EC Recommends Simplifying Cross-Border Withholding Tax Relief

by Ulrika Lomas, Tax-News.com, Brussels

21 October 2009

The European Commission has adopted a recommendation that outlines how European Union member states could make it easier for investors resident in the EU to claim withholding tax relief on dividends, interest and other securities income received from other member states. The recommendation also suggests measures to eliminate the tax barriers that financial institutions face in their securities investment activities while at the same time protecting tax revenues against errors or fraud.

The recommendation is designed to provide guidance to member states in how to ensure that procedures to verify entitlement to tax relief do not hinder the functioning of the single market.

Internal Market and Services Commissioner McCreevy said: "If we are serious about promoting cross-border investments in securities in the internal market, EU member states will have to simplify their withholding tax relief procedures, so that foreign investors receive any tax refunds to which they are entitled more quickly and so that tax rules do not hinder financial institutions from getting involved in managing such cross-border investments."

Taxation and Customs Commissioner Kovács added: "While it is true that complicated refund procedures may discourage cross-border investment, member states must be allowed to have sufficient safeguards in place to protect their tax systems against errors and fraud. The recommendation contains solutions that are designed to balance these opposing concerns."

According to the Commission's announcement, the recommendation:

• encourages member states to apply at source rather than by refund any withholding tax relief applicable to securities income under double taxation treaties or domestic law;
• encourages member states to apply quick and standardized refund procedures where they cannot provide relief at source, for example because the investor has not provided all necessary information, and lists possible elements of such refund procedures;
• encourages member states to accept alternative proofs of investors' entitlement to tax relief besides certificates of residence;
• suggests how member states can involve financial intermediaries in making claims on behalf of investors and, in particular, how the procedures could operate where there is a chain of financial intermediaries, in different member states, between the issuer of the securities and a beneficiary;
• encourages greater acceptance by member states of electronic rather than paper information;
• suggests that member states could apply a risk-based approach to setting requirements of proof of entitlement to tax reliefs;
• suggests how member states could set up single or joint audits or even external audits to investigate the compliance of financial intermediaries with obligations created in line with the recommendation;
• suggests follow-up discussions with member states on the implementation of the recommendation; and
• encourages greater use of existing channels for exchange of information between member states and the exploration of new channels.

The tax laws of member states usually provide for withholding taxes on dividend and interest income paid to non-resident investors. These withholding taxes are often reduced under member states' bilateral double taxation conventions, when the two treaty partner countries involved agree on sharing taxing rights. In certain circumstances, some member states even unilaterally reduce withholding taxes or apply exemptions on securities income paid to foreign investors.

However, investors may forego the reliefs to which they are entitled or be discouraged from investing across borders because member states' procedures to verify claims for withholding tax reliefs are often complicated and time consuming – a situation that the Commission is now keen to remedy.

The EC also acknowledges that these procedures often do not take into account the present-day multi-tiered financial environment where there may be a chain of financial intermediaries, based in several countries, between the issuer of the securities and the investor. A study by the Commission shows that the costs related to these present reclaim procedures are an estimated EUR1.09bn annually, whereas the amount of foregone tax relief is estimated at EUR5.47bn annually.

According to the Commission, the amount of cross-border holdings within the EU was USD16.7 trillion in 2006, composed of USD6.4 trillion in equity securities and USD10.3 trillion in debt securities. The EU accounts for more than 50% of the worldwide amount of such holdings, both with respect to the origin and the destination of the investments.

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