Issue 2 • summer 2014
WMA JOURNAL Working for the Investment Community & their Clients
TAX RECLAIMS
TAX RECLAIMS
Maximising tax reclaims should not be taxing Recent research by Goal Group has shown that more than US$64bn of withholding tax is deducted globally each year and that more than US$17bn of this is not reclaimed annually by investors, for a number of reasons. Separate research by taxback.com shows that UK investors are losing around 13% of their overall dividend returns as a result of not reclaiming withholding tax.
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any pension funds, pooled funds and hedge funds enjoy a legally tax exempt status and many wealthy individuals also enjoy a beneficial tax treatment through use of offshore trust funds. The complexities of the tax treatment of income on cross-border investments, despite the many double taxation agreements that the UK has established with other countries, still causes withholding tax to be paid and then reclaimed. Most pension funds, investment managers and their clients do not have a good understanding of the impact of the withholding tax that will be levied on their international equity investments and just assume that the custodian is performing this adequately as part of their overall service provision. There is a need to better educate the investors as to the potential benefits of improving the level of service that can be provided on tax reclaims. The level of local withholding tax levied on dividend income of a globally invested equity portfolio with asset allocation following the FTSE World Index can be shown to be more than 50 basis points, which is significant. This level of tax can be reduced to around 30 basis points by making the appropriate tax reclaims to the relevant tax offices. A number of significant rulings have also been made by the European Court of Justice which have the potential to reduce this tax impact by a further 7 basis points. Therefore making full use of the tax reclaims available
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can provide between 20 to 30 basis points of additional income for a typical global equity portfolio, which would have a material impact on the portfolio performance. In addition, if an investor has not been actively pursuing reclaims then the statutes of limitations may allow reclaims to be made for a number of prior years, which could lead to a significant windfall amount. Many investors assume their custodian is performing tax reclamation services on their behalf. Unfortunately, this may not be the case. This places the onus on the pension fund trustees, investment manager or the portfolio manager for ensuring they recover all monies to which the investor is entitled as part of their fiduciary responsibilities in today’s regulatory environment. When an investor receives income from one country and is resident in another,they often have to pay tax in both countries under the different tax laws. The tax charged in the country where the income arises is known as withholding tax, because it’s withheld when the payment is made. To help avoid this double taxation the UK has negotiated over 100 double taxation agreements with many countries. The typical rate under most of the UK’s agreements is 15% so in theory, a UK investor should receive overseas dividend income net of 15% tax. However, countries still deduct tax at the local tax rates that apply with that country because they do not know the tax status of the beneficial owner of the investments. So for example, Switzerland deducts 35%.
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Many investors assume their custodian is performing tax reclamation services on their behalf
To demonstrate the impact of this a Swiss company’s dividends would be paid to a UK investor minus a 35% withholding tax. Under Switzerland’s double taxation treaty with the UK investors can reclaim 20% of this tax. So, on a £900 Swiss dividend local withholding tax of £315 would be deducted and only £585 paid to the investor. A total of £180 of the £315 tax paid can be recouped from the Swiss tax office by making the tax reclaim together with the appropriate paperwork. For a small number of countries it is possible for the investor to claim Relief at Source by notifying the relevant tax authority with evidence that they are domiciled in a country and meet the conditions laid down by the applicable double taxation treaty. This will ensure that dividends are taxed at source in line with the withholding tax approved in the DTT. The most important example is the US, where the default tax is 30%, but the rate for UK domiciled investors is 15%. The withholding tax on dividends will be reduced to 15% by completing a W-8BEN form, but this must be submitted to the qualified intermediary before the income is received, as it is very difficult to reclaim the excess tax afterwards in this market. The founding treaty of the European Union contains an express prohibition of national laws that restrict the free movement of capital between “Member States and Member States and third countries”. Over the past few years, this rule has been subject to numerous judgments of the European Court of Justice (ECJ), such that it now appears that the free movement of capital also applies to investors based outside the EU making portfolio investments into Europe. So far as taxation is concerned the ECJ has handed down judgments that clearly state that:
• The payment of a dividend is a movement of capital; • A withholding tax is a prohibited restriction where a resident recipient of the same dividend would not have suffered the same withholding.
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Custodians are also under increasing financial pressures and need to reduce costs where possible by making themselves as efficient as possible. However, it is very difficult for a custodian to be efficient on tax reclaim processing, as each country has different processes and various items of paper documentation that are required. Keeping up to date with all the latest changes in terms of tax legislation around the world is also a real challenge and requires specialist expertise and knowledge. Most foreign dividend withholding tax reclaims need two key pieces of evidence. The first is confirmation from the tax office that the investor is entitled to the payment at the reduced treaty rate. Countries that have forms for reclaims usually also need the original forms stamped by the tax office. Those that don’t have official forms may require a letter from the tax office. Investors are often required to submit documents, such as a certificate of tax residence and a lengthy treaty claim form, which are often www.thewma.co.uk
only available in the local language. Some countries even require a form for each dividend payment. A number of specialist companies have developed tax reclaim services over recent years to provide a broader service than the custodians are able to do. However, not all these providers have a service capability to provide a really global service. The key items an investor should consider when choosing a tax reclaim provider include: • Market Coverage – do they support tax reclaims in all markets where a reclaim is possible? • Relief at Source – do they support relief at source where this is possible? • Systems – do they produce the required documentation for all markets? • Data Sources – how do they access the latest tax data to keep up to date? • Documentation – will they work under a Power of Attorney? • Time Scales – will they work to an SLA in markets where this is appropriate?
• Client Web Portal – do they have a web portal to allow clients to monitor the service being provided? In summary research shows that more than with US$17bn of withholding tax remains unclaimed each year. Investors are adopting new and emerging markets, which require knowledge of the local tax rules, impacts and reclaim processes. Maximising dividend income is an important contributor to performance and making full use of tax reclaims has the potential to provide between 20 to 30 basis points of income for a typical global equity portfolio. Choosing the right outsource provider for tax reclaims will maximise the level of reclaims that a portfolio should receive, without it being too taxing in the level of effort required by the investor. Philip Keeler of Colwin Associates in partnership with WMA associate member, Goal Group Limited – contact goalemeasales@goalgroup.com or go to www.goalgroup.com for more information WMA JOURNAL
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