Many Member States currently levy a withholding tax on dividends on shareholdings and interest on bond holdings paid to investors living abroad in the case of cross-border investments. However, investors must also pay income tax on the same income in their country of residence. According to the International Monetary Fund, securities held by foreign investors in the European Union were worth USD 10.7 trillion in 2019. In order to avoid double taxation, many countries have agreed to split taxation rights between source and residence countries by signing double taxation treaties. These treaties may entitle non-resident investors to a lower rate of withholding tax or to exemption from tax in the country, where it is levied.

The problem is that these refund procedures are often lengthy, costly and cumbersome, frustrating investors and discouraging cross-border investment within and into the EU. Currently, withholding tax procedures vary widely between individual Member States. Investors have to deal with more than 450 different forms across the EU, most of which are only available in national languages. The Cum/Ex and Cum/Cum scandals have also shown how tax refund procedures can be abused: the tax losses caused due to these practices have been estimated at EUR 150 billion for the years 2000-2020.

What has the European Commission proposed?

The key measures proposed on 19 June 2023 will make life easier for investors, financial intermediaries and national tax authorities and are as follows:

A common digital certificate of tax residence in the EU will speed up and streamline withholding tax exemption procedures. For example, investors with a diversified portfolio in the EU will only need one digital tax residence certificate to claim multiple tax refunds in the same calendar year. The digital tax residency certificate should be issued within one working day of the application. Currently, most Member States still rely on paper-based procedures.

Two fast-track procedures to complement the existing standard refund procedure: the “exemption at source” procedure and the “fast refund” system, which will make the refund process faster and more harmonised across the EU. Member States will be able to choose, which one to use – including a combination of the two.

• Under the “exemption at source” procedure, the tax rate applied at the time of payment of dividends or interest is based directly on the applicable rules of the double tax treaty provisions.
• Under the ‘fast refund’ procedure, the initial payment is made at the withholding tax rate of the Member State, in which the dividends or interest are paid, but any overpayment of tax is refunded within 50 days of the date of payment.

These standardised procedures are estimated to save investors around EUR 5.17 billion per year.

The standardised reporting obligation will provide national tax administrations with the tools necessary to check eligibility for the reduced rate and to detect possible abuse. Certified financial intermediaries will have to report dividend or interest payments to the relevant tax authority so that it can trace the transaction. In particular, large financial intermediaries in the EU will have to join a national register of certified financial intermediaries. The register will also be open to non-EU financial intermediaries and smaller EU financial intermediaries on a voluntary basis.  Taxpayers who invest in the EU through certified financial intermediaries will benefit from accelerated withholding tax procedures and avoid double taxation of dividend payments. The more financial intermediaries register, the easier it will be for the tax authorities to process refund claims, regardless of the procedure used.

What will be the benefit to investors?

The new resident certificate will allow investors to submit withholding tax refund claims digitally, making the refund process faster and simpler. Only one digital tax residence certificate will be needed to claim multiple refunds in a calendar year, thus avoiding the need for multiple tax residence certificates for an investor with a diversified portfolio in the EU.

Overall, the new withholding tax framework will give investors access to fast-track procedures, secure the tax rights, to which they are entitled, and avoid double taxation.

How will this benefit national tax authorities?

European tax authorities lose significant amounts of money every year due to withholding tax abuse.

The new reporting obligations will mean that the tax authorities will have full visibility of the financial chain to check whether investors qualify for reduced rates and to ensure that withholding tax refunds are correctly granted, thus combating tax abuse.

Will this place an additional burden on financial intermediaries?

The digitisation of tax residence certificates and standardisation of reporting obligations and refund claims would enable financial intermediaries to automate their processes, saving time and money. This would speed up the refund process and at the same time increase the security of tax withholding procedures.

How will the Commission ensure that financial intermediaries have due diligence procedures in place?

Under the proposal, Member States will require certified financial intermediaries to have adequate procedures in place to ensure that taxpayers are entitled to a refund. Certified financial intermediaries will collect electronic confirmation of the taxpayer’s tax domicile or relevant proof of residence in a non-EU country and verify this information in their own records. They will also need to collect a declaration that the taxpayer is the beneficial owner of the security and has not engaged in any financial arrangement that involves the payment of dividends or interest on the underlying securities.

Once adopted by Member States, the proposal should enter into force on 1 January 2027.

Source: https://taxation-customs.ec.europa.eu/taxation-1/corporate-taxation/faster-initiative_en

Author: Jiří Zoubek