Good stewardship on behalf of clients is taking centre-stage as a governing principle of the asset management industry. Increasingly, managers are being held to account for the extent to which they get the best results for their investors, writes Stanislas Conte.
Client expectations are rising all the time, and sooner or later, investors will turn their attention to what is little less than a scandal, the billions of euros being left on the table in terms of unclaimed cross-border tax, specifically Withholding Tax (WHT).
Many asset managers are unaware that they are failing to claim WHT, and those that are aware are uncertain as to how to go about the process. It is hard not to have some sympathy, given that the procedures can be tortuous and may become more so after Brexit takes the UK out of the orbit of the European Court of Justice (ECJ), which oversees the legal aspects.
But sympathy is unlikely to be sufficient once clients become aware of the scale of the problem.
The numbers involved are quite staggering. According to BNY Mellon, the banking and financial services group, almost €5.47bn in cross-border tax entitlements is unclaimed every year. What this means is that unclaimed tax can be a larger drag on investment performance than the asset management fees about which so much has been written recently.
In 2017, the professional services firm EY, looking at open tax periods, calculated that there are potentially trillions of euro in dividend WHT for which refund claims have yet to be filed.
At issue is WHT charged on dividends and interest paid by securities domiciled in a specific country to an asset-management firm based outside that country. Put simply, WHT can be reclaimed in two ways, either through the provisions of a double-taxation treaty between the two countries concerned or through litigation. A Double Taxation Treaty is a contract signed by two countries to avoid territorial double taxation of the same income by the two countries.
Litigation arises when the treaty in question effectively discriminates against non-domestic investment vehicles in comparison with their domestic counterparts, charging WHT on the former that would not be levied on the latter. The ECJ has consistently backed litigants in this area, given that such discrimination breaches the principle of free movement of capital within the EU and cannot be permitted.
The best-known example of the court’s staunch defence of this principle was the so-called “Aberdeen case”, named after the win by the Scottish asset manager, but it is just one of many cases in which the ECJ has found for the litigant.
While litigation could sound hazardous and extremely expensive when the other party is a National Revenue Agency, it is not.
So far, apparently straightforward. Which raises the question of how and why so much WHT remains unclaimed.
On the face of it, an asset manager’s custodian should process such claims as a matter of course, although this is far from being the case on too many occasions. Banks frequently find the Double Taxation Treaties confusing and, as mentioned earlier, asset managers do not always pursue the matter, either because they are unaware of the existence of the rebates or because the process seems too involved and complicated.
Where blame lies
Not all of the blame lies with investment managers and their Custodians. Deadlines for claims vary across European states, as does the paperwork, some of which is overly-bureaucratic and difficult to understand. Some tax re-claim forms unilaterally impose additional conditions that can be onerous to meet.
Some examples will suffice. In Germany, it can be necessary to make contact with five separate tax offices, and the documentation has to be composed in German.
There are similar obstacles in Poland with, again, multiple tax offices involved and all documents in Polish.
In Spain, refunds are considered on a case-by-case basis, and, even when the ruling is favourable, it can take up to two years for the money to be paid.
The process in the Netherlands is very costly, complicated and time-consuming and frequently results in a negative decision.
Most egregious of all, perhaps, is the position in Italy, whose tax authorities have, until now, systematically rejected claims, in defiance of the ECJ.
In light of all this, asset managers are hardly to blame if, having calculated that the costs are likely to outweigh the benefits of reclaiming tax, they choose to forego their rights – or, more accurately, their clients’ rights. In an average fund, half of the WHT refunds that are due are not claimed, both because of these complex procedures and also because of a lack of information from the authorities concerned.
After all, tax officials are unlikely to broadcast all the various entitlements in this area, but the result of this opacity is that even many asset managers are unclear as to where they stand.
In the past, a partial solution to WHT problems was the securities lending, in which asset managers would lend their shares to a borrower. When the shares distribute dividends, the borrower would then pay the lender the dividend net of WHT, ensuring the lender was not out of pocket, plus an additional sum for the loan; the total income for the asset managers would be close, but not the same, as the equivalent of cashing the dividend gross of WHT.
This door has been closing for some time, as one jurisdiction after another, the last, notably, Germany for German stocks, has ceased to allow it. At the same time, securities lending activity, even if the loans are fully collateralised in case the borrower defaults during the loan, still adds some risk for the underlying investors.
When WHT reclaim processes promise to become arduous and complicated, they should probably be undertaken only by specialists in the field. Some charge an up-front fee and a success fee. For asset managers, the initial fee, which can be high, may be problematic, especially when claiming smaller amounts.
Indeed, this charging model may deter them from claiming what is due.
Other specialists levy no up-front costs and charge only a success fee.
At the start of this article, we mentioned the “stewardship” that is now expected of by asset managers, management companies and funds’ directors. To many, this seems to translate as voting at the annual shareholders’ meetings of the companies in which they invest and taking an active interest in how those companies conduct themselves.
These are important aspects of stewardship, but we would argue that a good steward also seeks to avoid waste in terms of funds properly belonging to their investors. In addition, the market is offering a broad range of solutions and providers for any asset managers, including the smaller ones, eliminating any alibi not to act.
They need to prepare now, as the time is drawing near when clients will, as a matter of course, expect managers to treat tax reclaim as a key operational activity.
Understandably so, as all these and trillions are, ultimately, the property of the asset managers’ clients.