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Article (10/237)
Custody tax services: the new rules of the game for custodians and clients
Custody tax services: the new rules of the game for custodians and clients
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Custody tax services: the new rules of the game for custodians and clients

24/11/2020


Mariangela Fumagalli

Mariangela Fumagalli

Head of Global Asset Servicing Product & Custody Regulatory Solutions

BNP Paribas Securities Services

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Nigel Nelkon

Nigel Nelkon

Global Head of Tax Business Services

BNP Paribas Securities Services

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Over the last few years, tax risk and leakage have been a growing concern for tax authorities around the world. This has resulted in additional scrutiny and reporting obligations. Liability is no longer just on the investors but also on their custodian, which could potentially change the dynamics of the client/provider relationship. Partnership and digitalisation will be key elements going forward.

We spoke with BNP Paribas Securities Services’ Nigel Nelkon, Global Head of Tax Business Services, and Mariangela Fumagalli, Head of Asset Servicing Global Product and Regulatory Solutions, to discuss what it means for the services custodians provide to their clients.

New tax rules

Taxes are a complex matter. The sophistication of investment strategies and related cross-border tax aspects can make it challenging to properly identify beneficial owners.

 “Tax authorities in countries around the world want to ensure the person benefiting from any tax reduction – whether via relief at source or reclaim – is the beneficial owner entitled to it,” says Nelkon.

Major rule shifts have been, and are being, introduced to make sure that occurs. And as the European Commission noted in its July 2020 Taxation Action Plan:

“Fair and efficient taxation will be even more important in the months and years ahead, as the EU and the global community seek to recover from the fallout of the COVID-19 crisis.”[1]

A key recent initiative is the European Union’s Directive on Administrative Cooperation #6 (DAC 6). The mandatory disclosure regime requires notably that, as from 1 July 2020 (and retrospectively for 25 June 2018 to 30 June 2020), any cross-border arrangements that are perceived to bear indications of tax avoidance must be reported to local tax authorities. The information will be automatically exchanged between EU member state authorities on a quarterly basis.

The Commission plans to follow this in 2022/23 with a legislative proposal to introduce a “common, standardised, EU-wide system for withholding tax relief at source, accompanied by an exchange of information and cooperation mechanism among tax administrations.” The initiative, which will be informed by the OECD Treaty Relief and Compliance Enhancement (TRACE) scheme, aims to significantly reduce tax compliance costs for cross-border investors while preventing tax evasion.

The EU steps are just the latest in a series of cross-border tax avoidance and disclosure initiatives – including the US Qualified Intermediary regime, Foreign Account Tax Compliance Act (FATCA) and its global equivalent the Common Reporting Standard (CRS), with its focus on the automatic exchange of financial account information between jurisdictions.

Custodians in the spotlight 

Custodian banks have long acted as a withholding agent in many markets, responsible for withholding and paying the appropriate tax to the authorities. As part of this role, BNP Paribas Securities Services provides a custody tax service to ensure that the correct amounts are deducted from clients’ income in line with any tax treaty or domestic provisions to which they are entitled.

The wave of domestic and international measures is increasing requirements or obligations

 on custodians as tax authorities are leveraging the role of custodians. In this new environment, the partnership between custodians and their clients is critical.

“Tax authorities are increasingly concerned that benefits are going to persons or entities that are not the rightful beneficial owner,” says Nelkon. “Because custodians perform the tax service and either provide relief at source or submit the reclaims on clients’ behalf, tax authorities often see the custodian as having key role in managing risk.

Finland, for example, will introduce on 1 January 2021 a new Register of Authorised Intermediaries to replace the existing foreign custodian register. All custodians will have to apply to the new Register to operate as an authorised intermediary (AI).

Under the OECD TRACE model being implemented in Finland, AIs must investigate and identify their customers, verify the beneficiary’s country of residence and applicability of any tax treaty provisions, and report that information to the tax administration[2]. “

Poland has gone a stage further. Under its draft WHT collection rules, “potentially you even have personal liability if relief is given and it is proven you haven’t taken due responsibility,” he adds.

“This landscape is clearly having an impact on custodians’ tax services. These additional Know Your Customer information and processes custodians have to cover mean custodians need to adapt their operations accordingly” explains Nelkon.

Digitalising tax processes

Digitalisation initiatives are having a further impact. In certain jurisdictions, such as the Netherlands and Belgium, tax authorities are seeking to improve the WHT process and combat fraud, especially around tax reclaims, by replacing paper-based forms with digitalisation.

“These authorities have created portals with a file transfer mechanism that custodians locally present in the market use to exchange information,” says Fumagalli. “This benefits everyone by removing the paperwork that circulates between multiple entities along the chain – a step that, as the coronavirus pandemic has shown, is long overdue.”

Custodians are also required to sign agreements with the tax authorities. “That has increased the responsibility and liability on the custodian dealing with the tax authority at the end of the chain, as it has to collect and maintain all the data, perform some controls on what has been received and provide the digitalised version of the data to the tax authorities,” she explains.

What the changes mean for clients

Internally, custodians will have to digitalise their operational processes to meet the reporting obligations. “At BNP Paribas, we have been working proactively to digitalise our interactions with tax authorities wherever possible, as well as our processes between teams and with clients to see how we can best digitalise the exchange of tax information and make it secure,” says Fumagalli.

“To this end, we are working on enhancements to our internet portal, which will become the preferred way for clients to communicate with us for all tax related matters.”

More importantly, given the evolving responsibilities and liabilities the tax changes impose on both custodians and clients, custodians need to be able to respond and evaluate how their tax services operate in some circumstances to ensure the increased costs and risks don’t outweigh the commercial rationale.

“That will have an impact on custodians’ client relationships, as firms review their documentation requirements and contractual agreements to make sure they are fair and fit for purpose in this changing environment,” observes Nelkon. “Our processes are driven by the information we have and need to have, and most of that information (including the most crucial element which is the beneficial ownership) can only come from the client.”

Ultimately, both custodians and clients will face ever greater information demands, scrutiny and responsibility. But by maintaining a strong partnership approach based on two-way information exchange and collaboration, clients can continue to benefit from the tax rates to which they are legally entitled.

[1] An Action Plan for Fair and Simple Taxation Supporting the Recovery Strategy, European Commission, 15 July 2020

[2] Guidance on new Register of Authorized Intermediaries released, Deloitte, 10 July 2020, https://www.taxathand.com/article/14962/Finland/2020/Guidance-on-new-Register-of-Authorized-Intermediaries-released

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