WTax
WTax’s Lelanie Marais and Julia Bricker discuss the obstacles and fortuity of the WHT landscape, and what the FASTER directive will mean for European participants in particular
What are the biggest opportunities and challenges in the current withholding tax space?
Lelanie Marais: In terms of opportunity, there is always more to be done for investors, financial intermediaries and service providers. Many investors aren’t aware of additional reclaim opportunities outside of their standard process — be it through alternative reclaim mechanisms or additional recovery opportunities in more complex, emerging markets. It is key for investors to understand their relief entitlement and to ensure they are classified appropriately in order to secure optimal withholding tax (WHT) relief or recovery. While misclassification of investors can lead to missed opportunities, it is common, due to the complex field of WHT recovery and the differing tax legislation across investment markets. Engaging with experts such as WTax, who have an in-depth understanding of the tax regulations across various jurisdictions, provides investors with the opportunity to improve and maximise WHT yields.
European Court of Justice (ECJ) reclaims, also commonly referred to as ‘Fokus Bank claims’, have always been an attractive WHT recovery opportunity for investors; they allow certain types of investors to fully recover withholding. The ECJ reclaims are centred around the premise that the EU Member State — in which the dividend paying companies are resident — treats foreign shareholders less favourably for withholding tax purposes compared to domestic shareholders. Such a discriminatory treatment generally cannot be justified under EU law. While this reclaim opportunity has existed from as early as 2009, the positive developments made in court cases over the last few years have once again highlighted that ECJ reclaims can maximise WHT yield.
In terms of challenges, there are almost too many to name. The WHT recovery process is still incredibly manual and investors have to deal with diverging approaches, particularly the complexity of documentation requirements. Furthermore, the concepts of ‘beneficial ownership’ and the associated entitlement to tax relief are not clearly defined or unanimously applied across countries. This creates barriers for those seeking relief, as well as those seeking to facilitate relief. Financial intermediaries are weighing up the benefits of providing tax relief services with the risks and obligations associated with granting such relief.
In order to address some of these challenges there have been various policy efforts from international bodies, such as the Organization for Economic Co-operation (OECD) and the European Commission (EC), to design a more efficient WHT system. These efforts have been ongoing for more than a decade. The latest EC initiative is the EU Commission’s proposal for a Council Directive on Faster and Safer Relief of Excess Withholding Taxes 2023/0187, also known as FASTER. The proposal, and its consultation by the industry, has created an opportunity for various parties to discuss process optimisation in this complex space.
With many FASTER discussions still ongoing, there is a lot of uncertainty in the industry, a desire for change and also some concern around the practicalities around adopting the proposal by the EU Commission. As developments unfold, we expect to see more opportunities, and potential challenges, in the ever-evolving world of WHT recovery.
In what ways is technology becoming more of an asset for a typically manual-based business such as WHT? What are you seeing?
Marais: Although the WHT recovery and relief process is still heavily reliant on manual intervention, many industry participants are taking steps to automate processes wherever possible.
This includes the auto-population of certain documents, technology-enabled submission of relief or reclaim documents, and the use of tools to help identify and track potentially suspicious transactions.
Similarly, tax authorities are recognising the importance of digitalisation, with most offering some sort of technological solution. The availability of digitalised procedures, including e-filing and the acceptance of e-documents and e-signatures, differs significantly between tax authorities.
Technology is not only being used for process improvements, but also to identify and mitigate risk. Many tax authorities are enlisting the help of technology to analyse the numerous amounts of data reported to them by various parties involved in a transaction.
Where tax authorities have launched online portals for electronic submission of WHT relief, we have seen great efficiencies and faster processing times, combined with greater transparency on claim statuses. Many are working to integrate their systems into these e-filing portals through API connections in order to achieve greater automation.
Furthermore, financial intermediaries and service providers are utilising optical character recognition and other tools to help with matching, storing information and tracing income payments, in order to reconcile events through custody chains.
The FASTER directive re-emphasises the importance of technology in the WHT landscape by contemplating the distribution of electronic tax residency certificates across EU Member States. Although the processes in this space are still relatively dated, much is being done to bring technology to the forefront of the WHT process.
What are WHT reclaims, and why is reclamation so important? What is driving market demand and interest?
Marais: WHT is a tax withheld when dividend or interest income is paid to foreign investors. While each investment country has a statutory rate at which tax is imposed, there are many ways in which the rate of tax can be reduced or reclaimed, if levied.
The most common mechanism for relief is through the utilisation of a double taxation agreement between two countries, in order to reduce the WHT to a mutually-agreed maximum tax rate, provided other conditions of the agreement are met.
The mechanism of relief at source offers relief from WHT. In other words, the income is taxed at the correct (reduced) rate at the time of payment. In order to benefit from relief at source, an investor would still have to provide certain documents or information to evidence its entitlement to a reduced rate. Should the deadlines for relief at source be missed, or relief at source not be available in a particular country, there are usually ways to recover part or all of the tax after it has been withheld.
The process of filing a retrospective reclaim, to recover the excess WHT charged, is the WHT reclaim. As WHT imposed on investment income can be as high as 35 per cent, it is essential to effectively manage WHT recoveries, as WHT leakage has the potential to erode investment returns.
WHT recovery has attracted more interest over the last few years as a result of multiple court cases which have shed light on these taxes and sought to challenge any discrimination against foreign investors. Similarly, investors have also started to pay more attention to the substantial receivables they have gathered for these recoveries. The emergence of external service providers to assist with reclaims has also raised interest in this area.
To what extent has the geopolitical climate of the last few years affected tax reclaims processes?
Julia Bricker: Global WHT relief and recovery processes are still fragmented; each country has their own approach toward tax documentation requirements and process flows. However, we have observed increased collaboration and alignment between countries in recent years. As the most recent and relevant EU proposal, FASTER aims to standardise relief and reclaim processes across Member States of the European Union, though we may see some of these practices extend beyond the EU.
There have been geopolitical effects on WHT, the most notable being the numerous tax treaties suspended as a result of the Russia-Ukraine conflict. As with many other transactions in Russia, WHT reclaims were halted even before the suspension of tax treaties — when it became difficult to move reclaim proceeds out of Russia. Prior to the Russia-Ukraine war, the COVID-19 pandemic had consequences on the WHT sector.
Due to the unprecedented circumstances, some tax authorities needed to reconsider the paper-based approach to tax reclaim submissions, and even relief at source procedures became slightly more lenient in certain jurisdictions.
In addition, the financial aftermath of the pandemic underpinned some tax authorities’ decisions to introduce additional taxes for investors, such as the solidarity tax in Belgium, and the new financial transaction taxes introduced in Hungary.
Lastly, climate change is at the forefront of many countries’ political agendas.
The WHT industry welcomes the introduction of electronic filing opportunities that tax authorities have implemented. The move encourages consideration for a paperless WHT relief system.
The FASTER directive is a clear example of the industry’s direction of travel, and sits in line with ESG considerations.
During the last couple of years, some areas of the global market have struggled to retain staff or recruit new talent. Has the WHT sector experienced this at all? What would you say to those thinking about starting a career in the WHT space?
Bricker: Our experience has been quite the opposite. The space is incredibly nuanced and requires a fundamental understanding of capital markets, the nature of different, global investment vehicles, and of course the resulting WHT treatment and its ability to recover.
We have found that young people are particularly interested to learn about our niche environment, as it’s dynamic and ever-changing. The industry is looking for people to make an impact, and with technology implementation being considered the way forward, the opportunities for people from various backgrounds to enter this space are endless.
The only area where the industry is struggling to retain talent is in manual, paper-based tasks, as people are seeking more job satisfaction and growth. This is forcing the industry to consider how it can use machine learning and other optimised technologies to simplify certain processes.
My advice to people starting a career in this space is to connect with others in the industry as much as possible; learn from those who intrinsically understand the challenges we face.
Those already in the industry should work collaboratively with all stakeholders to pave the way for more efficiency and to minimise WHT leakage.
How do you expect the wider WHT landscape to change before 2025?
Bricker: The EC’s FASTER proposal will likely drive the most significant change in the coming years. Its public consultation period closed on 18 September 2023. The commission is now in the process of summarising all the feedback received for presentation to the European Parliament and Council, with the aim of feeding it into the legislative debate. The intended date for FASTER’s implementation is currently 1 January 2027.
We don’t expect material changes in the landscape before 2025. Given the complexities of this topic, the number of stakeholders involved and the legislative changes needed to accomplish change, progress in this area will continue to be slow.
However, we do expect that tax authorities will continue to increase the ‘burden of proof’ for WHT relief and reclaims by implementing further holding periods and documentary evidence in support of entitlements.
We hope the ECJ continues to add more pressure on the remaining Member States who have not yet acknowledged discrimination to start refunding claims. In particular, we expect some developments in the German market as a result of various cases potentially coming to a close over the next year.
Finally, as investment returns come under greater scrutiny, we expect that investors will demand more in the way of WHT relief and reclaims. We predict that they will also continue to place pressure on service providers to ensure their WHT leakage is minimised.
