Eurobond tax could threaten City
2 January 1999
Cliff Dammers, secretary general, International Primary Markets Association
Boyan Wells, managing partner, Allen & Overy
Simon Firth, partner, Linklaters
A curious spot of Euro-meddling in the billion-dollar eurobond market is threatening a calamity in the City. The European Union's (EU) determination to stamp out tax evasion has led to proposals for taxing the profits of eurobond dealing at source.
If the proposals are backed by the European Parliament this spring, it will no longer be up to investors to bear the liability of paying their own tax. Instead, the "paying agents" - the banks appointed by issuers to handle all the interest payments on bonds - could be responsible for collecting the tax themselves. The cost of this will be passed on to the issuers - the companies that raise finance by issuing the bonds - where they may be obliged under tax "grossing-up" rules to maintain the interest rates under which different bonds are issued.
The most serious consequences of the changes are expected to be a major shift of eurobond trade to markets outside Europe, more than 10,000 job losses in the City and early redemption of higher-rate eurobonds. But is the news all bad?
Cliff Dammers, secretary general of the International Primary Markets Association and former senior partner of US firm Millbank Tweed in London, thinks it is.
"The first major effect is the tax gross-up, which we think could hit $5bn worth of eurobonds - about 5 per cent of the market. This is going to impose a heavy cost burden on issuers, which will make London less competitive than other markets. We think that as a result, retail bond business will move to Switzerland and institutional business to New York, and a lot of people in London will be out of work. This could have a knock-on effect in the derivatives and asset-backed markets."
On the issue of the proposed tax he says: "We're not in the business of trying to protect people who are not paying taxes, but we think there are better ways of collecting this tax which won't disrupt the market.
"Some bonds will be more vulnerable than others to the changes. And because there's relatively little standardisation in drafting contracts, there will be disputes between investors and issuers. It will be a good earner for law firms - particularly litigators - but will involve drudgery for tax lawyers as they have to check clients' contracts."
Boyan Wells, managing partner of Allen & Overy's international capital markets department, says: "It's a highly emotive subject, as the eurobond market is a major source of raising finance that has benefited both companies and the British economy. If Cliff's fears are realised, then there could be a lot of jobs lost. If, however, the same tax conditions were introduced throughout all the main Organisation for Economic Co-operation and Development (OECD) jurisdictions, there might be a level playing field.
"The irony is that the US brought in similar regulations in the early 1960s, which then drove the market offshore - hence the eurobond market was born. Now the EU proposals have raised a number of fears.
"There's great concern that the EU tax will allow issuers to invoke their tax redemption provisions. That would be fantastic for the issuers and very bad for investors. But I think this has been exaggerated, as in the vast majority of cases - the tax redemption will not be triggered. Another fear is that it may drive investors away. Only time will tell."
Simon Firth, partner at Linklaters, believes many companies issuing eurobonds will consider early redemption if the cost of paying the "grossed up" tax on top of the interest payments makes it a more costly way of raising finance than other means available.
He says: "I think issuers will exercise their right to do that, unless the rate of interest at the point of issue was very low. The bottom line is that if a withholding tax is payable and issuers have to gross up, then most issuers will want to redeem early and seek a cheaper form of borrowing. This will make the market less attractive for investors and could really affect the secondary market."