Many double taxation treaties allow substantial mitigation of withholding tax on foreign dividends. In the case of direct investments, the lower treaty withholding tax applies immediately. On the other hand, if the investment is made through a tax-transparent vehicle (Luxembourg or Irish FCP), the conventional provisions cannot be applied to the latter. Treaty benefits may, however, be granted directly to the investor, who can recover the difference, often considerable, between the standard taxation applicable in the country of residence of the securities issuer and the conventional taxation.
For example, investments in US securities where the gap between the standard tax rate (30%) and the treaty rate (15%, and often 0% in pension funds) translates into a significant amount of the investment’s payoff. Therefore, in order to recover the higher tax applied, the investor may file a request for reimbursement to the tax authorities of the country of residence of the securities issuer in order to be granted the same tax treatment that would have been applied in the event of direct investment.
Aequitax S.A., with offices in Lugano and Luxembourg, represents a network of professionals operating in the legal, tax and banking sectors; a leader in the tax reclaim sector for Italian and European institutional clients, for over fifteen years it has represented the benchmark and the pioneer in procedures for the recovery of withholding tax applied to dividends distributed to vehicles, institutional investors and individuals.
Andrea Ballancin, lawyer, chartered accountant, and professor of tax law at the University of Eastern Piedmont, Italy, helps us to better understand this convenient opportunity.
Withholding tax on foreign dividends in the case of indirect investments, can you explain further?
The provisions of the bilateral tax treaty against double taxation cannot be applied directly to a fiscally transparent fund, which, as such, does not qualify as a "resident person” for the purposes of the Treaty. This party cannot, therefore, invoke the treaty rules as afforded to resident person, however, under certain circumstances these tax benefits may be forwarded to residence of certain participating countries.
In this case, is there any way of requesting the application of the treaty benefits?
The absence of passive subjectivity of fiscally transparent funds does not exclude, however, that, under certain conditions, the tax treatment envisaged by the Treaty is recognized in the hands of the fund participants. In fact, the clarifications made by the OECD in the Partnership Report (2014) and extended also to entities other than partnerships, which recognize the right of the partners of the transparent entity to invoke the conventional benefits, in relation to the income attributed to them, are applicable.
Under what conditions?
It is necessary that the income attributed to the investors is imputed for taxation purposes in their country of residence. For instance, the Italian Tax Authorities have, on several occasions, (rulings no. 17/E of 2006 and 167/E of 2008, Circular letter 6/E/2016 and, most recently, ruling no. 258/2021) clarified that the investors in a tax transparent foreign fund may benefit from the tax treatment set by the treaty between their resident countries and the State of source, under the condition that income is attributed to them for the purposes of taxation in their country of residence.
This condition is met both in the event that the latter country qualifies the fund as tax transparent and income is taxed, no matter if the amount has been received (so-called "fiscal transparency"), and in the event that the fund is a mere vehicle, through which the income flows to investors, to whom they are distributed at least annually on the basis of statutory obligations and on whose behalf they are subject to taxation in the country of residence (so-called "economic transparency").
Are there other requirements for the recipient and what taxation is applied if the above conditions are met?
Generally, there are no other specific requirements for the investors in the fund. Also in this case, as in the case of direct investment, the treaty taxation can be recognised if the recipient meets all the conditions for application of the Treaty, i.e. can be considered treaty entitled and beneficial owner of the income received. The first requirement assumes, in particular, tax liability, within its treaty meaning, i.e. as the attribution of income for the purposes of taxation, even if only potential. The second is that the recipient is the actual beneficiary, with no legal or contractual obligation to transfer the income to another party. If the above conditions are met, it is therefore possible to benefit from the treatment provided for by art. 10, paragraph 2, of the OECD Model, whereby the withholding tax on dividends cannot exceed 15% of their gross amount.
What steps can the investor take, therefore, to recover the higher taxation suffered?
In order to recover the higher amount withheld and thus see the same tax treatment applied as in the case of a direct investment, the investor must submit, within the terms, a request for reimbursement to the tax authority of the State of residence of the issuer of the securities, requesting, if the requirements described above are met, application of the Treaty. It is, therefore, important that investors wishing to take advantage of this opportunity act promptly.
Aequitax will join the FundForum International Panel: Turning regulatory challenges into commercial opportunities on 21st October at 15.40.