Act Exempts "Specified Collective Investment
Undertakings" from Irish Tax
The 1991 Irish Finance Act (attached), effective
retroactively to December 26, 1990, extends the exemption from
Irish tax to certain non-UCITS open-end investment companies.
Currently, funds structured as unit trusts and funds authorized
under the UCITS directive are exempt from tax in Ireland.
To qualify for the exemption, the fund must be (1) managed
from the Dublin International Financial Services Centre ("IFSC"),
(2) owned entirely by non-Irish residents and (3) designated as
exempt by the Irish Central Bank. A fund which qualifies for the
exemption is known as a "specified collective investment
undertaking" ("SCIU"). SCIUs may be publicly or privately
offered. Pursuant to the exemption, no tax is imposed at the
fund level on the SCIU's income and gains. In addition, no tax
is imposed on a shareholder's distributions, redemptions,
repurchases, gifts or bequests of fund shares. Finally, the
creation and transfer of SCIU shares are exempt from capital duty
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and stamp duty. As a result of these exemptions from tax,
however, SCIUs and their investors will not be able to claim
benefits pursuant to Ireland's income tax treaties.
If a variable capital company that would otherwise qualify
as an SCIU is not designated as exempt by the Central Bank, a 10
percent rate of tax will apply to the entity's taxable income and
gain. Like an SCIU, the fund's investors will be totally exempt
from Irish tax on distributions, redemptions, repurchases, gifts
or bequests of fund shares. Unlike an SCIU, however, the entity
will be entitled to benefit from Ireland's income tax treaties
with countries in which it invests. The ability of a variable
capital company to forego complete tax exemption in exchange for
Irish tax treaty benefits could be beneficial if the fund invests
in high-income-generating securities, where the treaty benefits
may more than offset the 10 percent Irish tax.
We will keep you informed of developments.
Keith D. Lawson
Associate Counsel - Tax
Attachment
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