The decision follows mounting international pressure on Luxembourg to end its policy of banking secrecy which critics argue has helped people hide money in the country from tax authorities.
Starting in 2015, the government said it will set up an automatic exchange of information about interest payments made to European Union citizens with bank accounts in Luxembourg in order "to ensure taxation according to the laws" of the customer's home country.
The country added that the fiscal regime for U.S. citizens "will be dealt with in a bilateral agreement under negotiation between the governments of Luxembourg and the United States."
But the government added that said the capital gains tax for those who live in the tiny country of just half a million people remains unchanged at 10 per cent and that "those residents will enjoy bank secrecy as it exists today."
Luxembourg has the highest level of income per individual in Europe, largely because of its huge financial industry which has more than 3 trillion euros ($4 trillion) in assets.
The growth of Luxembourg's financial sector was initially fueled by lax regulation, banking secrecy and low taxes, a cocktail that made it a popular tax haven and money-laundering spot. Though the country later changed many of its laws following pressure by its European partners, its critics have continued to argue that the financial industry still lacks the necessary transparency.
Wednesday's announcement is likely to increase pressure on Austria, the EU's only other holdout on providing tax information. However, Austria's opposition to greater transparency seems to be fading after Chancellor Werner Faymann indicated Tuesday the country might be ready to negotiate on the matter.
"We hope that they will be able to follow Luxembourg," said Emer Traynor, a spokeswoman of the EU Commission, the 27-nation bloc's executive arm, referring to Austria.
Switzerland, which is not an EU member, also takes pride in its culture of banking secrecy, but was pressured into negotiating some bilateral tax agreements with the U.S., Germany and others.
"Tax havens must be eradicated in Europe and in the world, because this is needed to save jobs," French President Francois Hollande said in Paris.
The discovery that his former budget minister — the man in charge of outing tax cheats — had lied about secret bank accounts in Switzerland and Singapore for months, Hollande acknowledged, "was a mortal blow to me."
Trying to counter the political headwinds from the scandal — and the discovery of another close aide's offshore accounts last week — the Socialist president on Tuesday announced a range of new measures to enhance his country's banking sector's transparency.
"It will no longer be possible for a bank to hide transactions in a tax haven," he insisted.
The publication of details of several wealthy people's offshore bank accounts by several international media last week, some of which included references to shell companies based in Luxembourg, reinforced the calls for change in the country. Finance Minister Luc Frieden first hinted at a change to Luxembourg's refusal on automatic information exchanges Sunday.
Luxembourg's 141 banks — many of which are subsidiaries of foreign banks — hold assets worth about 22 times the country's annual economic output of 44 billion euros.
The country is also the world's second-largest centre for investment funds, with about 3,800 funds holding assets worth 2.5 trillion euros ($3.2 trillion).
Associated Press writer Sylvie Corbet in Paris contributed reporting.
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