A plan that could provide cross-border investors in the European Union with annual gains worth more than eight billion euro has moved a step closer to becoming reality in 2030. EU finance ministers on Tuesday signed off on a major overhaul of administrative procedures to recover dividend taxes unduly withheld on cross-border investments.
The plan is drawing mixed reviews. Industry representatives are pleased with the agreement and expect it will promote cross-border investment as the current system is not fit for purpose. Representatives of retail investors are more critical, pointing out that it may be difficult to qualify for certification, while the costs of reclaims remain high.
For European investors, it is still easier to recover withholding taxes paid on investments in Switzerland and the United States than in other EU countries. A study published last year showed that 31% of European retail investors sold their foreign EU shares because it is too difficult to reclaim withholding taxes.
Double taxation
The new measures, tabled in Brussels a year ago, seek to end a common practice across the EU where many member states levy taxes on dividends paid on shares and interest paid on bonds to investors who live abroad. At the same time, those investors have to pay income tax in their country of residence on the same income.
Various bilateral agreements exist between member states to solve the issue of double taxation, but procedures to reclaim often are complex and vary from one member state to another. As a result, refund procedures are lengthy, costly and cumbersome, and can also be vulnerable to large-scale tax fraud.
“Aligning our tax relief procedures is essential if we want to improve the functioning of the capital markets union,” said Vincent van Peteghem, finance minister of Belgium, which currently holds the rotating EU presidency, at a press conference. “It will make investing in other countries easier and hopefully encourage retail investors in particular to invest in European financial markets, which will eventually benefit the whole economy.”
Digital residence certificate
The package ministers adopted on Tuesday includes two major components. First, a common digital residence certificate will be introduced to make withholding tax relief procedures faster and more efficient. Investors with a diversified EU portfolio will only need one single certificate to reclaim refunds from several countries.
The certificate will be digital and should be issued within one working day after it has been requested. It will replace paper-based procedures currently in place in most member states.
Secondly, two types of fast-track procedures will complement the existing standard refund procedure: a “relief at source” procedure and a “quick refund” system. This has been designed to make the relief process faster and more harmonised across the EU. Only with a digital certificate, investors can reclaim withholding taxes more swiftly. EU member states will be allowed to opt for one of these two procedures or to embrace both.
Concentration risk
Martin Molko, policy officer at investor interest group Better Finance in Brussels, acknowledged digitalization via the adoption of the an e-tax residence certificate (eTRC) as “a positive step” but highlighted several challenges.
He noted that while the new quick refund system - QRS - and relief at source procedure - RAS - might streamline withholding tax recovery, requiring certification of certain financial intermediaries may favour ‘market concentration’ – potentially excluding retail investors who don’t use such firms. Additionally, while economies of scale are anticipated, it is uncertain lower reclaim costs will be passed on retail investors. In many instances investors may still have to resort to the traditional refund process, which proved cumbersome and often inefficient.
Following Tuesday’s decision by minister in Brussels and last month’s green light at the European Parliament, a number of formal follow-up steps such as implementing acts, national legislations and administrative guidance will need to be prepared and adopted by 31 December 2028 for the new system to take effect in 2030. “It’s a very slow process, as is always the case in tax matters,” Molko said.
The Alternative Investment Management Association (Aima) called the adoption an “encouraging move towards a better functioning withholding tax system”. “We hope it is just the first step towards a fully-fledged withholding tax system, which will go a long way towards completing the capital markets union. We will continue to engage with policymakers as the new EU legislative cycle begins and encourage them to adopt more ambitious measures in this space,” Aima CEO Jack Inglis said.
Asset management industry group Efama called the agreement a “significant step forward” to remove existing tax barriers to the capital markets union, and “to improve inefficient and burdensome tax procedures which dis-incentivise cross-border investing”.
A 2021 survey by the European Central Bank showed that withholding tax relief procedures remain largely a paper-based process across the EU, requiring physical documents, wet-ink signatures, and physical interaction. This is a cumbersome and time-consuming process which discourages cross-border investment.
Obstacle course
Luxembourg only exempts professional investors if they are “corporate” shareholders resident in one of 86 countries that have a tax treaty with the grand duchy and which hold a stake of at least 10 percent in their Luxembourg company for at least 12 months. This applies mostly to Sicav and FCP investment funds. Luxembourg has such tax treaties with only 11 of the 27 EU member states, including France, Germany and Belgium.
Luxembourg insurance industry group ACA has said encouraging cross-border investment and simplification of taxes should be a priority for the EU. “Nowadays, too often, the process to claim a refund looks more like an obstacle course than a legitimate right,” ACA responded earlier in a EU consultation.
(This article has been updated to correct the name of Martin Molko.)