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UPDATE: Dividend Withholding Tax: What Happens Post the Brexit Transition Period?

UPDATE: Dividend Withholding Tax: What Happens Post the Brexit Transition Period?

Oct 19, 2020

WTax unpacks the post-Brexit impacts of withholding tax on UK-domiciled UCITS funds.

Earlier this year, WTax outlined some of the withholding tax implications of Brexit (click here). This article explores the latest developments, on how the UK’s official withdrawal from the EU will affect the withholding taxes levied on UK-domiciled funds, once the transitional period ends at the end of 2020. This is in light of the European Commission’s announcement on the 7th of July 2020, in which it was confirmed and stakeholders were informed that as from the end of the transition period (31 December 2020), the EU rules in the field of asset management — in particular Directive 2009/65/EC on Undertakings for Collective Investment in Transferable Securities (“UCITS Directive”) and Directive 2011/61/EU on Alternative Investment Fund Managers (“AIFM Directive”) — will no longer apply to the United Kingdom.

As an internationally renowned and trusted type of collective investment scheme, a UCITS (Undertakings for Collective Investments in Transferable Securities Directive) enjoys the right to operate freely by marketing and selling its investment products throughout the EU, on the basis of a single authorisation from one member state. Significantly, the UCITS Directive maintains that the ‘UCITS’ classification can only apply to those funds that are EU-domiciled and managed by an EU management company. As the UK becomes a third country (i.e. non-member state) for domestic tax purposes across the EU, UK-domiciled UCITS will consequently have to either be re-domiciled to an EU country and seek re-authorisation under the UCITS Directive, or discontinue operating under the UCITS regime altogether.

UK-UCITS funds to be disadvantaged post Brexit

While the United Kingdom remained within the EU, UK-based UCITS funds were able to benefit from favourable withholding tax treatment due to their classification as UCITS, which effectively reduced withholding taxes in certain EU Member States to zero. This is because many European jurisdictions apply reduced rates of, or full exemptions from withholding tax on dividends paid to UCITS-funds. As these funds lose their UCITS status, they will lose the related tax benefits and the UK will revert to relying on its double taxation agreements (DTAs) with individual member states to determine the rate of withholding tax that apply to UK-domiciled funds. The UK has double tax treaties with each of the remaining 27 EU member states. However, many of these treaties do not provide the same level of benefits as those afforded to UCITS (i.e. full exemptions), with the consequence that going forward, UK-domiciled funds may incur additional taxes. The UK may reach agreements with individual member states, which determine the withholding tax that will be levied in future, but this remains to be seen.

The UK-UCITS funds’ path to WHT refunds will be more intricate

The process for securing refunds for UCITS is relatively straightforward (as compared to non-UCITS funds), as domestic tax law often specifically exempts these funds from withholding tax. Post-Brexit, however, these funds will not be able to obtain refunds via these domestic exemptions and may instead need to file claims based on European Court of Justice (ECJ) principles to ensure that ultimately no foreign withholding tax is levied on these formerly UCITS-funds. ECJ claims may be filled when comparable foreign funds (including non-EU funds) are subjected to a different tax treatment than those afforded to domestic funds by an EU member state. Such a violation of the EU principles which ensure non-discrimination and protect the free flow of capital is prohibited specifically by Article 63 of the Treaty on the Functioning of the European Union (TFEU). Article 63 not only prohibits any restriction on the free movement of capital between EU member states but also between EU member states and third countries. Therefore, post-Brexit, UK funds will still have the right to file claims on this basis.

Former UK-domiciled UCITS funds will therefore have the ability to pursue this method of recourse, though it would be reliant on proving that the fund is comparable to the domestic funds receiving prefential tax treatment. Given that all UCITS funds are bound to a uniform regulatory framework, it is generally simpler to establish comparability to other EU funds, when the claimant fund is a UCITS. As such, once the transition period ends in December 2020, the reclaim process for these UK-domiciled funds will become more difficult than before, when they retained their UCITS status. In addition, ECJ claims tend to be more administratively burdensome in comparison to domestic exemption claims, and therefore requiring deep knowledge of the legislation and the relevant governing rules. As such, these refunds are notoriously more difficult obtain and have longer estimated refund timelines than domestic exemption claims.

Reassuringly though, in order to affect successful reclaims for its clients, WTax has a dedicated team who understand the complexity and intricacy of ECJ claims. Our team of specialists continuously monitor ECJ developments and are able to perform a detailed analysis of each client’s individual fund structure, to determine its comparability relative to structures in investment jurisdictions. This specialised, technical team develops a detailed case for submission to the relevant tax authority.

A practical example

Spain, for instance, provides a tax exemption for dividends received by a collective investment institution regulated by Directive 2009/65/EC (UCITS) resident in member states of the European Economic Area (EEA) (Article 14.1.l of the consolidated text of the Non-Resident Income Tax Act). Therefore, UCITS funds are entitled to claim a refund of Spanish withholding tax, charged on Spanish source dividends, which exceed 1%.

While this straightforward method of recourse was open to UK-domiciled UCITS funds pre-Brexit, in order to claim similar refunds from Spain once they cease their UCITS status, these funds will in future have to rely on proving instances of discrimination based on ECJ precedent.

Other investment considerations

Brexit also has the potential to impact investment behaviour more broadly. Where investment mandates dictate minimum thresholds of investments in EU instruments and derivatives, investment portfolios may need to be reconfigured, given that the UK will no longer considered to be within the EU/EEA.

Conclusion

If you believe that your business may be at risk of withholding tax exposure due to Brexit, please get in touch with WTax by leaving your details here or contacting Sarah Osato, CFA from our London office on saraho@wtax.co.