Important key takeaways from the results of the European Commission’s public consultation on a potential new EU system to avoid double taxation

In detail

This summer in August, the European Commission (EC) published the results and analysis¹ of the public consultation that took place from April 1 to June 26 based on the more than1600 feedbacks received. 

The starting point of this initiative is to tackle the cumbersome withholding tax (WHT) procedures for cross-border investors in the securities market. 

Indeed, the smooth functioning of the capital markets union (CMU) requires efficient withholding tax relief procedures. However, the objective of preventing tax abuse is also one of the main objectives of the initiative, with consistency requirements for the Member States to apply and share information on WHT.

Currently, Member States apply different scopes and rates of withholding tax and there is significant inconsistency across the CMUin the way the withholding tax is applied. In many Member States, the rules governing the refund procedure are also very complex, lengthy and costly with the general consequence making the prospect of cross-border investments less attractive in the European securities market, particularly in the recovery of dividends from listed companies.

Nature of the problem

The issues at stake highlighted by the responders confirmed the market players’ experience and reinforced the necessity of a change and a harmonisation within the EU countries. We identify four main categories:

Burdensome and unstandardised WHT reimbursement procedures

A number of countries have already opted for the principle of relief at source and online filing with a digitisation of all documentation to be provided. 

However—and even in the context of relief at source—paper procedures are still largely dominant with an exhaustive list of documents to be provided; and in some cases, there is no existing defined form to be completed or no guidelines available and it will be a matter of filing a written statement with a free format to the tax authorities. In these particular cases, it is unlikely that an individual investor will go it alone and if one does not give up from the start, he will have to engage specialised tax experts.

When some tax authorities do not propose clear and available guidelines, others will have very specific forms to use depending on (i) the country of residence (ii) the nature of the investment (e.g., Listed equities vs. corporate bonds) (iii) the type of investor (e.g., individual vs. corporate entities vs. partnership) and documentation to be adapted according to these criteria. In some cases, even the language of the official form with whom the investor may not be familiar might be an issue.

We understand the will of the tax authorities to deal with their own particular case and to ensure that they capture all the information required to ensure a safe and exhaustive control on the identification and the nature of the beneficial owner Nevertheless, if one puts themselfin the shoes of an (often inexperienced) investor, dealing with such differences in procedures from one country to another quickly becomes a laborious and more than burdensome path. Especially when we note inconsistencies in the definition of terms that lead to distinctions in the eligibility of beneficiaries or the qualification of income from one country to another or from one financial institution to another. 

When the application is finally filed within the limitation period, which is specific to each country, the processing by the tax authorities can take several months or even years in some cases, and often with additional information to be provided to the tax authorities requiring a certain monitoring by the claimant.

Costly procedures

As mentioned above, the procedures may be long and laborious. But it is also necessary to consider that they generate costs which can be largely dissuasive and the origin of the costs can be various:

• The production of the documentation for the filing: the financial institutions involved may charge fees for the issuance of income statement or some Tax Authorities require to receive translated and notarised documentation;

• The human cost due to the time spent on the procedure (identification, preparation, follow-up and reconciliation of the refund) which can be monetised if external service providers are in charge of the preparation;

• The legal and representation costs will have to be considered in the case of litigation.

When the reclaims practice is supervised for an investor, it is therefore quite usual to define minimum materiality thresholds below which the investor knows that the claims process will not be viable following a cost-benefit analysis approach considering the reclaimable amounts at stake versus the estimated costs, the chances of success, the time required for reimbursement and the complexity of the procedures.

Impossibility of providing required documentation or rejection of the documentation provided  by the Tax Authorities

When there is a potentially exhaustive list of documentation to be provided that adds additional complexity to the preparation of the reclaim file, sometimes it even becomes a showstopper, the investor or the person responsible for issuing the document being unable to provide the document as required by the tax authorities of the country of investment.

If we look at the justification of the payment chain for example, it is not uncommon for the tax authorities to request proof of payment from each intermediary involved in the payment (including custodian and sub-custodian banks) to the point of having to provide proof of ownership several weeks/months before or after the payment of income. Unfortunately, the non-integration of each level of the payment chains as a whole procedural flow or through a single tax grid increases the risk of inconsistency in the reconciliation of documents, which will be pointed out by the tax authorities and will require additional justifications which could leads to rejection of the reclaims for lack of sufficient supporting evidence.

The particular case of the acceptance of tax residence certificates is seen as one of the difficulties an investor may face when the tax authorities of the residence country of the investor will not be able to issue a residence confirmation with the exact terms required by the tax authorities of the investment country. This is usually seen when a commitment is required to guarantee that the applicant meets all criteria to be eligible to reclaim under specific provisions such as the Double tax treaty between the two countries.

Lack of knowledge by the investor

When one understands that completing a reclaim file sometimes requires patience and resilience, it is still necessary to be aware that such procedures exist.

The lack of transparency on the modalities of reimbursement or on the simple access to the procedures prevents many investors, especially those without the access to the knowledge of tax mechanisms, from launching reimbursement procedures. 

With statutes of limitations sanctioning the procedures, the European union estimated the foregone tax relief and opportunity costs under the scope of DTT at EUR 8.4 billion annually². This amount is significantly higher on an annual basis considering also tax reclaims based on European laws, National laws and CJEU cases.

Possible solutions

There is no doubt that support and action at the European level is needed to create leverage and synergies between the Member States. 

Towards a harmonisation and collaboration at EU level

The application of a simplified EU-wide system would limit the burden on taxpayers and tax authorities to efficiently apply value-added taxes within the EU. Relief at source and refund procedures, in line with OECD recommendations, could be improved by electronic means. Our experience with such procedures in EU member states indicates that the underlying data systems and record-sharing capabilities of tax administrations would not currently support a move to a highly digitised system, not to mention blockchain-based tax records, which are still in their early stages of development. The buy-in of a range of stakeholders, including qualified intermediaries and tax administrations, would be a prerequisite for any increased automation.

Beyond the purely fiscal considerations regarding the definition and impact of beneficiaries and their investments, a clearly operational aspect should be considered as a cornerstone in the implementation of a common European system that will allow a capacity of verification for the entire payment chain at any stage of the process and de facto decrease the cases of fraud related to burdensome and intense cross border taxation.

In any case the financial intermediaries will have a huge role in any solution that would be recommended and submitted by the EU Commission and the bulk processing of claims will remain for many the most efficient way to cover the needs of investors—also the procedures need to be aligned as much as possible and standardised to be able to generate a processing with the minimum error and maximum efficiency and to allow for some level of automation.

Towards a relief at source system

A harmonised relief at source system—perhaps along the lines of the Treaty Relief and Compliance (TRACE) system implemented in Finland— ³will remain the most favoured option for controlling the proper implementation of withholding tax and will be the most favorable for investors as the income will be paid at the correct rate directly. 

Nevertheless, even if the burden of review shifts from the tax authorities (generally in charge of post-payment procedures) to the financial intermediaries, the harmonisation of procedures, the emphasis on digitisation, the implementation of control procedures, the identification of liability will require a paramount and radical change with a long implementation based on a directive. The operational workload will not disappear, and it will require upfront eligibility analysis, regulator monitoring for the renewal of the documentation 

Notes:

1. European Commission Public Consultation - Withholding taxes – new EU system to avoid double taxation
2. Commission report of 24 March 2017 entitled ‘Accelerating the capital markets union: addressing national barriers to capital flows’ (COM (2017)0147)
3. Read our article on Trace implantation in Finland