4 Big Burdens in Dealing with Tax Regulations and How Financial Institutions Can Ease Them

Financial institutions are constantly called on to untangle the complexities involved in identifying domestic and cross-border tax requirements in connection with financial products or alternative financial instruments for issuers or individuals. Staying informed is simply the prerequisite to being able to execute monitoring, tax-withholding, and reporting processes in accordance with law.

Here are four of the biggest challenges when it comes to fulfilling tax compliance obligations:

Complying with stamp duties and financial transaction taxes (FTTs) on securities and derivatives is already a demanding challenge today. But managing FTTs is becoming even more challenging because an increasing number of countries are introducing or modifying transaction taxes. Compounding the complexity is the fact that adjustments often have to made within a very short time frame. When the French ministry of finance, for example, publishes its official list of companies subject to FTT on December 21, compliant handling and settlement have to function properly starting on the first trading day of the new year.

Financial institutions must accurately and efficiently identify currently valid as well as future FTTs and must be capable of dealing with them accordingly. They need up-to-date country-specific data on all securities and derivatives affected in order to be prepared when FTTs enter into force. Pre-trade checks and the fulfillment of operational requirements are needed in order to be able to calculate taxes on eligible transactions. Continuity must be ensured even if public authorities communicate their information at short notice.

A lack of knowledge is one of the biggest problems in connection with withholding taxes. The vast majority of investors currently receive no or only a small withholding tax refund because the critical information is missing and the procedures are cumbersome. This owes in part to the multitude of double taxation treaties, national legal provisions, and European Court of Justice rulings.

Financial institutions need customized data services and solutions that enable them to comply with country-specific tax regulations within the prescribed time frame. Every legal system has its own deadlines, which sometimes coincide with the dividend-payout date or may be harmonized with the calendar year or fiscal year.

Asset managers have to deal with more complexity than ever these days when it comes to navigating individually applicable tax regulations for investors in connection with investable financial products and their associated tax charges. Conducting suitability checks can be very costly and time-consuming.

Investors are becoming more and more demanding and are increasingly requesting information about the tax implications of their investments. Client advisors need tax data at an instrument level that take their clients’ profiles and asset portfolio structures into account. The comprehensive tax manuals available do not provide any help here.

Enhanced and enriched data are needed in order to make investment decisions that are sensible from a tax standpoint and that comply with regulations. The data must be complete and up to date and must be granular enough to reveal the actual tax implications of an investment. Gaining insights about tax implications at the level of individual securities and the ability to anticipate tax-related expenses enable asset managers to optimize their clients’ investment portfolios.

The US Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions to disclose information on US accounts or to levy a tax on them. Furthermore, more recent tax laws such as Section 871(m) and Section 1446(f) of the US Internal Revenue Code also apply to non-US persons and could compel them to submit a US tax declaration. This means, for example, that under Section 871(m), the US Internal Revenue Service (IRS) also taxes non-US citizens living outside the USA if they hold derivative financial products based on US stocks as their underlying asset. Identifying such instruments is a difficult task that requires a thorough understanding of equity-linked derivatives.

Section 1446(f), which imposes an additional withholding tax for non-US citizens living abroad and not holding a green card, entered into force on January 1, 2023. The regulation applies if such a non-US person sells shares in a company that US tax legislation classifies as a publicly traded partnership and which pays income taxes in the USA.

Financial institutions must collect and analyze an enormous amount of new data in order to comply with the IRS’s regulatory requirements, to classify clients and counterparties, and to be able to execute withholding tax processes. Data are needed to determine which companies are publicly traded partnerships under US tax law, and data are needed to flag clients whose tax domiciles differ from the jurisdiction of their accounts.