BEPS, FATCA, and codes of conduct… oh my!

The Yellow Brick Road to tax processing

by | April 3, 2018 | GlobeTax

Imagine a world where you have to walk a long and winding road of complex, interlinked informational requirements just to optimize tax. A world where failure to tackle those stringent demands in the right way could result in fines and lawsuits for abuse of treaty or tax arbitrage. In other words, imagine a world where the Yellow Brick Road does not lead to Emerald City. Unfortunately, financial intermediaries and investors don’t need to imagine it. It is already here.

Tax arbitrage, treaty shopping, and treaty abuse have inspired policymakers to design new bilateral and multilateral frameworks for detecting and preventing tax abuse, avoidance, and evasion. Initiatives including Base Erosion and Profit Shifting (BEPS), Foreign Account Tax Compliance Act (FATCA), Tax Relief and Compliance Enhancement (TRACE), and the EU Code of Conduct on Withholding Tax will, when fully implemented, introduce significant new requirements. Equally, these also represent an opportunity for specialists to develop standards and automation to shoulder some of the load.

While sensible in principle, these frameworks do have unintended consequences. They are complex and similar, but not the same. The intermediaries usually responsible for tax processing and recovery will have to adapt to a radically new landscape – a challenge considering existing compliance burdens and compressed profit margins. In the same way that institutional investors use intermediaries to manage the investment process, intermediaries themselves will increasingly need to partner with specialists to navigate these complexities.

Double taxation treaties: theory and practice

Double tax treaties (DTT) incentivize foreign investment. The country-by-country nature of these bilateral arrangements helps countries to agree who is eligible to receive entitlements under what circumstances, and change those permutations as needed to preclude abusive or evasive behavior.

Recent process changes in Belgium, Taiwan, and France illustrate this point. The Belgian Council of Ministers recently closed a loophole that enabled legal structures such as trusts and companies from countries considered tax havens to bypass withholding tax. By reclassifying trust income payments as deemed dividend distributions, the new legislation subjects such vehicles to a 30% withholding tax. Likewise, Taiwanese and French tax authorities both recently bolstered documentation requirements. The former now requires notarized beneficial owner letters; the latter now systematically requests a power of attorney to justify signatures.

While these moves might increase tax receipts, the systemwide consequences are less than ideal. The lack of global standardization encourages investors to “treaty shop” to find the jurisdiction with the most permissive standards. Moreover, divergent bilateral requirements make life difficult for investors and intermediaries who must navigate the regimes to recover over-withheld tax on global portfolios.

Correcting DTT shortfalls

Multinational bodies like the OECD and European Commission have long acknowledged the fragmented nature of the tax landscape, and have launched a number of initiatives to standardize requirements. Among the widest-reaching is the OECD’s BEPS project. Aiming to spearhead a new global standard for taxation, BEPS consists of sixteen articles governing every facet of cross-border taxation. Article 6 is particularly relevant. It deters “shopping” among withholding tax treaties by forcing investors to demonstrate an economic motivation for cross-border investment. To fast-track implementation, the multilateral instrument (MLI) in Article 15 automatically inserts BEPS principles into existing double taxation treaties. This mechanism allows countries to adopt standardized wording quickly without separately renegotiating each treaty, a process that could otherwise take years or decades.

Like the OECD, the European Commission is also advocating for multilateral tax reform. Acknowledging that the EU’s varying tax practices inhibit capital mobility, the body published the Code of Conduct on Withholding Tax in November 2017. The Code follows the work of Alberto Giovannini, the Fiscal Compliance group (FISCO) and the Tax Barriers Business Advisory Group (T-BAG), positing a range of approaches to improve efficiency. It strongly advocates for relief at source, providing solutions directed to the entire custody chain – tax authorities, intermediaries, and beneficial owners. The OECD has paralleled these efforts via TRACE, whose Implementation Protocol mirrors the principles of the European Commission T-BAG Report of 2013, and added operational detail like a standardized authorized intermediary agreement and a standardized and digital form of investor self-declaration (ISD).

Limits to standardization

While the OECD and EU initiatives both addressed some of the problems of fragmentation and complexity, the projects introduce new challenges for the intermediaries responsible for securing relief from over-withholding on investment portfolios. The OECD estimates that BEPS will change more than a thousand bilateral treaties within the coming year or two – that’s over 17% of all tax treaties. The alterations will force tax research functions to devote considerable resources to understanding the new models, ensuring they are consistent with existing operational practice, and changing procedures where necessary.

Similarly, although the Code of Conduct recommends moving toward relief at source, the document is non-binding and contains fewer actionable insights than the T-BAG report that preceded it. Rather than pursue a ‘Directive’ approach that forces Member States to comply, the code is voluntary and therefore lacks teeth. It does not deliver coherence because countries can (and will) adopt the recommendations piecemeal and at their own pace, contradicting, in part, the purpose of these initiatives for intermediaries who desire standardization as a means to boost efficiency and lower costs.

Coping with change

Because withholding tax recovery can offer upwards of 50 basis points of added return, intermediaries should be motivated to provide these services to investors. However, the logistical challenges involved – tracking tax rates, procedural changes, collecting beneficial owner documentation, identifying recovery opportunities, submitting claims, coordinating payments, and reporting – vex those tasked with service provision. The existing environment of depressed fees, budget cuts, ballooning expenses, risk management and compliance scrutiny only serves to make the situation that much more costly.

Intermediaries have a decision to make if they want to meet best practices, whether contractual or fiduciary. They can build, buy, near-shore, offshore, outsource or partner for a withholding tax solution. This is not a simple choice in an arena that is not “core” for most custodians. Buying off-the-shelf software or building a solution are both fraught with the problems of hiring, staffing, and training an entire department. The same types of limitations apply to near- and off-shoring to low cost jurisdictions, with the added challenges of geographic dispersion and cultural differences. The risk and liability associated with tax issues is not one of those that can easily be commoditized into a low-cost environment.

As such, many intermediaries choose to partner with external providers, gaining immediate access to specialized best-in-class technology and operational tax expertise without “reinventing the wheel”. Technological bridges like Application Programming Interfaces (APIs) mean that custodians can integrate outside technology into their own systems with minimal risk.

So, you may see lions and tigers and bears. You may also see BEPS, MLI and CoC, but none of these are bad things. They are challenges to be faced on the Yellow Brick Road, which after all, was an allegorical reference to the gold standard. Perhaps that’s the message here. Complexity is here to stay, but a gold standard for processing that complexity in an efficient way is what we’re all looking for.


Ross McGill has been the Managing Director of GlobeTax since 2003 and runs all GlobeTax’s offices outside the United States. Ross is a subject matter expert and frequent speaker on international withholding tax. McGill has authored nine books focusing on issues facing financial firms and institutional investors including technology management, standardisation and automation, global regulation, and withholding tax. Ross is also a member of several industry working groups including the International Capital Markets Services Association, ISO20022 Securities Evaluation Group, and the EU Tax Barriers Business Advisory Group.



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