Operations managers at custodian banks, broker-dealers, and other financial intermediaries, will soon face new administrative challenges and legal liability to secure quicker refunds of excess withholding taxes paid by investors in cross-border transactions for securities issued in the European Union (EU).
Among the top concerns mentioned by attendees at the recent Americas Meeting event held by The Network Forum in New York City was compliance with a new regulation, known as Faster and Safer Relief of Excess Withholding Taxes (FASTER), which was published in the EU’s official journal on January 10, 2025. The Directive was adopted by the Council of Europe on December 10, 2024 and the 27 member countries of the EU have until December 31, 2028 to transpose FASTER into their local legislation. The effective date is January 1, 2030. The goal of FASTER is to eliminate the disparate paper-based information and reporting formats required by the tax agency of each EU member state for cross-border investors to receive either a favorable withholding tax rate or a refund of excess tax. Instead, a single standardized electronic document would be accepted by all EU tax agencies from certified financial intermediaries (CFIs) to streamline the process and ensure quicker results. Speed aside, FASTER comes with a financial benefit for investors. A 2024 analysis conducted by GlobeTax, a New York-based firm specializing in outsourced tax reclamation work, showed that successful tax refunds could add nearly 30 basis points annually to the performance of an investor’s international portfolio. For pension plans, the increase could be closer to 70 basis points. (One hundred basis points equals one percent).
Although the timetable to implement FASTER may sound light years away, financial firms could need some time to adapt their technology to aggregate and reconcile the necessary investor data from multiple front, middle, and back-office systems. Global custodians might also be forced to alter their agreements with European subcustodians or agent banks, which will probably face the heaviest lifting to meet the Directive’s requirements. A subcustodian is hired by a global custodian to safekeep investor assets in markets not serviced by the global custodian. “Subcustodians are typically responsible for deducting the correct withholding tax at the time a dividend or income payment is made,” one operations manager at a U.S.-headquartered global custodian told FinOps Report. “Therefore, they are also likely handling the tax reclamation process.” European equities, bonds, and American Depositary Receipts (ADRs) of European companies will be affected by FASTER. However, Eurobonds do not have any withholding tax. Not all fund managers can take advantage of FASTER. Managers of U.S mutual funds and exchange-traded funds as well as managers of European UCITS (Undertakings for the Collective Investment in Transferable Securities), can benefit because they rely on global custodians and subcustodians to hold investor assets. The European version of a U.S. mutual fund, UCITS is a pooled fund that complies with the European Commission’s rules. Hedge fund managers must continue to file for European withholding tax relief under the cumbersome status quo and hope for the best.
Five network managers at European subcustodians, who spoke with FinOps Report while attending the Americas Meeting event held by The Network Forum, said that some of FASTER’s language was unclear and each European member country could tweak the broad text to generate differences. “At first glance, FASTER would require global custodian banks to offer tax reclamation services to all of their fund manager clients, not just the largest ones,” said one European network manager. “As subcustodians, we will have additional administrative work to keep track of investor records, and we will have to determine how to price our tax reclamation services.” Global custodians, in turn, must decide whether they will incorporate the extra costs into their safekeeping fees or charge clients separately. Spokespersons at several U.S. online brokerage firms, contacted by FinOps Report, said they are evaluating how they will adjust to FASTER. For now, it appears that U.S. retail investors must recoup any refunds from European tax agencies on their own with the help of third-party tax reclamation providers hired by the online brokerages.
To ensure their cross-border clients benefit from FASTER, custodian banks and broker-dealers must register with the national registry of one or more EU member countries as CFIs. The CFIs will report dividend and interest payments and any associated information on securities holdings to an issuer’s tax authority. Both global custodians and their European subcustodians are expected to become CFIs. BNY, JP Morgan, Citi, State Street, HSBC, Northern Trust, and Brown Brothers Harriman, are among the world’s largest global custodians while BNP Paribas Securities Services, BBVA, Deutsche Bank, Caceis, Santander Securities Services, and Societe Generale Securities Services are popular European agent banks.
Single eTRC
Instead of requiring financial intermediaries to use different documentation for each EU country, all EU tax agencies must accept a single electronic Tax Residency Certificate (eTRC), which includes information such as the name of the individual or entity, its tax identification number and address, the tax authority issuing the eTRC, and its date of issuance. EU members must provide an automated, electronic process for issuing an eTRC within 14 days of a request to replace the current slow and error-prone methodology. An eTRC issued by one EU country will be recognized as an investor’s valid proof of residence by tax authorities in all the other EU countries. Each European tax authority would not need to certify individual claims. As a result, cross-border investors can receive a refund of excess withholding tax in about 60 days instead of an average of twelve to eighteen months for most EU countries. In Italy, it can now take over five years for a foreign investor to receive a refund on excess withholding tax. An eTRC will cover a period of up to one calendar or fiscal year, allowing cross-border investors with diversified investment portfolios to claim a lower withholding tax for multiple transactions. An EU member can rescind an eTRC if its tax agency can prove that the affected investor has a different tax residence. A tax authority in any EU country can also request more extensive reporting if it thinks the requirements of another country are insufficient to detect tax abuse or fraud.
European stocks or bonds bought outside of their home markets are now subject to a withholding tax on their dividend or income payments, which means that foreign investors might not receive the full amount. Instead, they would only receive partial payment. In many cases the percentage of the withholding tax could be reduced if the country of residence of the investor and the country of the issuer of the stock or bond have signed double taxation treaties. “While statutory withholding rates can be as high as 35 percent of dividend or interest income, a double tax treaty can reduce taxable rates to 15 percent or less for eligible investors,” says Len Lipton, a managing director at GlobeTax. “Tax-exempt investors, such as pension plans, are often entitled to a full exemption or a zero percent withholding tax.” However, an investor doesn’t always receive the benefit of the lower tax rate at the time the dividend or income payment is made, otherwise known as relief at source. When an investor is taxed at the higher rate it must petition a European tax agency for a refund by submitting documentation verifying its eligibility through a financial intermediary. Foreign investors in U.S stock are typically charged up to a 30 percent withholding tax at the time a dividend is paid and no tax on U.S corporate bonds or Treasuries. (A list of global withholding tax rates can be found on PwC’s website).
Member states of the EU have a choice on how to implement the FASTER Directive. They can either offer “relief at source” or a “quick refund process” or both. The first option would require a lower withholding tax to be applied at the time the dividend or income payment is made. The second would allow the investor to receive the refund of any excess withholding tax in about 60 days. The FASTER Directive permits EU-member states to exclude requests for lower taxation rates at the time a dividend or interest payment is made or for a tax refund under certain circumstances. One exception is when the dividend payment is made on publicly traded shares and one of the financial intermediaries in the payment chain is not a CFI. Another exemption is when the registered shareholder bought the security five days before the ex-dividend date. That restriction is intended to limit arbitrage opportunities for investors and traders, which European tax authorities believe should make them ineligible for lower tax withholding rates. The ex-dividend date refers to the first day a stock trades without the dividend attached and is typically one business day before the record date. The latter is the date a company uses to identify shareholders eligible to receive dividends.
New Operational Burdens
FASTER’s benefit for investors comes with operational challenges for CFIs. For starters, they may need to adapt to new standardized data formats, such as the ISO 20022 XML-based protocol to transmit information on investors to European tax authorities. ISO 20022-compliant messages rely on XML, short for Extensible Markup Language Syntax, to provide a structured format to exchange information on payment and securities. The XML format makes it easier for computers to process information within a transaction. In a recent article appearing on its website, Societe Generale Securities Services (SGSS) endorsed the use of ISO XML-based messages to comply with the reporting requirements of FASTER by noting that they can be exchanged via an API, uploaded to a website or transmitted, through SWIFT. Another benefit of relying on the ISO XML-based messages, according to SGSS, is that CFIs can leverage their experience using the message types to comply with Europe’s Shareholder Rights Directive II (SRD II). (FinOps Report published a detailed analysis of the second incarnation of the Shareholder Rights Directive on June 11, 2020). Officials at SWIFT, the La Hulpe, Belgium-headquartered network operator which transports ISO 20022-compliant messages for payments and securities, declined to respond to e-mailed questions from FinOps Report on how it is adapting to FASTER. It is expected that national standard market practice groups will help SWIFT create the appropriate message types. In the U.S., the International Securities Association for Institutional Trade Communications (ISITC) would likely be that organization.
To ensure the right information is delivered within the new message protocol, CFIs will need to determine the correct positions of their clients on record date. To do so, they must track and reconcile all investor purchases, sales and related transactions such as stock loans, repurchase agreements and swap contracts. Ideally, all of the data must be tied back to the same client even if the information is located in different business lines and platforms. CFIs must also confirm whether investors have counter-positions in the same security with different custodians. A long position with one custodian bank might be offset by a short position in another.
The more efficient a CFI’s operations, the lower its risk of being sanctioned for mistakes. The text of FASTER indicates that the penalties for non-compliance will be “effective, proportionate and dissuasive.” Therefore, CFIs must verify all the information about account holders to determine if they are eligible for a lower tax withholding rate or no withholding tax. FASTER refers to CFIs taking “reasonable measures” to perform their analysis in good faith, but it never clarifies how that requirement should be translated into practice. It is also unclear what the penalties for violating FASTER will be, but it is presumed that subcustodians would reimburse global custodians for the amount of excess withholding tax investors didn’t receive.
Because subcustodians could have the greatest liability for any mistakes complying with FASTER, they will likely be forced to review their data governance process to ensure accurate records about investor holdings, dividend, and income payments. Global custodians could decide to change the boilerplate language of agreements with subcustodians to ensure the former are indemnified, several European network managers attending The Network Forum event in New York City told FinOps Report. “It remains to be seen whether our contracts will explicitly mention FASTER,” said one European network manager. “Instead of indicating it is responsible for compensating an investor for any errors it makes, a subcustodian could be forced by its global custodian clients to specify what the compensation will be under FASTER.” None of the European agent bank network managers who spoke with FinOps Report were willing to disclose whether their banks had already made the textual change.
Chris Kentouris
New York City
KentourisC@gmail.com
917.510.3226
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