Bermuda's banks look likely to take Bermuda's first blow to the body corporate from an overseas regulatory agency if the EU introduces its withholding tax on interest paid to non-resident depositors on schedule.

Bermuda and the other territories are specifically included in the new directive. The European Union's key strategy document on the tax says: "The proposed measures would apply only in the EU, but Member States with dependent or associated territories... should ensure, within the framework of their constitutional arrangements, that equivalent provisions are introduced in those territories.'' The language is strikingly similar to that contained in paragraph (5.24) of Britain's White Paper, issued in March, on the future of the Territories.

The 20 percent tax on cross-border income is to be introduced no later than December 31, 1999. It might, therefore, be part of the British Government's compliance checklist for Bermuda, referred to by British Foreign Secretary Robin Cook, but not specifically included in the White Paper, which also carries a year-end deadline.

If implemented, the European (EU) directive will offer Bermuda's banks a stark choice: deduct and remit, presumably to the Bermuda Government, the tax on the interest income of European depositors who are not Bermuda residents, or "provide information to other Member States on interest income from savings.'' Finance Ministers of the EU will meet in Brussels on May 25 to discuss progress towards meeting the year-end deadline for the implementation of the tax.

Whichever choice the Bermuda banks were to make, their operating costs would increase as they put reporting mechanisms into place. The increased cost would be accompanied by a reduction in the banks' ability to attract deposits from Europeans who are not residents of Bermuda. The tax would also affect the overseas operations of the Bermuda banks in other British dependent Territories.

The wording of the directive would exempt from the tax non-EU residents and, in the case of interest income earned in Bermuda, all Bermuda-resident individuals. Interest earned outside the EU could not be taxed by the Europeans, although some other reputable jurisdictions outside Europe have cross-border withholding taxes.

British Prime Minister Tony Blair, who had, some months ago, spoken of vetoing the implementation of the entire directive, is now fighting the other European countries over a sole exemption for small trades in the London Eurobond market. Only Greece explicitly backs Britain over the exemption.

"The Chancellor of the Exchequer has already said we will not hesitate to use the veto if it is necessary,'' Mr. Blair told the House of Commons this week, referring to the bond market exemption.

Mario Monti, the acting European Commissioner for financial services, was one of the commissioners who resigned when the whole bloc handed in their notice earlier this year over financial mismanagement in the EU. Like the other commissioners, Mr. Monti has continued in office pending resolution of the situation.

This week, he gave the City of London a choice: to reach a compromise with the European Commission on a withholding tax or to reject the tax and face a "serious political crisis''. London traders said the proposed withholding tax would damage the 3-trillion-a-year Eurobond market and jeopardise 11,000 jobs.

The London Primary Market Association has put forward a suggestion to limit the withholding tax to bond holdings of 40,000 Euros ($42,300) and below -- effectively those held by small investors. However, Mr. Monti said this week that he had never had a proposal from Britain along those lines and thought the figure of 40,000 Euros would be too low.

Mr Monti said: "I cannot exclude that a threshold may be considered, it depends on the member states but I think that figure would be too low.'' He said the EC was more likely to introduce a provision distinguishing between the wholesale and retail markets.

Traders said the uncertainty surrounding the Eurobond market had already caused selling in high-coupon bonds, which were considered to be at risk from the withholding tax. Mr. Monti hinted that existing bond issues may be exempt from the proposals but would not confirm it.

The issue "is turning me into the bogeyman from Brussels'', Mr. Monti told reporters.

Prime Minister Blair's pledge to stand up for the City's interest is in marked contrast to last week, when John Prescott, his deputy, accidentally mixed up the new withholding tax with another British tax, the poll tax, which gave rise to concern that the British Government was not taking the issue seriously.

Despite Mr Blair's comments, Chancellor Gordon Brown refused to say he would use the veto when he appeared before the Commons Treasury select committee recently. The Government hopes to negotiate its way out of using the veto by proposing amendments and delaying the issue until after the end of the German European Union presidency in June.

Finland assumes the rotating presidency of the EU on July 1 for the last six months of the year. The directive is something the Union needs,'' said a Finnish representative to the EU.

Luxembourg is pushing for a lower rate of tax. Swiss bankers have derided the tax as "dangerous and risky''. Even though it will not apply to the Swiss banks, the application of the tax is considered likely to dash the hopes of those Swiss who think that their country belongs in the EU.

See Mr. Monti's Flying Circus, Page 15 Mr. Monti's Flying Circus a smokescreen for stupidity The gentle trickle of euro-fudge into the works could be heard yesterday as Mario Monti, the man who was fired (along with all his colleagues) as a European Union commissioner and then carried on as if nothing had happened, flew into town to stuff us with his wretched withholding tax.

"Under government pressure, the International Primary Markets Association has reluctantly tabled a compromise proposal to try and hang on to the eurobond trade which has brought so much prosperity to London. The association was in a classic political pincer: either it kept saying no, in the hope that Britain would really exercise its veto (rather than merely threatening, before caving in as usual) or it produced something to limit the damage.

So when (British Chancellor of the Exchequer) Gordon Brown emerges from some squalid late-night session of Brussels horse-trading, he will be able to claim that the compromise was proposed and endorsed by the association. Meanwhile, Mr Monti's flying circus will distract attention from the sheer stupidity of the proposals, which are being pushed by the Germans (and others) to make up for the incompetence of their tax-gathering system.

It is worth repeating that London has by far the most to lose if this tax is imposed in any form, since nowhere else in Europe is there a financial centre worthy of the name. A fifth of Britain's annual wealth is generated by financial services, and the City's trading in eurobonds has drawn talented people and serious capital here from all over the world.

The mere prospect of hobbling this vast market is causing the Swiss to salivate at the opportunity before them. The Americans, whose own foolish tax rules drove the market here in the first place, can hardly believe that we would be so stupid as to jeopardise such a success story.

Yet here we are, struggling in Monti's fudge. The compromise proposal is that only holdings below $40,000 (or 27,000 pounds in real money) would need to have tax deducted, to catch those Belgian dentists who hold eurobonds and forget to declare the income. This imposes another irritating cost on the market, and provides a floor which can be progressively raised over time.

Super Mario, the man who you can zap as often as you like but who always has another life, will have got his way. The Belgian dentist, meanwhile, will have switched his holding to Zurich or New York, so the tax will not even raise any worthwhile revenue.