New proposal for a Directive to improve withholding tax relief procedures

September 2023 | SPOTLIGHT | CORPORATE TAX

Financier Worldwide Magazine

September 2023 Issue

On 19 June 2023, the European Commission (EC) published the Proposal for a Council Directive on Faster and Safer Relief of Excess Withholding Taxes, with the aim of making excess withholding tax (WHT) relief procedures at European Union (EU) level more efficient and safer for investors, financial intermediaries and member states’ tax administrations. The proposal also intends to prevent abusive and fraudulent WHT practices such as the ‘cum-cum’ or ‘cum-ex’ schemes.

To achieve these goals, the proposal provides for two different procedures for excess WHT relief, a ‘relief at source’ procedure and a ‘quick refund’ procedure, in relation to WHTs on dividend and interest payments derived from listed securities, as well as a set of reporting obligations and due diligence duties for certain financial intermediaries. The information provided by such financial intermediaries will allow tax administrations to be certain about who the beneficial owner of the dividends or interest concerned is and, consequently, to know whether the recipient of them – the registered owner – is entitled to the reduced WHT rate provided for in the applicable double tax treaty or specific national legislation or to the corresponding exemption.

Current situation

At present, there are significant differences between member states in terms of the procedure to be followed to obtain a refund of excess WHT paid and the duration of this process. Existing procedures are diverse, costly, lengthy, burdensome and time consuming, as, among other circumstances, most member states still rely on paper-based procedures. In addition, current procedures result in taxpayers having their refund claims refused for different administrative reasons.

This situation creates a barrier to cross-border investments in the EU and within EU capital markets. It also increases the risk of tax avoidance and tax fraud.

Key actions proposed

To streamline the WHT relief process and improve refund procedures, the new proposal puts forth several actions.

The first action is to introduce an EU digital tax residence certificate. This should be issued within one working day after the submission of a request online and will be valid for the calendar year in which it is requested.

Member states would recognise an EU digital tax residence certificate issued by another member state as adequate proof of residence for the taxpayer in that other member state. This certificate will enable multiple refunds to be carried out in different member states. Investors with a diversified portfolio in the EU will only need one digital tax residence certificate to reclaim several refunds during the same calendar year, which will contribute to a faster, more efficient excess WHT relief procedure.

The content of the EU digital certificate is intended to be standardised and must include the requesting taxpayer’s identification and confirmation of tax residency in the corresponding member state according to its national legislation.

The second action is to introduce two standardised fast-track procedures complementing the existing standard refund procedure. The proposal provides for a ‘relief at source’ procedure and a ‘quick refund’ procedure, which will make the excess WHT relief process faster and more harmonised across the EU. Member states will be able to choose which one to use, including a combination of both.

Under the ‘relief at source’ procedure, the tax rate, including the exemptions, applied by the WHT agent when paying dividends or interest will be directly based on applicable rules under double tax treaty provisions or specific domestic legislation on preventing double taxation.

Under the ‘quick refund’ procedure, the initial payment will be made considering the WHT rate of the source member state (the member state where the issuer of the security paying dividend or interest resides), but the refund of the excess tax paid must be made within 50 days from the date of payment.

Member states will be able to use a combination of both procedures. For example, they may allow the ‘relief at source’ procedure only for low-risk investors, while the rest must apply the ‘quick refund’ procedure.

Standardised reporting obligations and due diligence duties

To benefit from standardised WHT relief procedures, investors must engage with financial intermediaries certified to provide those services, known as certified financial intermediaries (CFIs).

Large EU financial institutions, including credit institutions and investment firms, that handle dividend payments from publicly traded shares, as well as central securities depositories that provide WHT agent services for dividend payments, will qualify as CFIs and be required to join the corresponding national register of CFIs. Member states can also opt to use the national register in relation to interest payments from publicly traded bonds.

CFIs will have to report dividend or interest payments to the relevant competent authority so that it can trace the transaction. However, a de minimis rule would introduce an exemption from reporting obligations for dividends paid to the registered owner for each group of identical shares held below a threshold of €1000.

Each CFI will report only on the part of the transaction that is visible to it. In other words, each CFI will report from whom it is receiving the dividend or interest payments and to whom it is paying them. Thus, the authority that receives the full report will have all the information needed to reconstruct the financial chain of the transaction from investor to securities issuer.

Furthermore, CFIs must obtain a declaration from the registered owner of the security that it is the beneficial owner of the dividend or interest as defined under the national legislation of the source member state. They must also verify whether the registered owner is entitled to apply the reduced WHT rate or the exemption provided for in the applicable double tax treaty or specific national legislation, and whether there is any financial arrangement in place (since financial arrangements can be used to shift the economic ownership, in whole or in part, of a security). However, to ensure a proportionate approach, reporting on this information should only be required by those CFIs that, due to their position within the chain, may have been directly involved in the relevant financial arrangement.

The proposal defines a financial arrangement, in very broad terms, as any arrangement or contractual obligation whereby any part of the ownership of the publicly traded share, on which a dividend is paid, is or could be, either permanently or temporarily transferred to another party. A financial arrangement may be, for example, a repurchase agreement (repo) or securities loan but also a derivatives product such as single stock futures. The reason for such a broad definition is to allow comprise on different types of arrangements.

Reporting on the possible existence of any financial arrangement is not required in the case of bonds or interest payments. In addition, the de minimis rule exempts CFIs from due diligence obligations.

In short, these standardised reporting obligations and due diligence duties will provide national tax authorities with the tools to check eligibility for the reduced WHT rate or the corresponding exemption and to detect potential abusive WHT schemes.

The establishment of national registers

Member states must establish a national and public register of CFIs to be updated monthly.

Large EU financial institutions and central securities depositories that provide WHT agent services are required to be registered with those member states in which securities issuers are located and where any of their clients have invested.

These national registers will also be open to non-EU and smaller EU financial intermediaries but on a voluntary basis.

Exclusions to using the standardised WHT relief procedures

To prevent WHT abuse, member states will not provide WHT relief under either of the two harmonised procedures if the dividend has been paid on a publicly traded share that the registered owner acquired within a period of two days before the ex-dividend date or if the dividend payment on the underlying security for which relief is requested is linked to a financial arrangement that has not been settled, expired or otherwise terminated at the ex-dividend date.

For these cases, the existing national refund procedure will be available.

Entry into force

The proposal is open for public discussion until 14 August 2023. Depending on the public input received, there could be changes to the content of the proposal.

Further, it remains to be seen whether the unanimity required for its adoption will be reached among all member states.

If the directive is eventually adopted by member states, they will have until 31 December 2026 to transpose it into their national legislation, entering into force on 1 January 2027.

Final remarks

This proposal is undoubtedly a major step forward in streamlining excess WHT refunds. However, the assessment of the proposal may be different for investors than for CFIs. For investors, the proposal is clearly positive, even though it may imply having to provide more information, as they will see a faster, simpler claims process, with a higher chance of receiving the requested refund. However, for CFIs, it is not as positive. The proposal imposes more burdens on CFIs, such as compulsory registration, reporting obligations and due diligence duties, with greater liability for having to verify both that the investor is eligible to benefit from lower WHT rates or a possible exemption, and that no financial arrangement exists.

In any case, the EC’s proposal is a long awaited, welcome initiative that will encourage investment in the EU capital markets by allowing investors to effectively obtain refunds and exemptions to which they are entitled. However, as currently drafted, the proposal will create uncertainty for CFIs forced to make a legal interpretation of the terms ‘beneficial owner’ and ‘financial arrangement’ to properly fulfil their reporting and due diligence duties.

Eduardo Gracia is a partner and Lorena Viñas is a senior expertise lawyer at Ashurst. Mr Gracia can be contacted on +34 91 364 9854 or by email: eduardo.gracia@ashurst.com. Ms Viñas can be contacted on +34 91 364 9417 or by email: lorena.vinas@ashurst.com.

Eduardo Gracia and Lorena Viñas

Ashurst