Abstract The increasing international mobility of production factors, especially capital, poses well-known problems for tax authorities in open economies. Of great importance to European Union (EU) countries is the challenge to national tax authorities posed by the liberalization of capital flows between EU countries, as evidenced by the European Council Directive of June 1988. According to the directive, member countries were to completely liberalize international movements of capital before 1 July 1990. To establish a genuine market for financial services, it was deemed important to lessen the obstacles arising from differences in taxation across member countries and across financial instruments, and from tax evasion. In this light, the European Commission proposed a directive in May 1989 concerning a common system of source tax on interest income in the European Community (EC). The Commission specifically proposed the introduction of a minimum Community-wide withholding tax on interest payments made to all Community residents to counter the risks of distortion, evasion, and avoidance in the present system. The minimum tax rate should be 15 per cent, corresponding to about the average of existing withholding taxes on interest in EC countries. The minimum withholding tax proposal, however, failed to secure the necessary unanimous support from EC member countries, and so was rejected in late 1989.