Bond players are worried that a planned tax reform in the European Union could undermine the market. The change, which is set for March 1, would introduce a withholding tax for investors in EU countries with strong secrecy laws, such as Austria, Belgium and Luxembourg. Last November, the EU decided tax authorities should share information between countries on citizens who declared income, but there is a seven-year exemption for these countries to charge a withholding tax instead, until they change their banking laws to conform with the rest of the Union. Not only could this hurt the European banking industry as investors choose to open accounts in non-EU countries such as Switzerland, but it also will have far reaching effects on the European bond market.
"A withholding tax will destroy the European bond market," says Bob Friend, portfolio manager of the United Bank of Kuwait Asset Management in London. The growth of the market was largely due to its tax laws, which are less stringent than in the U.S., says Friend, adding that if the EU decides to implement the tax "it will create a very big inefficiency in the market." This is a major problem in Japan because it withholds the taxes at the source and if you are a foreign entity exempt from the tax you have to sign special papers and wait months until you see your money, he adds.
A major problem will be for bond issuers that want to issue another tranche of the same bond. As it stands now it is possible to re-open a bond and issue more of the exact same paper. But after March 1, if issuers want to re-open a bond issued prior to the deadline, the legal taxation language will be different and the bonds won't be completely interchangeable. "A dollar in one person's pocket can be exchanged for a dollar in another person's pocket," says a strategist following the withholding tax policies, "but you can't exchange my wife for my neighbor's wife." This may impact liquidity, which is usually garnered by big bond issues. If a company can't re-open a bond they have already issued it will lessen liquidity.
