Withholding tax relief has long been a complex challenge for investors (retail, insurers, and investment funds amongst others) seeking to recover excess taxes withheld on their cross-border investments. The process is often burdened with complex or unclear procedural requirements, a plethora of tax forms and supporting documentation, language barriers, and bureaucratic hurdles that hinder efficiency and transparency. Despite efforts to streamline procedures (spanning over two decades!), many complexities persist, prompting the European Commission to propose initiatives such as FASTER (Faster and Safer Tax Excess Relief) to address these issues, which is expected to enter into force as from 2027.
Unravelling the complexity
When investors make cross-border investments, the dividends or interest they receive are typically subject to withholding tax in the country of investment (also called the source country). The applied withholding tax rate often exceeds the rate agreed upon by the source country in its double tax treaties. Consequently, investors in treaty countries have grounds to recover excess withholding tax by submitting reclaims to the source country's tax authorities.
Withholding tax relief is the process through which investors seek reimbursement (or reduction at source) of excess taxes on dividends or interest received from their cross-border investments. However, the journey towards reclaiming these taxes is anything but straightforward. The process entails navigating through a web of procedural intricacies, bureaucratic hurdles, and jurisdictional disparities, making it a daunting task for investors and financial intermediaries alike.
One of the primary challenges of withholding tax relief procedures lies in meeting the intricate procedural requirements imposed by tax authorities. Claimants must navigate through a maze of tax forms, declarations, and supporting documentation, each tailored to the specific requirements of the jurisdiction in question, including language requirements. Moreover, the submission of these documents requires adherence to stringent guidelines, leaving little room for error or oversight.
Discriminatory practices, where domestic investors receive preferential treatment compared to comparable non-domestic investors, pose yet another obstacle in the journey toward withholding tax relief. Such practices, prohibited under the EU rules governing the free movement of capital, create disparities in treatment among investors, undermining one of the fundamental freedoms of the EU single market. Despite the identification of this issue over twenty years ago, which has resulted in numerous decisions by the Court of Justice of the European Union favourable to investors (more particularly to investment funds and insurance companies), several EU member states continue to engage in discriminatory practices. As a result, investors willing to enforce their rights are sometimes required to initiate costly litigations against such member states.
Eligibility to reduced withholding tax rates represents another area of concern. These eligibility criteria often entail meeting specific conditions related to beneficial ownership, tax residency, holding periods, investment structures, etc. The complexity and lack of knowledge surrounding
eligibility criteria pose compliance risks for investors and financial intermediaries. Inaccurate or incomplete understanding of the criteria may result in the submission of incorrect claims, potentially triggering audits, penalties, or other legal consequences.
Example of complexity: Withholding Tax Reclaim Procedures in Germany
One recent example of the convoluted process of withholding tax reclaims can be found in Germany. Since 2023, reclaiming excess withholding tax on German source income entails a prior registration by the claimants (or their representatives) on the Bundeszentralamt für Steuern Online Portal (BOP). The registration is a cumbersome, multi-step process that involves passwords and activation codes dispatched via electronic or physical mailing channels.
While the BOP does facilitate electronic submission of tax reclaims, it presently lacks the capability for simultaneous uploads of multiple reclaims. Given the substantial volume of withholding tax reclaim submissions each year, this limitation significantly heightens the risk of errors and increases resource requirements, consequently impacting efficiency and costs. Additional constraints include the BOP being made available only in German, further increasing the risk of error for foreign BOP users, as well as a significant level of manual input requirements.
Adding to the complexity, it is crucial to note that the BOP is inaccessible to Swiss applicants, who must adhere to a wholly different procedure. It is also important to note that most investment funds filing reclaims based on the German Investment Tax Act must also follow a distinct, paper-based process.
European Commission’s FASTER proposal
Recognising the need for comprehensive reform, the European Commission has proposed the FASTER directive. FASTER, standing for Faster and Safer Tax Excess Relief, aims to expedite the withholding tax reclaim process while enhancing safety measures surrounding tax relief procedures.
The proposal contains two main components, each equally important in the eyes of the European Commission: speed-up cross-border withholding tax relief procedures within the EU (the Faster) and decrease the risk of fraudulent withholding tax reclaims by creating a new tax reporting regime (the Safer).
How will the new directive help to speed up relief procedures? It envisions two fast-track procedures supplementing the existing standard refund procedure: a “relief at source” procedure and a “quick refund” system. Member States retain the discretion to choose between the two – including a combination thereof.
Under the “relief at source” procedure, the reduced tax rate is applied upon dividend or interest payments based on the applicable domestic tax rules or double taxation treaty provisions. Under the “quick refund” procedure, any overpaid taxes must be refunded within 50 days from the payment date.
Moreover, FASTER will introduce a common EU digital tax residence certificate to expedite withholding tax relief procedures. For instance, investors with a diversified EU portfolio will require only one digital tax residence certificate to reclaim multiple refunds in the same calendar year. The
digital tax residence certificate should be issued within one working day after submission of a request, whereas most Member States presently rely on paper-based procedures.
These standardised procedures are estimated to save investors around €5.17 billion annually, according to the European Commission.
In addition to the fast-track relief procedures, FASTER foresees a standardised reporting obligation providing national tax administrations with the necessary tools to verify eligibility for the reduced rate and detect potential abuse. Certified financial intermediaries must report dividend or interest payments to the relevant tax administration, facilitating transaction tracking. That also means that financial intermediaries applying the FASTER procedures will have to enlist in a national register of certified financial intermediaries. Taxpayers investing in the EU through certified financial intermediaries will benefit from fast-track withholding tax procedures and avoid double taxation on dividend payments.
Limitations of FASTER
One significant limitation of FASTER is the requirement for financial intermediaries to register with the competent authorities of each member state from which income originates. This registration process can be cumbersome and time-consuming, especially for financial intermediaries dealing with cross-border transactions involving many EU jurisdictions.
Moreover, FASTER introduces onerous reporting requirements for each dividend (and potentially interest) payment exceeding 1,500 EUR. Financial intermediaries must meticulously track and report these payments to the relevant tax authorities, which necessitates robust systems and processes for tracking payment, and which may create challenges in terms of data management.
Impact of those complexities on financial intermediaries and their clients
The complexities inherent in withholding tax relief procedures also significantly impact financial intermediaries tasked with providing these services to their clients. As clients increasingly request withholding tax relief services, financial intermediaries face mounting pressure to navigate the intricate regulatory landscape and ensure compliance with evolving requirements. However, the heightened complexity makes it considerably more difficult and onerous for financial intermediaries to deliver these services effectively.
On the client side, documentation, certifications, and assurances to provide to their financial intermediaries are expected to increase dramatically. This implies the need for additional dedicated personnel, time, and financial resources, in addition to their routine oversight duties.
Lack of understanding of the rules governing withholding tax relief can lead to missed opportunities and unsatisfied clients. The burden of deciphering complex procedural requirements, managing documentation, and adhering to stringent guidelines places significant strain on financial intermediaries' resources and expertise. Consequently, financial intermediaries must invest in continuous training, technology, and controls to meet the evolving needs and expectations of their clients while mitigating risks associated with withholding tax relief services. And this comes at a cost…
Exploring Alternative Solutions: Outsourcing to Specialized Service Providers
Given the persistent challenges associated with withholding tax reclaim procedures, many investors and financial intermediaries are turning to specialised service providers for assistance. These providers offer withholding tax and operational expertise in navigating complex tax procedures across multiple jurisdictions. By outsourcing to these providers, claimants can leverage specialised knowledge and advanced technology to optimize withholding tax reclaim opportunities which ensure a simplified and more reliable oversight while mitigating tax and compliance risks. Service providers can take over the administrative burden (documentation production, collection, and reconciliation), the technology stake, the operational risks, and the management of tax technical knowledge. This enables banks, asset managers and insurers to focus on their core business while navigating peacefully across the withholding tax landscape.
