FASTER: the European Commission’s proposal to improve withholding tax procedures
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The intention to introduce a “common, standardised, EU-wide system for withholding tax relief at source” was announced in the Capital Markets Union Action Plan published in 2020 and an initial consultation on this proposal was held from April 2021 to June 2022. However, this is not the first time that the Commission has tried to do something in this area. The proposal notes that the Commission has been looking at addressing inefficiencies and combatting fraud or abuse associated with WHT procedures for “decades”, including a recommendation in 2009 to simplify withholding tax procedures.
So what does this latest proposal involve? There are four main elements:
- The establishment of a common EU digital certificate of tax residence. The common digital tax residence certificate (eTRC) is a key factor in streamlining the WHT process. The eTRC must generally be issued within one working day of submission, and Member States will be required to provide an automated process for their issuance to ensure this timeline is feasible. In addition, the content of the eTRC is intended to be standardised and it should be both machine-readable and readable by humans. The eTRC must be recognised by other Member States as proof of residence of a taxpayer and would generally remain valid for the calendar year in which the request is made, although the eTRC can be challenged by the issuing Member State before the end of that period if it has evidence that the person is not resident in its jurisdiction.
- New streamlined procedures for withholding tax (WHT) relief at source and quicker refunds. The new fast-track procedures are intended to sit alongside existing procedures and would have to be applied in relation to publicly traded shares (non-listed equities are out of scope). Member States can also choose to apply the procedures to publicly traded bonds as well. Chapter III gives Member States the option between providing (i) relief at source from WHT, in which case the WHT rate that applies under the relevant double tax treaty is applied at the time the dividend or interest payment is made; or (ii) a quick refund system under which tax is withheld at the full domestic withholding rate but any excess tax paid must be refunded within 25 days from the date of the request or when the relevant report is made (as to which see below), which should be within 50 calendar days of the payment date. Member States can also opt for a combination of the two systems, but must have at least one in place available to all investors.
- New standardised reporting obligations. In order that tax administrations have the information they need to check eligibility for reduced WHT rates and to detect potential abuse, there will be new reporting obligations imposed on financial intermediaries who will have to report (within 25 days) information in relation to the dividend (or interest) payment, including information on the payor and payee, together with, in the case of equities, certain information intended to help identify abusive practices, including whether the shares were acquired within two days of the ex-dividend date or whether certain financial arrangements are in place in respect of such equities (and indeed the streamlined procedures must be switched off if this is the case). These new transparency requirements are, for tax authorities, one of the most significant aspects of the proposals and are seen as a crucial step in combatting abuse and schemes such as cum/ex and cum/cum.
- The establishment of National Registers. In order to benefit from the streamlined procedures, investors would have to contract with “certified financial intermediaries” or (CFIs). These are intermediaries that are registered on newly established national registers in Members States that levy relevant withholding taxes. For dividends, a Member State that provides relief for excess withholding tax, must establish such a register. Member States can choose whether they want to have a national register in relation to WHT on publicly traded bonds. Those financial intermediaries eligible to be CFIs are credit institutions (as defined in the Capital Requirements Regulation or CRR), investment firms (as defined in MIFID II) and central securities depositaries (within the Central Securities Depositories Regulation (CSDR)) or those providing comparable services in third countries. Registration is compulsory for large institutions (as defined in the CRR) that handle payments of dividends (and interest, where applicable) originating in their jurisdiction, and CSDs that provide WHT agent services, and voluntary for other financial intermediaries.
What does this mean for investors?
Speeded up WHT relief procedures can only be a good thing for investors (although it is worth noting that certain financial institutions such as dealers in derivatives may not be able to use these new procedures). In certain jurisdictions, obtaining WHT relief in recent years has become increasingly difficult in practice. Concerns around potential abuse and uncertainty around the true economic ownership of the securities have created a huge backlog in processing WHT applications, and in some cases this has resulted in delays of up to 3 or 4 years in processing applications and in others the process has effectively ground to a halt. The Commission estimates that the proposals will save investors around EUR 5.17bn a year in costs, through a combination of less double taxation, less compliance costs and the ability to reinvest funds that would otherwise still be tied up waiting to be refunded. Whilst more information potentially has to be provided by investors up front which will be available to tax authorities, those experiencing severe delays may well see the increased transparency as an acceptable price for obtaining relief in a timely fashion.
What does it mean for financial intermediaries?
The rules undoubtedly impose additional compliance burdens on CFIs. Not only will CFIs have to comply with the new registration requirements, but they will also have new reporting obligations (as set out above) which means setting up new processes and workflows, collecting more data, adapting systems to work with new standardised computerised forms. That said having a single form of certificate would be preferable to having to deal with different certificates from each jurisdiction in all their various guises. CFIs will also have to retain and provide access to supporting documentation for 5 years for audit purposes. The Commission estimates that financial intermediaries will face implementation costs of EUR 75.9 million and recurring costs of EUR 13 million.
The new due diligence requirements may also be cause for concern. Under the proposals, CFIs will have to obtain a declaration from the registered owner of the security that they are the beneficial owner. The CFI must then verify the eTRC and the declaration against other information that they already have eg from AML processes, as well as verifying the investor’s entitlement to the treaty WHT rate and whether there are any relevant financial arrangements outstanding at the ex-dividend date. Effectively, the onus for checking entitlement to treaty relief is being passed from tax authorities to financial intermediaries. CFIs will have to have adequate procedures in place to be able to do this and will no doubt be concerned by the proposal (in Article 16) that they may be liable to tax authorities for lost WHT revenues in relation to these new WHT processes.
Creating a simplified, standardised WHT relief and refund procedure is a laudable aim. In certain jurisdictions where the painpoints around obtaining treaty relief have not been as acute or who have already adopted domestic solutions, this may seem like overkill and the proposals may be seen as creating issues for a problem that has already been resolved. However, for others, the additional compliance burden may be a price worth paying for unlocking treaty relief that in practice has become virtually unobtainable. For now, the consultation on the proposal is open until 16 August 2023. Member States were consulted prior to the publication of the proposal and were in broad agreement on the need for EU action in this area and were in favour of an EU-wide digital tax residence certificate. However, only some Member States expressed support for the new reporting obligations and standardised procedures so it remains to be seen if there will be consensus on these proposals. There may well be changes to the proposals as it goes through the various stages of negotiation and through national implementation. If adopted and implemented as planned, the proposals would apply from 1 January 2027.