European Union: The FASTER EU Directive Proposal: Real Simplification Of Withholding Tax Refund Procedures Or Just New Additional Reporting And Due Diligence Obligations For Financial Intermediaries?

OUR INSIGHTS AT A GLANCE

• On Monday 19 June 2023, the European Commission published the Proposal for a Council Directive on Faster and Safer Relief of Excess Withholding Taxes, i.e. FASTER, in order to tackle the current particularly burdensome withholding tax refund procedures for cross-border investors in the EU and, at the same time, the risks of tax abuse related to refund procedures.
• The Proposal aims at creating EU digital tax residence certificates that should ease the withholding tax refund procedures.
• Standardised reporting obligations will also be introduced for certified financial intermediaries in order to provide national tax administrations with the necessary tools to check eligibility for the reduced rate and to detect potential abuse.
• A relief at source system and a quick refund system will be introduced as two fast-track procedures complementing the existing standard refund procedure to relieve any excess withholding tax that can be withheld by a Member State on dividend or interest income paid on shares or bonds traded publicly to non-resident investors. The new systems of relief will be assorted with new due diligence obligations for certified financial intermediaries.
• We describe hereafter the implications and downsides of the Proposal.

On Monday 19 June 2023, the European Commission published the Proposal for a Council Directive on Faster and Safer Relief of Excess Withholding Taxes (hereafter "FASTER" or "the Proposal"). With this new initiative, the Commission aims to tackle the current particularly burdensome withholding tax refund procedures - which differ amongst Member States - for cross-border portfolio investors in the EU and, at the same time, the risks of tax abuse related to refund procedures revealed notably by the Cum/Ex and Cum/Cum scandals.

This Proposal aims at creating:

• EU digital tax residence certificates;
• Standardised reporting obligations for financial intermediaries to provide national tax administrations with the necessary tools to check eligibility for the reduced rate and to detect potential abuse; and
• Two fast-track procedures, assorted with new due diligence obligations, complementing the existing standard refund procedure to relieve any excess withholding tax that can be withheld by a Member State on dividend or interest income paid on shares or bonds traded publicly to non-resident investors.

We describe hereafter the implications of the Proposal.

EU digital tax residence certificate

A common EU digital tax residence certificate ("eTRC") is to be introduced by all Member States in order, mainly, to streamline WHT procedures. It will identify the recipient of a payment subject to WHT (dividend or interest) and confirm its tax residency according to the relevant Member State's national rules¹.

Nonetheless, the eTRC will be available to all persons that are resident for tax purposes in a Member State and the eTRC can be used to serve purposes other than relief of withholding tax under this Proposal. Indeed, the Proposal allows Member States to add onto the issued eTRC any additional information that may be relevant to serve purposes other than relief of withholding tax under this Proposal, or information required to be included in a tax residence certificate under EU law.

Provided that no exceptional circumstances occur justifying a delay, Member States will be required to issue an eTRC within one working day. To meet this requirement, a fully automated system to issue the eTRC should be implemented by Member States which allows for requests via an online portal accessible to taxpayers and parties authorised thereby (e.g. financial intermediaries requesting the eTRC on behalf of their clients).

Member States shall recognise the eTRC as adequate proof of residence of the recipient of an income in another Member State. According to the Proposal, the eTRC should cover at least a full calendar year - but could also cover a longer period depending on the concept of tax residence and internal decision of each Member State. Nevertheless, if the circumstances at the end of the year do not support the content of the eTRC issued during that year, such eTRC can be deemed not valid by the issuing Member State and any other Member State concerned.

Member States' National Registers

Member States will have to establish a national register ("National Register") of Certified Financial Intermediary ("CFI"). A Certified Financial Intermediary is a financial intermediary which meets the requirements of relevant EU regulations and is supervised for compliance therewith.

All large institutions as defined in the Capital Requirements Regulation (i.e. credit institutions and investment firms) that perform custodial activities and, in this context, handle payments of dividends from publicly traded shares originating in their jurisdictions to Registered Owners who are resident for tax purposes outside that Member State, as well as central securities depositories that provide withholding tax agent services for the same payments, will have to register, as CFI, with their National Register. However, Member States can also opt to use the National Register in relation to payments of interest from publicly traded bonds. Payments in relation to non-publicly traded shares or bonds are not in the scope of the Proposal.

The Proposal also aims at tracing payment flows until the final investors through the chain of financial intermediaries, and therefore defines certain reporting and due diligence obligations regarding Registered Owners. "Registered Owner" means any natural or legal person that is entitled to receive dividend or interest income from securities subject to tax withheld at source in a Member State.

Non-EU and smaller EU financial intermediaries may join the National Register on a voluntary basis. In this regard, it is expected that registration should be with the Member States their clients have investments in. Non-EU financial intermediaries can, however, not be certified if they are located in a jurisdiction listed on the EU list of non-cooperative jurisdictions for tax purposes or on table I of the Annex to Delegated Regulation (EU) 2016/1675 identifying high-risk third countries with strategic deficiencies.

Financial intermediaries that do not comply with registration requirements may be subject to penalties. In addition, only Registered Owners engaged with financial intermediaries that are certified to provide those services will benefit from the systems of relief described in the Proposal.

Obligations of CFIs

Standardised reporting obligation

CFIs will have to report a relevant set of information to the competent authority within specific timelines. For that purpose, the Proposal lays down a common set of reporting elements in Annex II, providing national tax administrations with the necessary tools to check eligibility for the reduced rate and to detect potential abuse. Nevertheless, information regarding application of anti-abuse measures described in Heading E of Annex II (i.e. information about the holding period of underlying securities and information about Financial Arrangements linked to the securities for which the taxpayer is requesting relief) does not need to be reported when the total dividend paid does not exceed EUR 1000 or if the information relates to interest payments.

Each CFI will have to report only on the part of the transaction that is visible for it, i.e. from whom it is receiving the dividend/interest and to whom it is paying the dividend/ interest. Thus, national tax administration will have all the information needed to reconstruct the financial chain of the transaction from the investor to the securities' issuer. The information required should be limited to information that is crucial for the tracing and identification of the chain of intermediaries and hence of the income flow from the issuer of the security until the final recipient, i.e. the sole investor or Registered Owner, and therefore useful to prevent risk of fraud or abuse, to the extent that such information is available to the reporting intermediary.

The reporting will take place via a standardised XML format scheme. The timeline to report the information comprised in Annex II is 25 days² at the latest from the record date, which is the date at which the issuer of a security checks its records to identify securityholders eligible for a dividend or interest payout.

Financial intermediaries that are not under an obligation to register as a CFI and have not opted to register as such, do not have reporting obligations under this Proposal. Nevertheless, information on the payments handled by such intermediaries that are not CFIs remains relevant and may be considered necessary by a Member State, at its discretion, to ensure transparency and to allow for the proper reconstruction of the payment chain before applying the relief procedures set out in this Directive (relief at source or quick refund). Therefore, Member States may request that CFIs obtain this information from such non-CFI and report accordingly for the relief procedures laid out in this Directive to be applicable.

CFIs that do not comply with registration requirements may be subject to penalties.

Request of systems of relief by CFIs

The Proposal allows Member States to choose between (or to combine both) two fast-track procedures complementing the existing standard refund procedure: a quick refund system (Option 1) and/or a relief at source system (Option 2).

Taking into account the different approaches in Member States, two types of procedures are envisaged: (i) relief at source by direct application of the appropriate tax rate at the time of withholding and (ii) quick refund within a maximum of 50 days of the date of payment of the dividend or, as the case may be, of the date when the bond issuer has to pay interest to the bond holder (coupon date).

No matter the option chosen, a CFI maintaining the investment account of a Registered Owner will request the benefit of the system of relief, on behalf of such Registered Owner,

• if the latter has authorised the CFI to request relief on its behalf; and
• if the CFI has performed due diligence duties to verify and establish the Registered Owner's eligibility to a reduced WHT rate. Such verification may also include a risk assessment that takes into account the credit risk and fraud risk.

Due diligence obligations

According to the Proposal, when requesting tax relief on behalf of the Registered Owners, CFIs will have to put in place adequate procedures to ensure these Registered Owners are eligible for the refunds.

For that purpose, CFIs will need to collect a statement from the Registered Owners indicating that they are the beneficial owners of the paid dividend (or interest) and that they have not engaged in a Financial Arrangement linked to the underlying publicly traded share that has not been settled, expired or otherwise terminated at the ex-dividend date, which is the date as from which the shares are traded without the rights flowing from the shares, including the right to participate and vote in a general meeting, where relevant (i.e. in this respect, "Financial Arrangement" refers to 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).

CFIs will also have to collect the eTRC of the Registered Owner, and/or appropriate proof of residence in a non-EU country, and will have to verify this information against their own records. CFIs will need to collect certain information from Registered Owners, including a declaration that they are the beneficial owners of the income and the absence of certain Financial Arrangements linked to the securities and which could create a risk of cum/cum or cum/ex. One aspect particularly interesting of the Proposal is that CFIs will also have to verify, based on the investor's specific circumstances, (1) the Registered Owner's entitlement to a specific reduced withholding tax rate in accordance with a double tax treaty between the source Member State and the jurisdictions where the Registered Owner is resident for tax purposes or specific national legislation of the source Member State, and (2) the possible existence – and thus not the existence as such but only the potentiality - of any Financial Arrangement involving the underlying securities that has not been settled, expired or otherwise terminated at the ex-dividend date, unless the dividend paid to the Registered Owner for each group of identical shares held does not exceed EUR 1000.

At this stage, the scope of the verification required is, however, unclear. Should CFIs perform a complete legal and tax analysis of the situation of the Registered Owner, or would a "reasonable" verification be sufficient? Moreover, taking into consideration legal uncertainties around the single notion of "beneficial owner" for which there is neither a legal definition nor a unanimous and constant case law defining that notion, on which basis could CFIs verify the entitlement to a specific reduced WHT rate?

In this respect, the burden put on CFIs seems heavy taking into account on the one hand uncertainties attached to the due diligence duties requested and on the other hand the financial sanction that could be applied. The Proposal states indeed that CFIs should be held liable for tax revenue losses that have been incurred due to the inadequate fulfilment of these due diligence obligations, to the extent that national law of the Member State where the loss incurred so provides.

• Option 1: Relief at source system

Under this option, CFIs maintaining a Registered Owner's investment account will be allowed (or will be required) to request relief at source on behalf of such Registered Owner by providing the withholding tax agent with the tax residence of the Registered Owner and the applicable withholding tax rate on the payment in accordance with a double tax treaty or specific national legislation.

Under this option, the correct amount of taxes is applied at the time of the dividend or interest payment directly without any further action required. CFIs are supposed to have verified the eligibility for a reduced WHT rate in advance.

• Option 2: Quick refund system

Under this option, CFIs maintaining a Registered Owner's investment account will be allowed to request a quick refund of the excess withholding tax on behalf of such Registered Owner, if some information is provided by the CFIs at the latest within 25 calendar days from the date of payment of the dividend or interest.

For that purpose, CFIs will have to identify the dividend or interest payment at stake, the legal basis of the applicable withholding tax rate and total amount of excess tax to be refunded, the tax residence of the Registered Owner and provide the Registered Owner's declaration according to which he is the beneficial owner of the paid dividend (or the interest) and he has not engaged in a Financial Arrangement.

In such situation, the initial payment is made taking into account the withholding tax rate of the source Member State, but the refund for any overpaid taxes, including late payment interest if applicable³, is made within 25 days from the date of the request or from the date reporting obligations under this Proposal have been met by all relevant CIFs, whichever is the latest. This should take place within 50 calendar days from the date of payment.

Non application or limitations to the application of the systems of relief

Each Member State needs to ensure that at least one of the two systems is available to all investors when the conditions set out by this Proposal are met. Nevertheless, within these two systems Member States have the discretion, for instance, to only allow low risk taxpayers to request relief at source whilst other taxpayers can only request a quick refund.

In addition, Member States may exclude the benefit of systems of relief under the Proposal where at least one of the financial intermediaries in the securities payment chain is not a CFI and a subsequent CFI in the chain has not provided to the competent authority the information that the financial intermediary should report under this Directive if it were a CFI. Member States may also exclude the benefit of systems of relief under the Proposal when a full exemption of the withholding tax is claimed (as opposed to the application of a reduced rate). It will be interesting to note whether this choice is made by Members States, and how the additional review and checks of the requester's eligibility will translate in practice. In any case, the objectives of the Proposal do not raise hope of any ease of the current applicable relief system experienced by private equity structures and nonlisted securities for which it sometimes takes several years to recover excess WHT and which are subject to more and more questions on the beneficial ownership of payments and on the application of anti-abuse rules.

Moreover, systems of relief under the Proposal are never provided where 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 when 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.

Where the relief at source and quick refund systems set out in this Proposal do not apply, the standard refund procedure will be applied, where the taxpayer or its appointed representative, which does not necessarily have to be a financial institution, are able to directly request a refund from the tax authority.

Implications

We welcome the Proposal since it has the potential to simplify withholding tax relief procedures and to improve withholding tax procedures for non-resident portfolio investors to the extent it should facilitate cross-border investment within the EU. We especially welcome the introduction of the eTRC, its broad scope of application and the very short deadline in which tax authorities will have to provide it.

Nevertheless, this Proposal creates new heavy reporting and due diligence duties on CFIs with a potentially high degree of liability. At this stage we can, however, already note that, as the systems of relief apply only at the request of the recipient of the dividend (or interest) payment and as the due diligence duties must be performed when the systems of reliefs are requested, if the recipient of the dividend (or interest) payment does not authorise the CIF to request a relief on its behalf, such CIF does not have to perform the due diligence duties to verify and establish the recipient's eligibility.

The Proposal guarantees that all investors can benefit from at least one of the two standardised systems, as long as they meet the conditions set out in the Proposal, but if the CFI concludes that they do not meet the eligibility condition it can thus refuse to request the benefit of a system of relief on behalf of a Registered Owner. However, it is not clear at this stage whether CFIs could refuse, for any reason, to apply the systems of relief, notably when the verification required is not possible or their liability could be engaged. In the latter case, the CFI could also be exempt from the due diligence duties to verify and establish the recipient's eligibility.

In any case, notwithstanding that CFIs must perform a due diligence verification to request the benefit of the relief at source system or the quick refund system on behalf of the Registered Owner of a security, it appears nowhere that the due diligence conclusions of the CFIs on the non-eligibility of a Registered Owner for a reduced WHT rate should be communicated to the tax authorities. In such a case the systems of relief would not apply and the Registered Owner or its authorised representative could still request a refund of the excess withholding tax, under the condition that they provide, if required, at least the information required under Annex II, heading E (i.e. information about the holding period of underlying securities and information about Financial Arrangements linked to the securities for which the taxpayer is requesting relief) to the competent authorities.

Next steps

The Proposal is now in the hands of the Council of the EU and the EU Parliament. Once adopted, the Proposal should be implemented into national legislation by 31 December 2026 and should come into force on 1 January 2027.

Footnotes

1. The following information shall be included: (a) the first and last name of the taxpayer and the date and place of birth, if the taxpayer is an individual, or its name and its European Unique Identifier number (EUID), if the taxpayer is an entity; (b) tax identification number; (c) address of the taxpayer; (d) date of issuance; (e) the covered period; (f) identification of the tax authority issuing the certificate; (g) any additional information that may be relevant where the certificate is issued to serve purposes other than relief of withholding tax under this Directive or information required to be included in a tax residence certificate under EU law.

2. "As soon as possible after the record date, unless a settlement instruction in respect of any part of a transaction is pending on the record date, in which case the reporting for that transaction shall take place as soon as possible after the settlement. If 20 days after the record date, settlement is still pending for any part of the transaction, certified financial intermediaries shall report within the next 5 calendar days indicating the part for which settlement is pending".

3. At a rate equal to the interest or equivalent charge applied by the Member State to late payments of income tax by Registered Owners, or, if the national legislation of the Member States does not include such provision, at the Euro short-term rate plus 50 basis points or the equivalent interest rate used by their Central Bank plus 50 basis points, if they are not part of the European Exchange Rate Mechanism.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.