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OP-ED: Commission needs to rethink withholding tax plan

FishermanThe EU Commission’s guidelines on withholding taxes do not have nearly enough bite, says Lorraine White, BNY Mellon’s global head of securities and client tax.

Withholding taxes are a significant barrier to cross-border investment. Towards the end of 2017, the European Commission issued a code of conduct designed to reduce costs and simplify procedures but unfortunately, in my view, it falls significantly short of meeting those laudable aims.

In particular, the recommendations outlined in the code may not sufficiently simplify procedures to enable pension funds and other regulated funds such as Ucits to have clarity and certainty as to their entitlement to withholding tax relief.

While a pension fund may be exempt from taxation in its home country, income and gains from investments abroad may not be exempt from the source country withholding tax. The substantial administrative burdens for institutional investors can mean the complexity and cost of obtaining the tax relief to which they are legally entitled are too great. The outcome is often the foregoing of tax relief, with the tax leakage having a significant impact on returns, as well as undermining the objectives of treaties to reduce disincentives to cross-border investment.

Where tax relief is foregone, the tax burden shifts from the investment country tax authority to the investor’s home country tax authority.

The intentions behind the European Commission’s code of conduct are sound. The code outlines a range of practical ways for member states to address issues such as a reliable and effective timeframe for tax authorities to grant withholding tax, the creation of user-friendly digital forms, helping smaller investors deal with complexity, and a single point of contact in each member state’s tax administration to deal with questions from investors on withholding tax.

However, the code does not address a number of fundamental issues, such as the need for harmonisation, the wider digital agenda and broader industry engagement. This, combined with the guidelines being non-binding on EU member states, means that investors will continue to suffer significant administration costs and reduced investment returns.

Errant forms
Harmonisation is crucial. Currently there are over 100 different forms required to claim tax relief across the EU alone. It is clear that investors are confused by which forms to complete and intermediaries incur costs associated with checking that forms are correct and that they do not conflict with other information held about account-holders. The result is that tax authorities are in receipt of numerous errant forms, thereby clogging up the review and refund process. It should be possible to standardise forms – whether relief at source or reclaim – to support a common tax claim process and deal with source country concerns around receiving sufficient evidence of entitlement to withholding tax relief.

The code of conduct does little to push member states towards form standardisation. Similarly, with tax authorities adopting different technology solutions, the costs for investors and their service providers rise due the need to design, build and maintain multiple systems. Without harmonisation, costs will inevitably increase.

Despite the European Commission’s code of conduct referring to user-friendly digital forms, tax authorities appear unwilling to accept electronic or digital signatures and continue to require physical documents when dealing with any withholding tax relief refund requests. This means a full move towards complete digital reclaim filing cannot be achieved.

Some tax authorities are moving towards digitalisation. The Netherlands appears to be making the most headway. But there is slow or non-existent progress elsewhere. This is perhaps understandable; investing in mechanisms that will in effect reduce a government’s tax revenue will rarely be a spending priority. Nevertheless, the seamless transmission of data via progressive solutions that are interoperable, standardised, global and available to all parties, would clearly improve refunding times, help increase governance and, importantly, enable tax authorities to focus their resources on real areas of concern.

Domestic tax policy is a matter for individual governments. However, the issues around withholding tax relief are administrative rather than policy. Engaging with the wider financial services sector and the investment community is likely to bring about more workable procedures than those currently set out by the European Commission. There is a precedent for this: when developing the Common Reporting Standards, governments chose to work with industry, resulting in workable procedures and technology solutions.

Governments should also consider other ongoing regulatory objectives that, in some circumstances, share the same end goals to increase transparency, create efficiency and further the ambition to achieve a true Capital Markets Union.

For example, the legal entity identifier (LEI) system was developed by the G20 in response to the inability of financial institutions to identify organisations uniquely so that their financial transactions in different national jurisdictions can be fully tracked. The LEI system is a good example of the use of central registers to enable every legal entity or structure that is party to a relevant financial transaction to be identified in any jurisdiction.

The Commission and governments might consider the creation and maintenance of a tax register along similar lines that could help achieve simplification of tax relief procedures, including for pension funds, Ucits and and alternative investment funds. This would provide simplification and certainty and in turn open the pathway to relief at source for such registered entities.

Not workable
Possibly the most important recommendation in the code of conduct refers to follow-up and monitoring. Unfortunately, there is no mention of what should be monitored and what success would look like.

Measuring the value of uncollected relief or the time taken to repay claims once filed does not necessarily mean that end investors find the solutions workable. Similarly, if a country implements a relief at source procedure and sees a reduction in the number of claims filed, it does not automatically follow that the relief at source procedure is effective.

We are witnessing some governments exploring withholding tax solutions and processes that will merely exacerbate the existing problems. Meanwhile, well-advanced solutions that have been discussed in fora across the investment industry are possibly being overlooked – for example, the work of the OECD and its Tax Relief and Compliance Enhancement (Trace) project.

While the long overdue discussion about these issues is welcome, more needs to be done with tax authorities working with the Commission and – importantly – the investment industry to help overcome the many practical barriers that investors continue to face.

This article was first published in the June edition of Funds Europe

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