There is no question of touching our banking secrecy

Switzerland's ministry of finance

The tax deal was dealt a body blow on Tuesday when Switzerland, which is not a member of the EU, said it will refuse to make its banking system more transparent.

"We are ready to help the European Union in the matter of tax harmonisation but there is no question of touching our banking secrecy, which is guaranteed by law," said a Swiss finance ministry spokesman.

Luxembourg's PM Jean Claude Juncker outlines his grievances to French finance minister Laurent Fabius

The Swiss position matters because the EU member states Luxembourg and Austria are refusing to sign up unless Switzerland and other countries agree to enter into equivalent agreements with the EU.

This is because the EU member states Luxembourg and Austria are refusing to sign up unless specified non-EU countries are prepared to negotiate equivalent agreements with the EU.

Luxembourg and Austria also want Liechtenstein, as well as off-shore centres such as Isle of Man and the Channel Islands, and even the USA, to tow the EU line.

Again, this seems unlikely since secrecy in the principality and on the islands is critical to ensure the survival of their banking and finance centres.

Tax avoidance

The tax mechanism agreed by Monday's Ecofin meeting would ensure that EU residents are taxed on the interest earned on their savings, regardless of where in the EU their money is deposited.

At the moment, many people from other EU member states deposit their savings with banks in Luxembourg because the Grand Duchy operates a policy of secrecy that is similar to that of Switzerland.

In other words; Luxembourg will not reveal details about these bank accounts to tax inspectors from other EU countries.

Since the savers will only have to pay tax on the interest from their savings if they are honest and declare it all to the tax authorities in the country where they live, there is ample scope for abuse of the system.

Luxembourg's objection

Luxembourg, which is heavily dependent on its banking centre, has long been a vocal opponent of a pan-European savings tax regime.

Introducing such a regime within the EU would simply lead to a flight of capital into non-EU principalities where bank secrecy is maintained, the Grand Duchy argues.

The savings tax mechanism

The regime agreed by ministers on Monday is based on a 15% withholding tax on savings income during the first three years, rising to 20% for the remainder of a 10-year transition period.

The country levying the tax would retain 25% and pay 75% of the amount to the EU country where the saver lives and works.

After 2010, when the transition period has been completed, savers will be taxed by the country in which they live, regardless of where they keep their savings.

By then, 2010, standards should be in place for the exchange of information among EU tax authorities, the agreement dictated.