DEFINITION of 'Grandfathered Bond'

The grandfathered bond was a classification for bonds in the European Union that excluded the payments made on these bonds from retention taxes. For a bond to fall into this classification it had to have been issued before March 1, 2001, or had its prospectus certified before this date. In addition, the bond must not have had any re-issues at any point after February 28, 2002.

BREAKING DOWN 'Grandfathered Bond'

The retention tax, which became effective on July 1, 2005 when the European Union Savings Tax Directive was implemented, is a withholding tax on interest payments. This tax simply withholds some of the interest on a bond, and the ultimate amount taxed on the interest will depend on several factors including the individual's overall income. The retention tax only applies to the residents of an EU member state and also covers savings accounts, fiduciary deposits, and investment funds. It does not affect the interest payments made to non-EU residents and made on a type of bond known as grandfathered bond.

Grandfathered bonds were negotiable debt securities which had their interest income excluded from retention tax. The interest, premiums, and discounts derived from these bonds were not considered debt claims or savings income. Hence, investment in these bonds did not count when deciding whether the thresholds which determine whether income from certain collective investment funds is savings income had been passed. A grandfathered bond was defined as a bond which was issued prior to March 1, 2001, matured before 2012, and had no further issuance made on or after March 1, 2002. The transitional period during which grandfathered bonds were not treated as debt claims ended on December 31, 2010.

Grandfathered bonds were the preferred securities for tax evaders: in the absence of further taxation in the country of residence, tax evading investors will prefer bonds that are exempt from the withholding rates over bonds that are taxed or bonds that are deposited at banks in countries that provide information exchange.

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