Michael Dobson (pictured), senior tax manager at BNY Mellon comments on the challenges of claiming cross-border tax entitlement for investors.
More money is left unclaimed in cross-border tax entitlements in the EU every year than is generated by Monaco’s economy. Taxpayers in one jurisdiction trying to reclaim tax paid on investment returns in another face so many obstacles that many do not bother.
For a fund manager in one country to reclaim tax on investments in another is so expensive, difficult and slow that within the EU alone, almost €5.47 billion in cross-border tax entitlements remains unclaimed every year, according to the European Commission.
Personal investors can also find themselves in such situations through no choice of their own. When Abbey National was acquired by Santander in 2004, its UK shareholders, more than 1.7 million of them, were taxed on their dividends at source in Spain.
They were entitled to UK relief on this Spanish tax, but to get it they had to make an annual claim to the Spanish tax authorities. Many did not bother.
The challenge faced by Abbey National’s UK shareholders is the tip of the iceberg. Cross-border portfolio investment exceeds $35 trillion, according to the Organisation for Economic Co-operation and Development . With tax rates on the returns at source typically between 10% and 25%, but as high as 35% in Switzerland, the final tax can be a far higher drag on investment performance than asset management fees.
To encourage growth and cross border investment more than 3,000 bi-lateral double taxation agreements have been concluded. These treaties aim to reduce source taxation on a reciprocal basis. However the collection of due tax entitlements at source is becoming increasingly difficult. The average time it takes to refund withholding tax ranges from one month to 10 years, according to the British Bankers’ Association .
Governments are placing cross-border portfolio investors under increased scrutiny to verify treaty relief or claims for domestic law tax reliefs of a source country. In a number of countries governments are still introducing stringent non-standard complex documentation requirements before they will honour any refund claims. These additional requirements introduce more costs and complexity for cross border portfolio investors.
In recent years, the amount of tax documentation requirements for tax relief at source has doubled.
Some states also require foreign investors to employ a local tax adviser to help file a claim. Investors will then need to undertake a cost benefit analysis to weigh up whether the engagement of an adviser is worthwhile. In many instances investors will forgo entitlements as the costs exceed the benefit.
Many investors want the current plethora of cross-border tax treaties simplified. This makes it all the more surprising that a leading global initiative to solve the problem hasn’t been widely adopted. The Tax Relief and Compliance Enhancement project (TRACE) has been in development by the OECD since 2006. The implementation package (IP) for the project was endorsed by the OECD Committee for Fiscal Affairs in January 2013 and published the following month.
Under the TRACE IP, financial intermediaries based in one jurisdiction can be endorsed to act as “authorised intermediaries” in another jurisdiction, entering into an agreement with the government to claim tax relief at source for their customers on a pooled basis.
This enables cross-border investors to claim tax relief at source under a double tax treaty, or claim domestic relief (where appropriate). The IP also documents the due diligence, documentation and reporting requirements that apply to the authorised intermediaries.
There is currently a renewed vigour for the advancement of the TRACE IP as a number of funds themselves (collective investment vehicles and pension funds) are joining forces and making representations direct to the OECD pushing for TRACE to be implemented. Historically custodians and industry bodies have been the ones lobbying diligently to move this initiative to the next stage.
What is now needed is for a government to make the bold first move and adopt TRACE. Cross-border portfolio investors are keenly monitoring developments expectant of a positive outcome.