“I Want My Money Back!” Questions To Ask About Tax Reclaims
If you’re an institutional investor, here are five questions that you should be asking. I use these as benchmarking tools and you can find them in chapter 12 of my book ‘Investment Withholding Tax – Best Practice and Strategies for Intermediaries and Investors’ published by Palgrave Macmillan.
1. Will I get relief at source on all my holdings automatically?
While its clearly the most efficient model, Relief at Source and its sibling ‘Quick Refund’ have to be legally allowed in the country where the income is sourced AND your custodian has to support the process involved. By the way, if you’re using a prime broker, forget it. PBs don’t usually do any form of tax optimization. There are some markets where some custodians don’t support tax relief, for cost reasons, so having an account there means you won’t get RaS even though it is allowed. So there is a benchmark called ‘RaS Efficiency’ – in other words, how well does your custodian’s coverage of relief at source markets map to your portfolio. Any mismatch will create loss of performance and delay.
2. When do I get my money back?
It depends – and don’t take the first answer you get as either complete or accurate.
This is really only relevant to what are called ‘long form’ or standard reclaims i.e. post pay date. The problem is that most people will quote the period between filing a claim and obtaining a refund. That, unfortunately, is only one part of the process. There are six other parts:
Your custodian has to ‘recognise the claim entitlement’. That’s usually a batch process, so there may be a delay between being over taxed and anyone realising you have a claim.
You will need to provide evidence of who you are, your residency and that you were overtaxed. That means there’s an outreach process to acquire and validate this documentation. This can take up to six months unless you gave a power of attorney to your custodian, which only occurs in roughly 60% of cases.
Most custodians use their sub-custody agent bank network, so the claim has to be sent to the agent bank in the country of issue – that takes time.
The agent bank does have a ‘day job’, so there may be a delay simply because the received claim just sits on someone’s desk or because they too work on a batch process, which may not be aligned to the sender.
The claim now actually gets filed to the tax authority. There are generally accepted time frames for each market for refunding money once it gets to this stage.
Even when the money is returned to the agent bank, this will usually be pooled with many other claims. So the agent bank has to reconcile the refunded cash with the claims it filed. Tax authorities are just as prone to error as everyone else, so there will be a delay due to reconciliation, after which the agent will be able to refund the money back to its counterpart – your custodian.
If you’re running a segregated account, the credit should be fast, but normally the agent will be paying into one omnibus account and from there it has to be credited to your account. Again, time. I’ve seen management reports of custodian banks that show a three year claim process for a market that actually refunds (step 5) in 18 months. The benchmark that tracks all of this to come to an overall assessment is called PE – Process Efficiency.
3. Do I need to worry about time delays?
Yes, and it’s not just a matter of the time value of money.
Efficient tax processing can add up to 250 basis points to the average portfolio, so you want your money back asap. Each market has a statute of limitations (SoL). This is a double-edged sword. First, if you or your custodian has not got to step 5 in the process by the SoL date – it’s not your money any more. It belongs to the foreign government, to whom you have essentially just made a non tax-deductible donation. The other side of that coin is that, if you haven’t been claiming in the past, you may still have entitlements that can be claimed if they are still within statute. However, from a benchmarking perspective, the measurement is called ‘Statute Risk’. This measures the number of claims against when they were filed versus the statute period (starting on the pay date). A large proportion of claims that are filed towards the end of the statute period can be a sign that the custodian may have a backlog of claims, have insufficient resource, not be recognising claims quickly enough or have some other weakness in its processing. A high Statute Risk value means that this custodian might be more prone to error in a process that has a defined limit, at the end of which you lose money. I recently saw one custodian who had to make its client whole for this very reason – to the tune of €1m!
4. How do I know I’m optimizing my tax position?
You don’t, unless you use the ‘Fit’ benchmark.
Fit is an issue both for institutional investors and also for network managers at custodians. The custody industry currently operates on a complex network of counter parties to be able to offer investors efficient access to the global markets. These network managers are responsible for assessing counter parties in terms of the services they want to be able to offer their customers. The problem is that tax is often under-analysed, due mainly to a lack of awareness and detailed scrutiny of this kind of offering. Also remember that most custodians do not view tax as a product, they view it as a task so there is little innovation. Network management scrutiny of counter parties is often narrow and limited by what their own firm knows. The result is a fragmented, limited scope offering. The benchmark ‘Fit’ is probably the most complex to measure because it needs to take a holistic and detailed view of the institutional portfolio then map this to the equally holistic and detailed tax offering of the custodian. As you can see, in most cases this will mean penetrating the custodian offering to identify the qualitative and quantitative aspects of the sub-custodian network. That mapping is done purely from a tax perspective.
5. How important am I to you?
That depends on the Backlog Index benchmark.
Tax optimisation is, to some extent, cyclical and most custodians operate by having a small core team which can be enhanced at specific times of the year to cope with increased volumes. All that said, the rate of creation of claim events usually exceeds the rate at which those claims can be packaged and filed. That means that at any one time, it is likely that a custodian will have some level of backlog. The benchmark is an index which categorises a custodian based on the level of backlogs experienced over a period, together with an algorithm that models the spread or absorption of this backlog across the available resource. In essence, is the backlog temporary or systemic? If its systemic, you may have a problem. You may think your custodian is ‘on their game’ but the reality is that they aren’t. Equally, this index also gives you an idea of how long it is going to take before your claims are likely to be even looked at, let alone filed.
Trust me, even these benchmarks represent a much simplified picture, but hopefully this post gives some greater insight into a set of more quantitative ways to assess tax performance.
Image Credit: PhotoSteve101
Ross McGill is the CEO and subject matter expert for TConsult. Ross is a specialist in QI and FATCA operational compliance, cross border tax reclaims, relief at source and information reporting. He over 23 years of experience in financial services, including 19 years at C level; and 30 years’ senior management experience in blue chip FMCG, including sales, marketing and operations.