Why focusing on withholding tax reclaim opportunities will lead to better returns for you or your clients
In brief
In today’s global economic context, players in the Wealth and Asset Management sector are experiencing pressure on their investment performance and margins. To remain competitive, these players are launching initiatives focusing on investment strategies or cost reduction. One pragmatic solution with direct impact on investment performance, investors’/clients’ satisfaction and cost management is optimal management of the withholding tax applied on the income derived from investments.
Reclaiming withholding taxes will positively impact the investment return of the investors by recovering cash paid in excess to tax authorities. However, this then triggers many challenges due to the very complex and diversified withholding tax relief and reclaim procedures around the world. To show you an obvious illustration, in 2016 the European Commission estimated the foregone tax relief and opportunity costs under the scope of double tax treaties to a value of more than EUR 8.4 bn annually. This amount is significantly higher when considering European case law and national law-based reclaims.
We see an acceleration in the Wealth and Asset Management sector to set up, and ultimately monitor, their withholding tax framework in order to remain relevant when advising their clients with cross-border investments and meet their clients’ returns expectations.
How to achieve WHT tax relief at source/ reclaims in a nutshell?
Double Tax Treaty ("DTT") based reclaims
With the application of the bilateral treaty concluded between two countries, the eligible resident is required to submit a relief-at-source application to have the correct withholding tax rate applied or a refund claim to get the excess tax withheld back. When applicable, the withholding tax applied on the incomes derived from the investments significantly decrease the net return on income (generally from 15% to 30% for dividends) and therefore recovering the excess of tax based on the reduced DTT rate helps to increase the return on investment. Such procedures are requiring eligibility criteria that are wide and burdensome and for which administrative processes are heavy, mainly on paper and requiring a meticulous management of the documentation and data collection.
European case law based reclaims
The withholding tax reclaim based on the EU cases laws (so-called "Fokus reclaims") is an opportunity for investment funds, life-insurance companies or institutions for occupational retirement provision (IORPs) to recover in most of the case up to the full withholding tax borne on dividends and interest in some EU / EEA countries (where a discrimination on the free movement of capital is seen). In general, it is necessary to have a legal representative residing in the investment country, and a strong tax expertise for the elaboration of the argumentation.
National Law based reclaims
The possibility to reclaim the unduly paid withholding tax on dividend is also possible by using the domestic provisions of the national law of the investment country.
While the operational process could be like the other types of reclaim procedures these particular reclaims are based on the national law of the country in question and would require a detailed knowledge and understanding of a foreign law.
In detail
Why do you need to focus on it now?
Tax reclaims have always been a complex topic as tax authorities required more and more transparency on the designation of the beneficial owner, the numerous stakeholders involved in the chain of payment, the non-harmonisation of procedures across countries, etc.
However, it is paramount to keep a close eye on the tax reclaim activity given the recent market and regulatory updates, which include - among others: the developments within the EU case law based reclaims area, notably in Italy, the new CSSF Circular 20/744 which is a complement to the Circular CSSF 17/650 and TRACE, and the new regulation that will increase responsibility to financial institutions.
Although it can be challenging due to multiple layers of complexity, all these recent market and regulatory developments are revealing that it is a must-have to set up a robust framework (policies, procedures and tax matrix) to manage withholding tax, supported by tax expertise on cross-border investments as well as a robust operating model which is eventually based on partial/ full outsourcing.
What developments and challenges have we seen?
- 1. A burdensome and complex topic
- 2. A constantly changing tax framework: e.g., Fokus reclaims in Italy
- 3. Full transparency on outsourced activities: AML Tax Fraud and Tax Function within the AM industry
- 4. Increasing responsibilities moved to the claimants
1. A burdensome and complex topic
In most of the investment countries, the withholding tax is first levied in full and then refunded until the taxpayer has claimed the tax back. In order to eliminate the double or higher taxation, the non-resident investor is required to submit a refund reclaim to get the excess tax withheld by the investment country back. In practice, taxpayers rarely file a tax reclaim.
The reclaim or set-up of relief at source is usually part of standard services offered by Custodian Banks and some Private Banks, however the list of countries in scope is generally limited to the standardised procedures allowing economy of scale and possibility of automation.
What we see in practice is that the beneficial owners who are legitimately entitled to reclaim the overpaid withholding taxes are not always aware of their own eligibility nor of the numerous possibilities and opportunities available. And when the potential claimants have a view on their reclaim possibilities, the procedures are so heavy in terms of documentation to be provided, proof of ownership of the income and costs to be borne that they often give up their right to a correct taxation.
2. A constantly changing tax framework: e.g., Fokus reclaims in Italy
On 7 February 2022, the Pescara Tax Court of First Instance ruled that a Luxembourg SICAV is comparable to an Italian investment fund which means that the Luxembourg SICAV would be entitled to the refund of the full withholding tax suffered on the dividends received from Italian companies.
This judgment has a fundamental importance since it represents the first official confirmation by a Tax Court in Italy of the discriminatory tax treatment suffered by foreign investment funds in Italy on the dividend payments received.
This decision shows the obligation to be up to date on tax reclaims news. In addition to the complex process, not having reclaim experts in the area of the said reclaims can bring complexity to the claimants to understand and determine the subtleties of each country requirement in terms of tax residence definition, comparability characteristic among the investment vehicles, etc. as each country has its own tax reclaim procedure.
3. Full transparency on outsourced activities: AML Tax Fraud and Tax Function within the AM industry
On 3 July 2020, the CSSF issued the Circular 20/744 (a complement to the Circular CSSF 17/650 related to the extension of laundering offences to aggravated tax fraud and tax swindle) and expansion of the list of indicators to specifically target the collective investment activities and the professionals providing services in the Asset Management sector. The first CSSF visits took place in mid-2021 and several remediation letters have been sent where we see that the CSSF expects to take these new indicators into account and to build / reinforce the tax function and governance oversight.
Therefore, when tax reclaim functions are delegated to bank institutions or external service providers, the clients from the Asset Management industry should require more evidence of controls, status reports and key performance indicators to justify a correct governance on their tax risks. Even when not being directly impacted by this circular, the right to transparent and correct information is an essential need for performance analysis and a clear view on the status of the reclaim lifecycle. However, access to dedicated tools or dashboards is still rather limited today, especially when it comes to obtaining a global overview of the services (for example, in the case of complementary services of a custodian bank and a tax firm or to keep a history after a change of service provider).
4. Increasing responsibilities moved to the claimants
It has always been complicated for portfolio investors to effectively reclaim the reduced rates of withholding tax due to, among others, administrative barriers. The OECD Treaty Relief and Compliance Enhancement (TRACE) initiative launches the framework of a standardised system allowing the reclaiming of withholding tax relief at source on portfolio investments. This will help minimise administrative costs for all stakeholders and allow them to ensure proper compliance with tax obligations.
When TRACE suggests a commitment for future harmonisation, this will however increase the legal liabilities and responsibilities of the financial institutions. Since the new system was implemented in Finland on 1 January 2021, we already saw key financial players who choose to change their market offering by not implementing relief at source of Finnish dividends anymore as they are not willing to cope with an increased risk exposure, legal liabilities and responsibilities.
Although the implementation of TRACE will be limited in the coming years, following the emergence of the so-called "cum-cum" and "cum-ex" systems, which have given rise to significant tax evasion and avoidance, tax authorities have become increasingly cautious and eager to ensure compliance with tax obligations and to avoid exploiting weaknesses in national or tax treaty provisions, particularly when it comes to identifying the beneficiary of income. As claimants, beneficial owners are increasingly being asked to define and evidence their own eligibility to access certain types of reclaims or relief at source. Considering the complexity of certain types of claims, people impacted by unduly withholding taxes face limitations in their ability to analyse and frequently have to turn to tax experts in this area.
How should you react to this?
While it is the obligation of the tax applicant to understand the duties and tax requirements when requesting the implementation of relief at source or a withholding tax reclaim, it also imposes substantial compliance obligations by, among others, deploying a robust data quality procedure or monitoring the status of the reclaims. This can generate some risks such as: operational risk due to complexity and the charge of the tax requirements, manual and burdensome processes, financial risk considering the resources or development to be deployed, reputational and legal risk of failure to meet the tax authorities’ requirements. Besides, it is more than complicated to be up to date on the various new legislations / legal developments without creating a specific watch with dedicated trained tax experts.
When (re)designing the tax reclaim strategy, the beneficial owner and its advisor should consider stream-lined deployments eventually with the partial/ full outsourcing of some activities:
- Clear operational processes: this provides transparent guidelines on how relief at source/refund application should be prepared across investment countries and types of claims. This will define the roles and responsibilities of the dedicated people in charge among the organisation or in the case where the services are partially delegated to an external service provider.
- Smart and efficient tax operating model to cope with increasing volumes and complexity: it is paramount to target efficiency gains and agility to adapt to ever changing reclaim procedures and requirements. For example, setting up a delegation of tax reclaim operations to specialised service providers can help you tackle operational challenges in the different phases of your tax reliefs/reclaims.
- Dedicated tax functions with a good balance of tax expert and operational profiles: tax experts help to understand and comply with the requirements, avoiding multiple risks and assessing the impacts. Specialised operational tax teams can relieve resources and offer stability in the tax reclaim process and allow the others teams to concentrate on the core business activities.
- Require transparency and feedback to your services providers: as part of their development strategy, the financial institutions and others providers must show awareness on the tax consequences within your structures and develop dedicated reporting and indicators to monitor your portfolio taxation.
Takeaway
Being up to date on the tax news and opportunities, understanding every specificity of each tax reclaim process and complying with the tax authorities’ requirements and the financial institutions’ expectations at the same time can sound like a tricky mission to recover the unduly withholding taxes and generate substantial risks.
Of course, there are several ways to tackle these heavy procedures and ease these operations, and this could be the right time to assess your tax reclaim strategy and rethink the model in place.
Our Global Tax Reclaim Services and dedicated teams can help you tackle challenges faced within the tax reclaim process and capture your refund opportunities. We can provide you insights and support that improve investor services, decisions on strategy and operational efficiency in day-to-day business. This includes the following range of solutions:
- We help you in different phases of your tax relief/reclaim set up by enhancing your awareness and conducting health checks on your existing activities and investment portfolio,
- We support you by developing and transforming your operational tax activities and by running your entire operations or with a focus on specific markets/streams,
- We assist you in managing your tax compliance risk and oversight and help you at every step of the tax reclaim process by combining our expertise and operational efficiency set-up supported by state-of-the art tools.
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