The Cayman Islands has won a ruling from the European Union saying that the proposed EU Savings Tax Directive cannot be applied to the Cayman Islands. By extension - although the outcome is by no means clear - the directive ought not to be applicable to Bermuda.

The Government may, however, need to seek relief from the automatic application of the directive, as Cayman has done.

The Government of the Cayman Islands went to court to force the European Union to make clear its position on the application of the directive to Cayman and, by logical extension, all the British Overseas Territories.

Bermuda has as yet announced no formal response to the passage of the directive. It is believed that the Government of Bermuda assumes the directive to apply here.

In the first week of March, members of the EU signed the text of a proposed Savings Tax directive, which requires all member States to report bank savings interest by expatriates to the recipient's Government.

The purpose of the directive is to catch European citizens who are not reporting their bank savings interest earned in other countries.

The directive applies only to bank savings accounts, perhaps the least efficient of the various savings mechanisms banks offer. Critics of the directive have argued that those affected will simply ship their savings into other non-reportable instruments, or to countries that are not bound by the directive.

The Cayman Islands Government fears that the application of the directive to Cayman might result in a reduction in bank deposits in Cayman.

The Bermuda Government has been silent on the application of the directive to Bermuda banks, and the assumption has been made here that since Britain had signed the directive, its Territories would also have to enforce its rules.

British Prime Minister Tony Blair had once said the directive would only be signed over his "dead body", but he caved in to EU pressure and the proposed directive was signed while he was still alive.

The directive is separate from the OECD "harmful tax" initiative, but many of the smaller Caribbean nations have argued that the directive undercuts the OECD plan and exacerbates the unfairness of the lack of a "level playing field".

That term is shorthand for the fact that the OECD has been enforcing its will on smaller countries, especially those in the Caribbean, without first ensuring that its own members are in accord with its rules.

On March 17, representatives of the Cayman Islands Government attended the European Union's Court of First Instance in Luxembourg for what was essentially a preliminary matter: an application for interim relief prior to the hearing of the main application by Cayman, which relates to a request from the Cayman Islands for the European Commission to establish and convene a Partnership Working Party. No date has yet been fixed for the main application.

Partnership Working Parties provide a mechanism for dialogue among the European Commission, European Union Member States and Overseas Territories such as the Cayman Islands and Bermuda.

The principal objectives in bringing the March 17 application for interim relief before The Court of First Instance were:

To assist in establishing that the position of the Cayman Islands, which is that the European Commission is obliged to establish and convene a Partnership Working Party at the request of the Cayman Islands, is legally correct and to challenge the European Commission's refusal and delay in setting up a Partnership Working Party to discuss the potential implications of the savings directive on the Cayman Islands;

To require the European Commission to state its position with respect to the legality of any potential direct application by the European Union of the proposed directive on the taxation of savings income to the Cayman Islands and thereby to determine the most appropriate position to take should the proposed directive be adopted and implemented by the European Union Member States at some point in the future. Further, in the event that the proposed directive could, contrary to the arguments of Cayman, be directly applied to the Cayman Islands; and

To require the European Commission to withdraw its proposed directive for the taxation of savings income from the European Council prior to the ECOFIN meetings of March 7 and March 19 in order to allow for discussions to occur in the context of the Partnership Working Party.

Four days prior to the March 17 hearing, having read the arguments of the Cayman Islands that were submitted to the Court of First Instance, the European Commission formally acknowledged to the Court and the Government of the Cayman Islands that the proposed directive on the taxation of savings income could not be imposed directly by the European Union on the Cayman Islands.

In its judgment, which was obtained by the Government late on March 26, the Court of First Instance agreed with this interpretation and confirmed that the European Union could not directly impose any obligation on the Cayman Islands to implement the proposed directive on the taxation of savings income.

The decision of the Court of First Instance further confirmed that in the event that the proposed directive is ultimately agreed within the European Union in its current form, then it would not be credible for the United Kingdom as a Member State of the European Union to argue that the United Kingdom was legally required by the directive to impose "the same measures" on the Cayman Islands.

The Court of First Instance also noted that the proposed directive is a fiscal measure, a classification that carries with it a connotation favourable to the position of the Cayman Islands from a constitutional perspective.

Finally, the judge noted that as a matter of European Community law, any European Union intergovernmental agreement, (such as the undertaking given by the United Kingdom's Chancellor of the Exchequer to ECOFIN in December 2002 to the effect that the United Kingdom would ensure that the Cayman Islands would implement the proposed directive), was unenforceable.

The judge also noted that any damage caused to the Cayman Islands by the imposition of the proposed directive on the Cayman Islands by the United Kingdom would be the result of the UK's actions and not those of the European Union.

The savings directive is still in draft and the EU Council of Ministers has adopted no final text. It is the Cayman Islands Government's understanding that the next scheduled meeting of this Council is in May.