EU Commission seeks to ease withholding tax mechanism on cross-border investments

October 26, 2021 Europe, European Commission, Featured News
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By Francesca Amaddeo, Lecturer-Researcher, Tax Law Competence Centre (SUPSI), Manno, Switzerland

The EU Commission on September 28 opened a public consultation on an initiative titled “New EU system for the avoidance of double taxation and prevention of tax abuse in the field of withholding taxes”. The initiative aims to address impediments to cross-border investment posed by the burdensome nature of withholding tax mechanisms.

According to the Commission’s 2017 Code of Conduct on Withholding Tax, there is a need to improve investments’ flows through Member States, especially by non-residents. One notable obstacle is the risk of double taxation.

Usually, when an EU resident makes an investment in securities in another Member State, the payments received in return, i.e., interests or dividends, are normally subject to withholding tax in the source country at a rate that is higher than the reduced rate on the basis of an applicable international treaty.

Indeed, as it is well known, international standards based on a strong network of double taxation conventions rely on the reduction of the withholding tax in the source state. It may be realized by the payor or through a specific reimbursement request presented by the payee. 

Unluckily, such a mechanism brings several disadvantages in terms of resources, costs, and time.

In some cases, the burden is so huge that it drives non-resident taxpayers to forego their right to apply for tax treaty benefits that they are entitled to. Double taxation on the income follows, and this results in less attractive net returns than for domestic investments.

In brief, the initiative under consultation aims to tackle such obstacles in investments’ flow through the common market and simultaneously to limit and prevent tax abuse. 

“This initiative has the specific objectives of making withholding tax relief procedures for non-resident investors more efficient and of increasing the ability of tax administrations to identify and target investors that abuse rights granted under double taxation conventions”.

The EU Commission seeks policy options, which, among others, might include an improvement of the withholding tax refund procedures to make them more efficient, an establishment of a fully-fledged common EU relief at source system, and/or an enhancement of the existing administrative cooperation framework to verify entitlement to double tax convention benefits.

The idea is to adopt by the fourth quarter of 2022 an ad hoc directive based on article 115 of the Treaty on the Functioning of the European Union (TFEU), which stipulates that EU action in the field of direct taxation is well-grounded where the functioning of the internal market would be hampered by the persistence of uncoordinated national legislation. 

Keywords: efficiency, effectiveness, fairness

The main issue concerning the withholding tax is its inefficiency, which often results in fraud or abuse of refund procedures. As a rule of thumb, domestic laws of Member States allow for a refund of the tax withheld to non-resident investors.

However, such procedures tend to be extremely resource-intensive, costly, and lengthy for both taxpayers and tax authorities. The result, in the best scenario, in a late refund. In the worst scenario, there is a high risk of abusive planning. Moreover, the procedure inevitably affects cross-border investment and fragments the single market.

As identified by the 2017 Code of Conduct on Withholding Tax, the main areas of concern are the entitlement to submit refund claims or apply for relief, the effective reliefs and provision of refunds in a short period, and the relief at source.

Keywords leading the path to success are efficiency, effectiveness, and fairness.

The common thread is the absence of harmonization between national legal systems. As a consequence, non-residents always need to engage a resident (intermediary, agent, or other) to overcome the widespread mistrust due to cross-border elements and the asymmetric reciprocal knowledge.

The same reasoning can be highlighted within the quality of reliefs and refunds. Such a procedure requires the knowledge of a legal framework that is different from the one the taxpayer is used to. Tax certainty is placed under a serious threat when the taxpayer is supposed to operate consistently within a legal system that the taxpayer is not familiar with. It is hard to think that foreign taxpayers have the skill to autonomously proceed with a refund request. Intermediaries – that is to say, tax consultants and experts – must necessarily be involved. A secondary issue, sometimes taken for granted, concerns the use of different languages, which risk exacerbating taxpayers’ compliance.

In addition, it would be desirable to grant taxpayers a refund in a shorter period of time, that is to say, six months (where legal criteria are properly satisfied). In this case, the assumption is that taxpayers truthfully submit refund claims and supporting documentation to tax administrations, respecting deadlines.

Looking for new angles

Issues under exam are well-known and not easy to solve.

Sometimes what it takes is looking for new angles. One may argue that the majority of the issues underlined by the Commission are due to the lack of knowledge of foreign tax systems.

The reimbursement procedure requires taxpayers to approach tax administrations and rules far from the domestic ones to which they are accustomed. 

One suggestion may be to shift the procedure from the source state to the residence one.

In this way, it would be possible to satisfy all the requirements above, and, moreover, it could increase taxpayers’ confidence in tax authorities and the legal framework. In terms of efficiency, the residence state can access all data concerning individuals and businesses involved within its territory, from tax returns to the exchange of information collection. It means less bureaucracy and prompt replies to taxpayers’ requests.

Of course, it follows that the residence state would have to anticipate the reimbursement for the asking taxpayers, and, only in a second stage, compensate all the amounts with the source state through proper mechanisms. The obstacle here is mistrust: jurisdictions would have to cooperate confidently with each other.

As regards issues related to the interpretation of concepts and terms, the directive itself could prevent such issues through specific definitions. After issuance, the European Court of Justice could help via the preliminary ruling referral under article 267 TFEU. 

The public consultation closes on 26 October. Stay tuned!

Francesca Amaddeo

Francesca Amaddeo

Lecturer-researcher at Tax Law Competence Centre, Department of Business Economics, Health and Social Care, University of Applied Science and Arts of Southern Switzerland (SUPSI)
Dr. Francesca Amaddeo, PhD in European law and national legal systems, is an Italian lawyer that works as Lecturer-researcher at the Tax Law Competence Centre, Department of Business Economics, Health and Social Care, University of Applied Science and Arts of Southern Switzerland (SUPSI).

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