Ross McGill

October 22, 2015|9 Minutes

Tax Is A Product, Not A Task


Most custodians I meet view tax processing as an administrative task, not as a product opportunity. It’s like a grain of sand in their shoes. As a result, it’s badly understood at management levels, and therefore under-resourced and under-delivered.

When the Good Times Rolled

Most custodians are facing increasing pressure from clients to do a better, more extensive and more efficient job. Clients are getting much smarter about their investment strategies. Pre-2008, when liquidity was high and the industry was awash with performance, no one cared a jot about 25 or even 250 basis points of performance gained by doing this arcane back office processing. Today’s custodians are (slowly) waking up to the fact that this performance is important to their customers – they’re just not set up to deliver it.

Custodian, Know Thyself

Most custodians don’t really know their true processing costs. They may know the number of FTEs filling in forms, but they rarely calculate the cost of space, technology or research, much less the inevitable write-offs from inaction or mistakes. Even if they did, most don’t care because their client fee models are based on a simple ‘everything is in one bucket’ custody fee. Even the most reclusive custodian knows that this model is ubiquitously known to be broken. Everyone knows they want to move to an unbundled price model, it’s just that no one wants to be first to have to make the value proposition for unbundling – and that’s because they think of the issue as an administrative task, not a product.

Focus on the Client

Regulatory pressure, such as FATCA from the US and the OECD CRS and AEoI frameworks, means that tax processing is increasingly complex and in future will be linked to annual information reporting – both activities that cost money to no obvious benefit to the client (or the custodian). But there is a benefit when you look at the process as a product. The benefit of being compliant is that you’re getting permission to play in the foreign capital market’s sandpit. Given that the regulators are the fall guys here and not the financial institution, any competent product person would jump on this as a competitive advantage. That really has not been adequately recognized.

There’s also the issue of fiduciary duty, especially in the funds and institutional investor space. In the US, ERISA regulation provides for the fiduciary responsibility of a fund manager with respect to due diligence and performance. It can easily be argued, especially in a world where pension schemes are generally under-funded, that failure to recognize the issue of tax reclamation and failure to act on such knowledge would constitute a breach of fiduciary duty to the pension members. We are aware of the US’ own Department of Labor citing pension trustees for lack of oversight on this issue and where one regulator goes, others often follow.

Client knowledge and pressure has another effect. It means the custodian has to figure out how to expand its resources to cope with the increasing demands from clients in scale, scope and quality. They can’t do that when they are mainly focused on cost reduction. They can’t do that when they think tax processing is administration, not a product.

The end result is that the industry’s pricing model, its focus on task rather than value, and its inability and incapacity to respond to client pressure in this area, holds the industry back from innovation.

Is the Immovable Object Really Immovable?

The tax regulatory and governmental framework in which tax processing sits is equally broken. Both OECD and the European Commission have had TRACE and T-BAG groups working for nearly ten years asking business to come up with a workable solution – and they did. The problem is a failure to implement and a failure to adopt. This, I think, has been mainly caused by the narrow mandates given to these influential groups, which did not allow them to create the implementation landscape that included the regulators. It’s also because these groups failed to make a compelling case for what the governments get out of it. The business case is clear, but the governmental imperative was not well enough explained. They can do it when they want to – compare this with the speed the governments are signing up to AEoI. When governments want information that will let them increase their tax take, they jump at it. So, why not with the OECD and T-BAG proposals? Well, the end result would be that more investors would get tax relief. The current system sees many billions of Euros going unclaimed, so the tax authorities benefit from the inefficiencies of the system. They just don’t see meeting treaty obligations as that important and they definitely don’t ‘get’, or perhaps believe, the fact that a robust and fair tax system will increase direct foreign investment flows to their country’s businesses.

So, while a more streamlined and efficient tax system would increase the flow of capital and benefit investors, the cog that will be most difficult to change will be the treaty system and its infrastructure. In other words, we’re going to be stuck with a paper based, inefficient, fragmented and complex system for some years.

That brings me back to tax as a task or as a product. As the inefficiencies pile up and the regulations get more complex, and as more treaties get signed and emerging markets mature, custodians are faced with an impossible mountain to climb in which networks of variously inefficient counterparties struggle to look as if they know what they are doing – because they underfund the activity and continue to resource it as an unfortunate but necessary ‘task’.

How different would that be if they merely handed the tax reclaim function concept over to their product development team?

Price, unbundled, becomes a differentiator and measure of value, especially in the world of tax. It also becomes a profit centre, not a cost centre. Scale and scope become issues of internal investment to generate a return, not costs to be minimized wherever possible. Quality of service becomes an issue of outsourcing to specialists who can deliver scale, scope and quality quickly and efficiently.

Go for Product!

So, you may think tax is an administrative burden. I think it’s one of the greatest unsung and unrecognized product opportunities for custodians. Ironically, this simple fact is being increasingly recognized by CSDs, but not custodians. Challenged by thin margins on their core businesses, CSDs seem to quite easily see what custodians fail to see – that networks of manually based, limited resource operations can be served centrally by the CSD offering an outsourced service to their clients. In this model, they are able and willing to invest in solutions so that their clients can benefit and margins can be increased. It’s a shame that one level down, this message has been so difficult and slow to permeate.

Is tax an administrative burden or a product? Product – every time.

Image Credit: Alan Cleaver

Ross McGill

Ross is the founder and chairman of TConsult. He has spent over 26 years working in the withholding tax landscape with companies developing tax reclaim software and operating outsource tax reclamation services.

Ross not only sees the big picture but is also incredibly detail oriented. He can make even the most complex issues simple to understand. He has authored 10 books (including two second editions) on various aspects of tax, technology, and regulation in financial services, making him one of the leading authorities in the world of tax.