At the best of times, the process of obtaining tax relief on overseas investments is a cumbersome, costly and time-consuming administrative process. The COVID-19 crisis has brought it to a juddering halt. The problem primarily arises from the challenges of moving the paper documentation – including physical documents with wet ink signatures – needed to obtain tax relief. This, combined with the slowdown or cessation of production of required documents (such as certificates of residence) and information due to changed working arrangements in government offices and other organisations, has led to an inevitable backlog of claims.
The investment industry has long been encouraging tax authorities towards a more standardised and digitised process, but with limited success. The lockdowns and disruptions across many countries because of COVID-19 could be a catalyst for smoothing the process.
Withholding taxes are a significant barrier to cross-border investment. While, for example, a pension fund may be exempt from taxation in its home country, the income and gains from investments abroad may not be exempt from the source country withholding tax.
There are treaties in place between many countries, allowing for overseas tax relief, but there are substantial administrative burdens for institutional investors in securing the tax relief to which they are legally entitled. Indeed, the outcome is often the loss of tax relief, with the tax leakage having a significant impact on returns, as well as undermining the objectives of treaties to reduce disincentives to cross-border investment. Where tax relief is surrendered, the tax burden shifts from the investment country’s tax authority to the investor’s home country tax authority.
At the core of these administrative barriers is a reluctance by many tax authorities to embrace digital processes. Tax authorities appear unwilling to accept electronic or digital signatures and continue to require physical documents when dealing with any withholding tax relief requests, meaning a full move towards complete digital reclaim filing cannot be achieved. It is this requirement for physical documents that has made the practicalities of obtaining tax relief almost impossible under the COVID-19 lockdown.
While some tax authorities are moving towards digitalisation – the Netherlands appears to be making the most headway – there is slow or non-existent progress elsewhere. The full benefits of digitisation will only come with greater acceptance that physical documents can be replaced by the use of advances in technology to transmit tax relief information electronically. For example, replacing the myriad of tax forms with a requirement of submitting the customer tax date to determine tax relief would provide realistic solutions to a real problem.
There are more than 100 different forms for claiming tax relief across the European Union alone. Investors are confused by which forms to complete while intermediaries incur costs associated with checking that forms are correct and ensuring they do not conflict with other information held about account holders. The result is that tax authorities are in receipt of numerous errant forms, thereby clogging up the review and refund process. This system blockage will increase leading to further challenges for an already challenged system.
Digitisation is not the solution to this week’s or this month’s withholding tax problems. Indeed, withholding tax is unlikely to be high on the priority list for many institutional investors or tax authorities right now. However, the COVID-19 disruption may increase pressure on tax authorities and regulators to accelerate moves towards digitisation and harmonisation.
One key learning from the crisis is the value of digitalisation and automation processes. The seamless transmission of data via solutions that are interoperable, standardised, global and available to all parties would have enabled this important – but often overlooked – part of the financial system to keep functioning at near to normal levels. Then, in more ‘normal’ times, it would clearly improve refunding times, help increase governance and enable tax authorities to focus their resources on real areas of concern.
Mariano Giralt is global head of tax and regulatory and Lorraine White is global head of securities tax and client solutions at BNY Mellon. The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon.
