October 2011

BACK OFFICE VIEW: One-quarter of withholding tax lies unreclaimed

S_EverardStephen Everard, chief executive officer at Goal Group, a professional services firm, talks about reclaiming of withholding tax.


Fund managers have increased the proportion of foreign shares in their portfolios from around 20% in 2001 to about 28% by the end of the decade. In the fixed-income market, the inflow of capital has also prompted the value of domestic bonds listed on global markets to rise to more than $63 trillion (€47 trillion) a year or two later.

As savvy investors are increasingly adopting an international investment strategy, the issue of unreclaimed withholding (retention) tax has taken on greater significance. Even though double taxation agreements exist between governments to protect investors from being taxed twice, a vast amount of reclaimable withholding tax is still languishing in foreign tax regimes every year. 

According to Goal Group’s latest research, $17.39 billion of investors’ rightful returns from their foreign shares and bonds were lost in 2010 because withholding tax on dividends and income is not being properly reclaimed. This represents an increase of more than 50% in the annual amount lost compared with 2006. In other words, of the total $64.4 billion of reclaimable tax in 2010, around a quarter is currently unreclaimed. Investors in the United States led with a substantial loss of $3.16 billion as the biggest annual loser, followed by investors in the UK who also waived a considerable $1.65 billion.

Subsequent to the financial markets crisis there had been a natural suppression of dividend payouts, in line with suppressed profits. However, indicators have been showing a major resurgence in dividend payments. Standard & Poor’s, a US credit rating agency, has reported that across the 7,000-plus publicly owned companies whose dividends it tracks, only 21 decreased their dividend payment during the second quarter of 2011. Dividend increases rose 32.5% in this period to 444 from the 335 recorded in the second quarter of 2010. 

Similarly, investors in the UK also enjoy the return of healthy dividend payment. According to Capita Registrars, UK firms made the largest cash payout in the second quarter of this year since 2008 at £19.1 billion), a 27% increase year-on-year. In the first half of 2011, dividends have increased 19% from the same period last year, totalling £34.1 billion. The forecast for this year’s dividend payments has now been raised to £66 billion, up 16.9% from previous year.

In light of the gloomy economic data in the Western world and the sovereign debt crisis in the US and across Europe, skittish investors increasingly see debt issued by investment-grade companies as a safe haven as corporations have weathered the tumultuous economy over the past few years and have regained strength to build up strong balance sheets. According to Data Explorers, provider of securities lending and repurchase data, there has been a 12% increase in holdings in investment-grade US corporate bonds between January and early August, which is equal to $15 billion. This may well increase further after the 2011 summer of uncertainty on international stock markets.

Recovering withholding tax
Contingent on the development of the sovereign debt crisis and the strength of the global economic recovery, bond and equity performance could remain volatile in the months to come. Risk-averse investors are becoming increasingly rigorous in their scrutiny of investments and are putting the fund management community under growing pressure to maximise their investment returns.

In the past, recovery of withholding tax had not been on the radar for many hedge fund managers. Traditionally, these funds were domiciled in tax havens such as the Cayman Islands, where investors hardly paid any tax and thus the amount of reclaimable withholding tax was normally trivial. As the geographical distribution of hedge funds is undergoing a change, reclamation of withholding tax will be a welcome bonus.   

With the growing popularity of both dividend payments and cross-border securities, the unreclaimed tax will continue to rise unless fund managers’ service providers – often custodian banks – improve reclamation levels. Technology is widely available today to automatically perform the highly complex task of tax recovery. So there is no more pretext for fund management and custodians not to harness these technology-based services to the benefit of their investor clients.

©2011 funds europe