Tax is something that requires more education in the financial services industry. From the process of reclaiming to the lack of centralised, coherent and global framework, tax continues to be a complex issue.
In terms of what investors need to take into consideration when it comes to tax, consultant and subject matter expert Ross K. McGill highlights that the big question is ‘how much tax am I missing out on?’. He says: “If the amount is small, it’s probably not worth trying to get it back. If it’s large, then it’s worth pursuing – as long as you understand what’s involved, how long it might take and what it’s going to cost you.”
Vicky Dean, COO and vice president of sales and relationship management, Americas, at Goal Group, says investors should not only be aware that withholding tax is deducted from their dividend payments, but also that it can be a significant amount, depending on tax treaties between the country of residence and country of investment.
Dean highlights that every investor wants to yield the highest return possible and unfortunately, if they are not knowledgeable in the world of withholding tax and how to reclaim it, they lose out, as they are being taxed twice at a high statutory rate; once by their country of residence and again by the country of investment.
“Based on their domicile, the entity type and the market of investment, there is often a percentage that can be reclaimed from the foreign tax authorities. In addition, as all countries have varying statutes of limitations, once this timeframe has passed, the money is legally no longer recoverable,” says Dean.
Goal Group estimates that around $38 billion remains unclaimed each year. Essentially, a percentage of the tax deducted is owed to the investor, as the money is rightfully theirs. Due to complex rules, calculations and submission processes, as well as the fact that it is not widely publicised that this money can be reclaimed, it is often a neglected process.
Tax reclamation
In the securities services industry, there is a mixture of knowledge when it comes to tax reclamation. And even then, when it is understood, reclaiming tax is a tricky, complex process.
Dean observes that custodians will be aware but may only deal with a handful of markets, while investors may be aware but may not understand the processes and/or calculations or want to undertake the laborious process of completing forms.
“Additionally, even though there is awareness, fund managers, custodians, banks and even investors may not have the resources to be able to follow these reclaims through. On the other hand, no. This is not something that is widely advertised, therefore, money that is not reclaimed is essentially lost, once it becomes statute barred,” Dean states.
Once it comes to actually reclaiming the tax, Len A. Lipton, managing director, sales at GlobeTax, affirms that the process for reclaiming excess foreign withholding tax is complex, paper-intensive, and ever-changing. “As it is expensive and risky to administer tax services – especially in an environment of fee compression — many asset servicers struggle to provide a comprehensive service to clients. Many financial institutions leave tax reclamation to the investor,” Lipton says.
McGill explains that tax relief and quick refunds can only be processed by financial institutions, although they themselves may sometimes use third parties to help them do this.
He says: “Generally, for each country of investment there will be a defined process for reclamation that may vary depending on the nature of the investor (i.e. whether they are an individual, a corporation, a fund etc), the size of the claim (larger claims are audited by tax administrations more frequently), the type of income and the rules about how that claim should be processed.”
“The principle, however, is always the same. The investor (or their agent) must file the correct reclaim form for that jurisdiction and provide supporting evidence of who they are (typically a certificate of residence) and what their claim is (proof of income and withholding – usually a tax voucher).”
“Recent fraud cases have meant that tax administrations are increasing their scrutiny of claims and may ask for much more information, including trading history. As the nature of the topic is complex, so are the available services,” McGill adds.
Challenges
The biggest challenges around tax, McGill stipulates, is that the cost-benefit equation often doesn’t work because the claim value is too small. Indeed, according to McGill, the amount of work required to prepare, submit and follow up a claim, which may take years, is usually not worth the value of the claim returned.
McGill says: “Most financial institutions and third parties apply a ‘de minimis’ threshold of claim value below which even they don’t process a claim. For institutional investors, the claim volumes and values are usually much higher and so its worth filing claims. However, the challenges are still numerous. Investors want to get their money back as fast as possible – and that means relief at source, but not all countries allow it and not all financial institutions support it, even when it’s allowed.”
Additionally, gathering the necessary documentary evidence is difficult and there is only partial automation and less standardisation in this area, McGill observes.
“The mechanisms for processing claims are generally manual and have lots of contingencies. If your claim is in France, your claim cannot go directly to the French Authority; it must go via a French Agent bank. If your claim is on an American depositary receipt, your claim must go to the sponsoring bank, not the tax authority. The biggest challenge for an investor is having enough information about the issue to make intelligent and informed decisions about their likely entitlements, whether they are worth pursuing and if so, who is best placed to help - if they don’t want to do it themselves,” comments McGill.
Reworking the process
Adding to the challenges is a lack of a centralised, coherent and global framework.
Lipton argues that inconsistency makes sense. “Countries are reluctant to relinquish their sovereign rights to administer their country’s tax policy. After all, governments use tax to fund their priorities, so each country naturally maintains a perspective on their needs and the best way to fund them,” he says.
According to Lipton, from a withholding tax recovery standpoint, those different perspectives often mean that each taxing authority may require different evidence or data to grant relief. This can be confusing to claimants, frustrating both their efforts and efforts of their custodian to file claims or ensure relief is granted upfront.
Meanwhile, international bodies like the EU and OECD have attempted to remedy the situation by developing multilateral information exchange agreements, the Common Reporting Standard, and Treaty Relief and Compliance Enhancement (TRACE) to enable transparency and tax relief. Countries, however, are hesitant to adopt the provisions, Lipton notes.
“The winds might be shifting, however, as there is significantly more attention focused on withholding tax than ever before. Both tax authorities and investors recognize the value of withholding tax recovery and new alliances are being regularly forged to develop solutions that account for the needs of all parties in the custody chain,” he affirms.
Weighing in on this, Dean points out that with regards to withholding tax, regulations, rates and submission methods are constantly evolving.
“Due to our dedicated research department, a strong network of industry contacts and publications and some high-profile partnerships, globally; we monitor, track and implement these changes on a continual basis. We would expect that eventually there may be a global standard to be followed for all markets, however, this is a long way from happening and until that point, we will continue to monitor all markets and adapt our service offering accordingly,” Dean adds.
Education is key
In order to develop a better understanding of this space, further education and guidance around tax in the securities industry is needed.
Reinforcing this point, McGill comments: “When I joined the industry in 1996, I couldn’t find a book on withholding tax, so eventually I wrote one, three in fact. I also wrote 22 benchmarks that could be used to comparatively assess service levels either by an asset manager or internally by a financial institution or third party vendor.”
“Those benchmarks establish standardised methods for determining the effectiveness of any given part of the tax process and a gap analysis between what’s being offered and what the claim opportunities are.”
“The EU also noted in its 2013 Tax Barriers Business Advisory Group Report that one of the main obstacles to efficient withholding tax systems in Europe was the lack of standardised, clear guidance from tax administrations about tax recovery processes. That remains the case today.”
Responding to this gap in tax education, Lipton says that GlobeTax spends a significant amount of time on market education.
“Many industry professionals do not know about double taxation treaties or the benefits of foreign tax recovery. Due to the inconsistent knowledge base, investors become disproportionately responsible for identifying opportunities to reclaim excess tax or even lodge documentation ahead of time to mitigate excess withholding up-front. Failure to understand these tax rules means losing out on tens of basis points of annual performance and, in some cases, violating fiduciary duty,” Lipton affirms.
Over at Goal Group, Dean remarks: “We believe that all investors should be aware of the opportunities available which allow them to maximise their returns and reclaim what is rightfully theirs, but perhaps the opportunity lies in educating and guiding them on both the opportunity and the services available to them to facilitate these reclaims on their behalf.”
“Often the opportunity will be ignored, due to the work involved in obtaining the reclaim, time constraints, lack of knowledge or resources or a limited understanding of what is possible. We network through several industry groups to try to increase awareness and knowledge, h
