Developing a relief at source gold standard

By Len Lipton | 13 October 2017

As Greek mythology tells it, King Midas was granted one wish: to have everything he touched turn to gold. Although the results were mixed – gold looks better than it tastes, it seems – the metal’s allure nonetheless pervades to this day. Gold remains shorthand to represent the highest ideal of excellence, not to mention the investment of choice in difficult times.

When it comes to recovering over-withheld taxes on international investment income, relief at source is, without question, the gold standard. Simply put, it is the fastest way to recover client money that would otherwise be over-taxed. Unfortunately, the relief at source process is complex, time-consuming, and expensive. Although financial institutions acknowledge relief at source is a best practice, they often cannot deliver the service. Already contending with cost-cutting pressures, they lack the resources to navigate complex fund/omnibus account structures and apply ever-changing tax treaties and documentation requirements within abbreviated time horizons. As a result, governments pocket billions of dollars of over-withheld tax each year, money which rightfully belongs to global investors.

To remedy this imbalance and provide relief at source more widely, financial institutions must have a way to ‘look through’ omnibus accounts to identify beneficial owners. They then must develop processes to manage continual document and rule changes. Simultaneously, the remaining links in the custody chain must devise a standardized and automated way to exchange tax data and documentation– all within the exacting tax relief election deadlines.

Efficiently and cost-effectively managing global relief at source is not easy. We believe it is impossible without a groundbreaking new technological platform. Below, we envision several crucial elements involved in such an integrated solution.

Omnibus accounts

Navigating the chain of financial institutions and layered fund structures to identify the ultimate beneficial owner represents one of the key challenges of withholding tax recovery. Tax authorities – who are concerned with fighting fraud, treaty abuse, and tax evasion – increasingly insist on transparency to confirm that entitlements are only being granted to the proper recipients. Market participants, however, are incentivized to layer account or fund structures, obscuring the ultimate beneficial owner. For instance, custodians use omnibus accounts to commingle the holdings of multiple clients, given the expense of opening and maintaining separated accounts for each beneficial owner. Likewise, fund managers often structure investment vehicles as pass-throughs or ‘disregarded entities’, a process that also blurs beneficial owner identity.

Unfortunately, most intermediaries along the custody chain cannot provide transparency. Global custodians lack the resources to uncover and disclose underlying owners in the brief election/instruction windows required for relief at source. Compounding matters, withholding agents are often not only unable to process relief at source for layered fund vehicles, they are sometimes unwilling. After all, they are liable for any tax benefit granted to non-resident customers. Because of these conflicting incentives, both omnibus account holders and fund managers are increasingly deprived of relief at source benefits. Tax authorities and intermediaries simply lack an effective method for verifying ultimate beneficial owners within pass-through accounts.

As such, any technological solution to the relief at source conundrum must first and foremost address the friction surrounding end customer documentation. It must afford financial institutions the wherewithal to gather and store data and documentation from underlying owners in omnibus accounts and fund vehicles. Why is solving the pass-through problem so crucial? Account holders would not only secure previously-inaccessible treaty entitlements, they would also save money by obviating the need for expensive and duplicate segregated accounts in local markets. Similarly, they would avoid the arduous process of filing for a standard refund. To be sure, financial institutions and custodians would benefit as well. Not only would they fulfill fiduciary responsibilities to key clients like pension funds, they would also enjoy new operational efficiencies that deliver additional value to clients—a crucial competitive advantage.  

Rules and document management

Identifying beneficial owners is but one piece of the tax recovery puzzle. The next challenge involves understanding which treaties are applicable and whether the necessary documentation has been submitted to agent banks in all relevant jurisdictions. For omnibus accounts, this reconciliation is typically manual and labor intensive. Each time an event is declared, market players must quickly determine beneficial owner eligibility and lodge instructions to one or more parties in the custody chain – whether it’s the CSD/global custodian, sub custodian, withholding agent, or tax authority. Distributing instruction and supplemental documentation for each client, for every dividend event, in every jurisdiction, is difficult to manage efficiently, to say the least.

The ideal relief at source solution would programmatically identify who is entitled to what benefits for every dividend event—all within the short deadlines necessary for relief at source. Robust rules and document management systems would form the basis of this platform. A rules system would collate and store continually updated information about global taxation treaties, protocols, domestic laws, and the evidentiary requirements of local sub-custodians. A document management system would work in concert, storing and tracking all client documentation and renewal deadlines for all relevant jurisdictions.   

Given the volume of data and paperwork, algorithms would be employed to instantly parse the information and determine the most favorable tax rate based on event type, beneficial owner domicile, entity classification, and documentation status. Because financial institutions and beneficial owners seek transparency over the tax recovery process, a user-friendly dashboard could be implemented for oversight. It would enable users to track the real-time progress of each claim, view documentation status, and receive notification of upcoming events and payments. To be sure, designing an integrated database network that automatically responds to the fast-changing tax recovery landscape is not easy. However, it is impossible to deliver effective, transparent, and regulator-approved relief at source without such features.

King Midas 2.0

In the current era of high speed global finance, having the “Midas Touch” no longer signifies transforming earthly objects into gold. Rather, today’s fintech alchemists deliver value by digitizing paperwork, tax law, and administrative practice, and subsequently standardizing their processing.

Given the requirements to administer relief at source across a labyrinthine global client base, it is no surprise that existing attempts at tax relief alchemy have fallen short. Nonetheless, a comprehensive solution is desperately needed. The standard refund process has become increasingly difficult and costly as tax authorities work to combat tax evasion, fraud, and sophisticated arbitrage transactions. Despite this complexity and rising dividend tax rates, investors are not dissuaded. Their appetites for global investment options only continue to grow.

We believe an automated technological platform for managing relief at source is not just the best solution:  it is the only solution. If implemented across the custody chain, more financial institution clients could access relief at source for more securities in more markets, improving portfolio performance for a vast number of global investors. Likewise, financial institutions would gain operational advantages, reducing the risk and cost that surrounds the current administration of tax relief services. King Midas 2.0 would surely covet this new gold standard.

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