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taxation.be

Thursday
Aug 17th
Home arrow Money

Why?

With stocks hitting rock bottom, and the banks speculating with the money of their clients, many of us wonder what they have to do to protect their savings. Do we sell our stocks? Or is it the moment to buy? Do we keep our savings safely in a bank account? How do we spread our risk?

I am not going to tell you what you have to invest in. I have no crystal ball. I’m just a tax lawyer, and my investments have dropped in the last weeks as well. What I propose to do is to make a survey of the different forms of investment: savings accounts, bonds, stocks, unit trusts insurance bonds, etc.  I will give special attention to the tax side of these investments. How much tax do you pay on the return? Which investments are tax-exempt? And which ones help you pay less tax?

And then there is the international dimension. Do you have to declare overseas bank accounts? How do you avoid the double taxation trap? And what do you have to consider when you plan to move abroad?

I can only try to anticipate what you want to read.  I can anticipate a large number of the questions, but not all of them. And the internet enables us to make this an interactive series.  If you have questions or comments, you can leave those on www.taxation.be (under Money).  I cannot answer all questions individually, but I will try and integrate the answers in the text.

 

General introduction: What is investing ?

We all have savings. Money that we don’t need immediately, that we keep for later. In a month’s time, in five year’s time or much, much later. In the meantime that money can work for us. That is investing.

When you compare different forms of investment, you need to look at the return, the risk and the liquidity. The costs and the taxes are important too.

The most important criterion is the return you will get on your investment.  The return is everything you will get from your investment. That is in the first place the income: interest on a savings account, dividend, coupons, bonus shares etc… But some investments gain value over the years … and unfortunately sometimes they lose value. For most investments the return is unpredictable. It depends on the success of the company or the investment strategy of the investment fund.  You only know your return at the end of the ride.

Why? That is because there are many events that you cannot predict both good and bad. Financial analysts call these ‘risk’. Risk comes in many forms: macro economic risk (the economic conjuncture, recession…), political risk (e.g. the change of government in a country), market risk (the dollar / euro exchange rate, interest rates …), credit risk (the solvency of the state that issues the bond). And then there are other situations like the subprime loans and SocGen’s rogue trader. 

Since last year, the Mifid Directive obliges your investment adviser to help you define your risk profile. Do you go for a risky investment with a high return or whether you take a lower return with less risk? When you are young, you can afford to take more risk – in the long term the risk may be less. But that doesn’t mean you want to take risk. And when you retire, you want the security of a regular income from bonds without much risk, because you may need the money.

Keep in mind :

Return
Risk
Liquidity
Cost
Taxes

And that’s how we come to liquidity. How easy is it to get your money out? A house is the example of an investment that is anything but liquid. If you need to sell it in a hurry, you will not get a good price. A rule of thumb: if you've got money that you will need in the next five years (as a down payment on a house, or tuition fees for university), you should not invest it in the stock market.  A dynamic investor will want investments that he can sell quickly to reinvest in new opportunities. A defensive investor prefers investments with a higher return that are less liquid.

Most investments come at a cost: entry fees, exit fees, transaction costs, stock exchange tax and even VAT.  Sometimes, there are costs that are less visible. The taxes that the insurance company on the premiums you pay.

Contrary to return, taxes are predictable and they reduce the return. You should only take account of the return after taxes. Your financial adviser should always advise you of the tax regime of investments.  In Belgium, the rule is that dividends are taxed at a flat rate of 25 % and interest at 15 %. That tax is levied by the Belgian bank or financial institution that pays the dividends or interest. If so, you do not need to declare the dividends or interest in your tax return. It is only if you collect the dividends or interest directly from a foreign bank or financial institution that you must declare them in your tax return.

And the good news is that Belgium does not tax capital gains. That explains the success of Sicavs, but that’s another story.

 

Saving accounts

The savings account remains the most popular form of investment in Belgium. Belgian families hold some 20 percent of their savings in savings accounts; that is over 150 billion euros.  One can wonder why. The four largest banks pay a measly interest of 1.5 % (Fortis and Dexia) or 1.75 % (KBC and ING) (plus a fidelity or growth premium of 0.5 %).  Smaller banks try to draw clients away by offering double that interest.  Deutsche Bank for instance offers 3.5 % plus 1 %.

Savings accounts may not be very sexy or lucrative, they are risk-free and you can take out your money at short notice.   Another attraction is that they benefit from a tax exemption. The first € 1.660 in interest you receive on a savings account is tax exempt.  There is no withholding tax and you do not need to declare the interest in your tax return. If the bank pays you interest at a rate of 1.75 %, you can invest some € 94,857 tax free. A high yield account at 3.5 %, reaches that ceiling at about € 47,428.  That tax benefit is limited to real savings accounts that pay a premium on top of the interest. That is why smaller banks sometimes offer a symbolic premium of 0.01 %.

Savings accounts is tax free

Tax exemption : € 1,660 x 2 for a couple
that is a capital of € 189,714

Compare at http://www.spaargids.be/sparen/spaartarieven.html

Each spouse or civil partner is entitled to that exemption of € 1,660. They are taxed separately on their earnings and income, and they are each entitled. However, the interest that their children receive is added to their own. It is taxed in the hands of their parents until they are 18.  Children only file a tax return of their own when they start earning their own money. And then they are entitled to their own tax exemption.

Each taxpayer is now entitled to the exemption of € 1,660. On a joint savings account you have with your partner, you can double the investment, and enjoy an exemption of € 3,320.  At least that is the theory, because most banks disregard the joint exemption. They continue to withhold tax on interest over € 1,660.   They claim it is too much work to check whether the account is really a joint account.  Also banks cannot check whether their clients have money on savings accounts with other banks; that is a serious loophole.

The tax exemption and the flexibility explain the success of the savings account. However, banks are widely criticised because they have a competitive advantage but pocket the profit.  Smaller banks try their best to get a piece of the cake, but their attractive interest rates are usually nothing but loss leaders to attract new clients.  

Clients are starting to wizen up, but they remain faithful to their banks, who are redirecting them to other fixed interest investments, such as term accounts, cash certificates, and even insurance bonds. But that’s for later.

Term deposit accounts and savings certificates

Where do the clients of the major banks put their money that they take out of their savings accounts? They invest in savings certificates or term deposit accounts.

The money invested on term deposit accounts cannot be withdrawn for a certain "term" or period of time: two weeks, one month, three months, a year or several years. These accounts are about as important in size as savings accounts, but that is in part because companies can hold such accounts as well.   

These accounts offer a higher interest rate with the big banks that vary around 4 % depending of the duration and the capital invested. There is not much difference in interest in the short and the mid term. Therefore, do not block your money too long.

That interest can be paid out regularly, or it can be capitalised. That means that it is added to the invested capital until the end of the term.

But that interest is taxed at 15 % which the bank will withhold. And if you receive the interest after tax, you are released from the obligation to declare it in your annual income tax return.

Savings certificates (bons de caisse) are IOUs issued by a bank for amounts of € 250, 1,000, 2,500 and 10,000, typically for fixed terms of 1, 2, 5 and even 10 years.  These savings certificates are continuously issued by the bank. However, contrary to term deposit accounts, banks do not charge any fees for issuing savings certificates.

Savings certificates were traditionally issued in bearer form, with detachable coupons for each year’s interest. They helped create the myth of the Belgian dentist. For decades he had a reputation with international bankers as the unsophisticated, reasonably well off investor with a predilection for bearer certificates. Until 2005 he could collect the interest tax free in Luxembourg.  And he could avoid inheritance tax by handing over his savings certificates to his children.  A savings certificate can easily be handed over for a hand to hand donation, which is a valid way of avoiding inheritance tax, as long as the donor lives for another three years.

That Belgium has abolished all forms of bearer securities as of 2008 does not mean the end of the savings certificate. Even if they are held via a securities account, they remain a democratic and transparent investment.

The interest is usually paid out once a year (after deduction of the 15 % withholding tax). Capitalisation certificates pay the interest at maturity, and some banks allow you to choose every year whether you want the interest to be paid out or to be capitalised. And those are just some of the forms savings certificates come in.

Although the interest rate of savings certificates dropped recently to 3.75 % for a one year certificates, they remains quite attractive compared to the savings account.  When share prices fell on the stock exchanges, investors rediscovered the savings certificate as a safe investment.

Bonds

In our last column, we mentioned that savings certificates are IOUs issued by a bank.  Strictly speaking they are a form of bond. But bonds are much older than that. The bond was born the first time a monarch borrowed a large sum of money from a rich neighbour, agreed to repay the money with interest, and wrote this up on a piece of papyrus, the bond was born. Deficit-laden governments use bonds to finance their budgets, cash-strapped companies sell debt in order to get the money they need to expand.

Bonds are a form of debt that is sold to the public in multiples of €1,000. The lender gets a piece of paper that stipulates how much was lent, the agreed interest rate, how often interest will be paid, and the duration of the loan.  There are different forms of bonds, depending on the issuer. Different issuers have different ratings, depending on their credit-worthiness. The better the rating (e.g. AAA), the smaller the credit risk … and the lower the interest rate.  Ratings are given by independent bureaus like Moodys or Standard & Poor’s.

The issuer can be a government (treasury bonds or bills) or a government agency. These are usually backed by the government, so that the risk is limited.  In fact the government can print more money if it needs to.

Companies issue corporate bonds just like they sell stock. Companies have quite a lot of leeway to issue bonds; still they must make them attractive to be able to sell them. One of these marketing techniques is to issue convertible bonds, which can be converted into stock if certain conditions are met.  Because of the risk that the company may default on the bond, it will have to offer a higher interest rate. If the credit quality of the company is below investment grade, Moody’s calls it speculative grade; we call them ‘junk bonds’.

To compare bonds, you need to look at their par value, coupon rate, and maturity date.

Par value is the capital mentioned on the bond. That is the amount of money the investor will receive when the bond matures. The issuer will return to the investor the original amount that it was loaned (e.g. € 1,000). However, that is not always the price you pay for the bond as we will see.

The maturity date is when the bond issuer must pay back the capital borrowed. That ends the obligation to pay interest. Sometimes corporate bonds can be ‘called’, or paid back well before the maturity date.

The coupon rate is the percentage of the par value that will be paid out as interest. The interest is usually paid every year, but it may be monthly or quarterly. To calculate the return of a bond, you cannot just look at the coupon rate; you must divide the annual interest by the current price of the bond.  

That is because bond prices fluctuate as interest rates change. If the interest rates are higher than the coupon rate, you will expect to pay less for the bond and you buy under par (e.g. 800). And if you own a bond with a higher than normal interest rate, you would be able to sell above par (e.g. 1,200). If you hold a bond to maturity, you will get back the capital. If you buy or sell bonds before they mature, you can make or lose money depending on the maturity date, the current interest rates and the transaction costs involved.

Zero-coupon bonds are a type of bond that pays no interest until the maturity date. At maturity you the capital back plus interest for the duration of the bond.

In the next column, we will look at how you buy bonds, the transaction costs and the taxes.

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