AGEFI Luxembourg - juillet / août 2022

Juillet / Août 2022 17 AGEFI Luxembourg Consultance By Eric CENTI, Tax Partner and Nenad ILIC, CFA, TaxDirector, Deloitte Tax&Consulting T he EuropeanCommission is currentlyworking on an in- teresting initiative that, if adopted, could significantly sim- plify thewithholding tax reclaim or relief at source procedureswhile reducing the risk ofwithholding tax fraud. The initiative aims to tackle a longstanding issue of excesswith- holding taxes on interest anddi- vidends sufferedby cross-border investors. While cross-border inves- torsmay be eligible for re- ducedwithholding tax rates under double tax treaties, froma practical perspective such reduced rates are difficult to achieve due to overly complex procedures and lack of standardiza- tion at EU level. What is the issue? When a cross-border investor makes an investment in securities in a member state, the dividends or in- terest heor she receives arenormally subject towith- holding tax in the country of the investment (i.e., source country). The withholding tax rate generally appliedisthedomesticratewhichisoftenhigherthan the rate agreed by that source country in its double tax treaties. Thismeans that an investor residing in a treatycountryisoftenentitledtorecoverexcesswith- holding tax by filing a reclaimwith the source coun- try’s tax authorities. The biggest challenge for investorswilling to recover withholdingtaxstemsfromthefactthatthetaxforms, supportingdocumentation,languages,proceduralre- quirements,andperiodsforsubmittingtheclaimsare differentforeachsourcecountry.Aninvestorholding shares of aGermanandaFrenchcompany (and thus receivingGermanandFrenchdividends)willneedto file two completely different sets of documents with the German and French tax authorities, respectively. In addition, the technical criteria the investors must satisfy to be considered eligible for the reduced rates alsodiffer.Thismeansthatinvestorsoftenneedtoap- point tax professionals to help them navigate com- plexities and effectively exercise their right to recover excesswithholding tax. TheECestimatedthetotalcostsofwithholdingtaxre- fund procedures at around €8.4 billion, which was mainly due to foregone tax relief, the costs of reclaim proceduresaswellasopportunitycosts. (1) Evenwhen reclaimprocedures are followed to the letter, tax au- thoritiesoftenneedseveralmonths,ifnotyears,topro- cess the claim and repay excess tax. Delays are essentially caused by a lack of digitalization as most countriesstillrequiretaxreclaimstobefiledonpaper. To be fair, some countries do offer the possibility to apply relief “at source”, in which case the reduced ratesareapplieduponincomepayment.Theinvestors receivethecorrectamountofnetdividendsorinterest, and they do not have to recover any excess tax a pos- teriori . While relief at source is certainly preferred to tax reclaims froman investor’s perspective, the same challenges outlined above persist. To apply relief at source,investorsstillneedtopreparecomplexpaper- workwhichvariesfromonememberstatetoanother. EuropeanCommission’s response andproposals The issues outlinedabove arenot newandhave long been identified as a barrier to a well-functioning EU capitalmarket.Alreadyin2001,itwasobserved (2) that although most of the Member States have bilateral treatiestoavoiddoubletaxation,therearenocommon procedures for claiming tax treaty benefits. In 2009, theEuropeanCommission(EC)acknowledged (3) that complex withholding tax procedures “hinder the functioning of the capital markets”. And in 2017, the EC issued a Code of Conduct on Withholding Tax (4) in which it expressed concern that burdensome with- holdingtaxprocedures“increasethecostofcross-bor- der trading and are a barrier to achieve a single Europeansecuritiesmarket.”Thesenon-binding rec- ommendationscalledforvoluntarycommitmentsby member states to address the issues, unfortunately with little success. In2020,theECtookamoreassertiveapproachbyan- nouncinglegislativemeasuresthatwouldbebinding formemberstates.First,aspartofitsTaxPackage (5) ,in which theECannounced that itwillworkonadirec- tive for a harmonized, EU-wide system for withholding tax relief at source and pre- vention of tax evasion through an ex- change of information mechanism between tax administrations. Then as part of the Capital Market Union (CMU) action plan (6) , which specifi- cally referred to alleviating tax obsta- cles to cross-border investments though a standardized system for relief at source. In 2021, the EC initiated the first step of the legislative process and issued an “inception im- pact assessment” which outlines the threemainoptionsitis consideringforsimpli- fying thewithholding tax relief procedures andpreventing tax fraud. Thefirstoptionreferstoharmo- nized tax reclaim procedures enablinginvestorstoreclaimwithholdingtaxbyfiling standardized forms. Under this option, investors would still be subject to excess taxation and face po- tentially long repayment delays. However, they would be able to file standardized tax reclaimdocu- ments, potentially electronically, regardless of the member state the income is sourced from. The second option refers to harmonized relief at source procedures that enable investors to submit a standardizedset of documents, potentiallyelectron- ically. Under this option, the reduced withholding tax rate would be appliedwhen the income is paid, and investors would not need to subsequently file tax reclaims. While the first twooptions aimat improving the ex- isting tax reclaim and relief at source procedures without reinventing them, the third option consti- tutes a completeparadigmshift throughnewmech- anismfortheapplicationofwithholdingtaxesacross the EU. This third option is strongly inspired by an OECDinitiativecalledTreatyReliefandCompliance Enhancement (TRACE) (7) that was formalized in 2013butneverreallyliveduptoitspotential.(During itsnineyearsofexistence,onlyonecountry–Finland –actually implementedTRACE).Under this option, afinancial institution throughwhich thedividendor interest is paidwould be able to become an “autho- rized intermediary” on behalf of member states’ tax authorities. In this way, the financial institutionwould be able to apply reduced withholding tax rates on income re- ceived by its clients and sourced from thesemember states. The reduced rates would be achieved “at source” with significantly less paperwork and in an almost automated fashion. The correct application of withholding tax rates and thepreventionof tax fraud would be ensured through annual reporting by the authorized intermediary to the tax authorities. Con- trolsbyindependentthird-partyreviewersmightalso be required. Referring to our previous example, any EU (and po- tentiallynon-EU)financialinstitutionactingasanau- thorized intermediary would be able to withhold French or German withholding tax, a task that was generally reserved to French andGermanwithhold- ingagentsonly.AninvestorholdingFrenchandGer- man securities on an account with that financial institutionwould be able to submit standardized tax documentation to the financial institution instead of filing claims with local tax authorities. The financial institutionwouldapplythecorrectratesdirectlyupon incomepaymentandwouldnolongerberequiredto forward its client’s tax documentation to the French or Germanwithholding agents or to file it with local tax authorities. Tocollectfeedbackontheseoptions,theEUlaunched a public consultation, ending in June 2022, that en- abled close to 1,700 respondents to share their view on the most appropriate relief mechanism. Needless to say, the feedback received was overwhelmingly positive. Respondents generally welcomed the EC’s proposalswithamajorityfavoringharmonizedrelief atsourceprocedures(includingthroughtheEU-wide implementation of TRACE) while acknowledging that harmonized tax reclaim procedures would still be required as a fall-back solution in case relief at source is not achievable. Theway forward ThisEU-wideharmonizationofwithholdingtaxpro- cedures ismore than 20 years in themaking. Despite this,theformationofanEUdirectivelooksmorelikely nowthanever.TheECplanstoadoptthedirectiveby the end of 2022, which is very ambitious considering thecomplexityoftheissueandtheEC’smyriadother initiatives.Investorsandfinancialintermediariesalike are encouraged to monitor these developments and anticipate potential impacts in the comingmonths. The one-off implementation costs and ongoing costs to ensure compliance with the new rules will be of particular importance to financial institutions that may become authorized intermediaries. Such costs shouldbeweighedagainst long-termbenefits associ- ated with the reduced administrative burden, in- creaseddigitalizationandimprovedclientservice.An objective cost-benefit analysiswill be fundamental in deciding on the best course of action once the text of the directive is released. 1) COM(2017) 147 final 2)Cross-borderclearingandsettlementarrangementsintheEuropean Union, Economic Papers N°163, 2002 3) 2009/784/EC 4) Code of Conduct onWithholding Tax, EuropeanUnion, 2017 5) COM(2020) 312 final 6) COM(2020) 590 final 7) TRACE implementation package for the adoption of theAuthorised Intermediary System, OECD, 2013 Toward a unified EU system to avoid double taxation and prevent withholding tax fraud - Organisme de formation agréé - Audit - Consulting - Mise à jour du package règlementaire - Assistance avec un Helpdesk Compliance - Mise en place d'un outil de digitalisation des obligations AML BLL Consulting vous accompagne sur toutes vos questions regulatory, de la formation, à l'outil en passant par la mise à jour de vos process interne. - AML - Due Diligences - KYC - Prévention de la corruption - RSE - Fraude