The world of investment structuring and tax planning is filled with complicated decisions, from fund structuring to asset allocations and investment jurisdictions which aim to maximise returns and minimize tax leakage. Unfortunately, cross-border withholding tax is often overlooked during the investment structuring process especially when tax transparent structures are established as the vehicle of choice. In many cases, withholding tax recovery opportunities are missed or forfeited entirely but the effects of withholding tax are only felt once investments start generating returns. Careful consideration can result in improved investment returns through cross border recoveries. The use of investment vehicles that are treated as transparent or “look through” for tax purposes continues to rise. It’s crucial to understand the nuances of these structures and how the selected vehicle affects your ability to recover excess withholding taxes.
The rationale for particular investment structures varies from regulatory and compliance considerations, to ease of set-up, subscription and redemption of investors, operational factors and of course, tax compliance and liability. Tax transparent vehicles are considered as “look through” in their domestic market which means that the investors bear the tax burden as opposed to the investment vehicle. The increasing popularity of transparent structures has complicated the withholding tax landscape, ironically, as in many situations, the structures are formed to simplify and reduce domestic tax obligations. Foreign withholding tax usually isn’t considered a top priority and as such, recovery opportunities aren’t properly investigated. The downside is that, whilst from a domestic tax perspective, investors are tax efficient, their investment returns can be eroded by foreign withholding tax.
The most widely available form of withholding tax recovery exists through a network of double taxation agreements which aim to reduce the effects of double taxation on global investors. These agreements (often referred to as double taxation treaties) cater for eligibility of different investor types and usually do not cater for treaty relief in situations where investors are domiciled in tax havens. This is where the opportunity for look through and transparency becomes vital. Foreign tax authorities generally consider an investment vehicle to be transparent if it is treated as such in the domestic market in which it is registered. Take, for example, a US limited partnership. The structure is transparent in the eyes of the IRS and tax obligations flow through to the partners or investors in the partnership, for US tax purposes. Most tax authorities around the world follow this treatment and therefore require proof of investor eligibility for withholding tax relief, before refunds of excess withholding tax can be granted. Transparency can therefore be the key to unlocking major recovery opportunities and should be seriously considered when structuring new vehicles and contemplating how to maximize returns. Even if funds are domiciled in tax havens, if the structure is transparent, there may be an opportunity to “look through” the structure and claim on behalf of the investors if they are resident in treaty eligible jurisdictions.
Looking through transparent structures requires an in-depth understanding of the various investment structures as well as methodical planning and record-keeping to ensure that recoveries are maximized for each investor. Material benefits can be obtained for investors through withholding tax recoveries, where each nuance is catered for.
Furthermore, understanding the investor demographic results in added benefits and additional opportunities. When dealing with transparent vehicles, end investors are considered the ultimate beneficial owners and can therefore generally take advantage of their treaty benefits as if they were directly invested in the relevant instruments. Of particular interest are tax exempt investors such as pension plans and non-profit organizations. Tax exempt investors form one of the largest investor classes for transparent investment vehicles. Where tax exempt investors are identified as such, they can benefit from further reduced and often full recovery of withholding taxes suffered, on their proportionate share of the fund’s foreign investment income. This is due to the availability of further exemptions for pension plan and NPO investors around the world.
The global marketplace has also resulted in investors in any market being able to invest in structures around the world. This creates a unique opportunity for withholding tax recovery as additional benefits can often be obtained for investors domiciled abroad. This is particularly true for EU investors invested in non-EU funds. The EU investors can often take advantage of proportionate, additional EU-related withholding tax relief and catering for this in a non-EU structure adds diversity and attractiveness to a particular vehicle.
Assume a US-domiciled limited partnership (LP) holds 200,000 Bayerische Motoren Werke AG shares.
The LP has 10 investors, each holding 10% ownership of the LP.
Investor Breakdown:
Dividend Payment Date | 21 May 2019 |
Dividend Per Share | EUR 3,50 |
Total Gross Dividend | EUR 700,000 |
Withholding Tax Suffered | EUR 184,625 |
Withholding Tax % | 26.375% |
Net Dividend Received | EUR 515,375 |
Standard Treaty Rate | 15% |
Reduced Treaty Rate* * This reduced rate applies for US NPOs and pension plans | 0% |
Investor Type | Reclaim Percentage | Ownership Percentage | Reclaim Amount (EUR) |
1 US 501(c)(3) Non-profit organization | 26.375% | 10% | 18,462.50 |
1 US 401(a) pension plan | 26.375% | 10% | 18,462.50 |
8 US-domiciled individuals | 11.375% | 80% | 63,700.00 |
TOTAL | 100,625.00 | ||
Investment returns can be boosted by EUR 100,625, a 19.5% improvement in return by pursuing a withholding tax recovery claim.
As can be seen above, pursuing these recoveries can add significant value and should therefore be seriously considered.
Withholding tax has always attracted complexities and specialized knowledge but the need to partner with an experienced provider is especially true in the transparent fund space:
In many cases, claims for transparent investment vehicles need to be justified and substantiated with foreign tax authorities. Supporting explanations must accompany claims to ensure that investment income withholding tax claims are considered as valid. However, where these claims are suitably positioned, recoveries of up to 35% in investment income withholding tax can be achieved.
Tax authorities require certainty with regards to eligibility for reclaims in the withholding tax space. This ensures that all investors are properly documented and actually applying for the refund, which results in recoveries which investors were typically unaware of and creates a great boost in investment returns. The documentation required includes investor ownership percentages to investors’ powers of attorney and tax residency certification.
The nature of many structures is that they are complex, often with various hierarchies and layers to ensure maximised results are achieved. Considering withholding tax and ensuring that no amounts are left unclaimed should be a priority for all in the transparent fund space.
There are major benefits to pursuing withholding tax recoveries for transparent investment funds that ensure that global tax leakage is minimized, and investment returns maximized. WTax specializes in withholding tax recoveries for transparent vehicles around the globe and follows a methodical, hassle-free process in supporting its clients’ claims.
To initiate a review of withholding tax opportunities relating to transparent funds, please get in touch with WTax today.
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