The Treasury Department yesterday shelved its controversial plans to withdraw entirely from a tax treaty with the Netherlands Antilles, reversing course on a decision that created havoc in the European bond markets.
The department said it has modified plans to terminate the treaty, keeping in place provisions exempting from a 30 percent withholding tax the interest on more than $30 billion of Eurobonds issued through the islands.
U.S. insurance companies, pension funds, and other Eurobond investors have been pressing the department to reverse its earlier plan because of the prospect that the value of their Eurobonds would plunge by hundreds of millions of dollars. The earlier proposal, announced last month, had also shaken the confidence of European investors in American bond issues, Wall Street professionals said.
"The Eurobond market reacted much more violently than I anticipated," said Roger Mentz, assistant Treasury secretary for tax policy. He said yesterday's action "will calm the Eurobond market because it will put it back to where it was June 29."
That day, the Treasury stunned investors when it unilaterally announced the cancellation of its tax treaty with the Netherland Antilles. Although it was not the main objective, the decision meant that certain Eurobonds sold by American companies through the Antilles before 1984 to gain tax benefits would suddenly be subject to taxation.
The action prompted several American firms to announce plans to call in the bonds, which threatened to deprive investors of hundreds of millions of dollars in interest. The bonds were issued before 1984, when interest rates were much higher than today.
The Treasury sought to allay the fears of those investors by proposing legislation within a matter of days to exclude Eurobonds sold through the Antilles from withholding taxation. But the action failed to calm the market, and the Treasury yesterday moved to reinstate part of the treaty.
The exemption the Treasury is reinstating is not restricted simply to Eurobond investors, but permits other third-country investors to use entities in the Antilles to gain favorable U.S. tax treatment. But Treasury officials said they would seek legislation narrowing the loophole only to Eurobond investors.
"That's the kind of tax evasion we wanted to stop," said Mentz. "But we couldn't stop it completely without affecting the Eurobonds."