Spanish Association of Collective Investment Schemes and Pension Funds

INVERCO REPLY TO THE EUROPEAN COMMISSION CONSULTATION ON TAXATION PROBLEMS THAT ARISE WHEN DIVIDENDS ARE DISTRIBUTED ACROSS BORDERS TO PORTFOLIO AND INDIVIDUAL INVESTORS AND POSSIBLE SOLUTIONS 1.- INTRODUCTION INVERCO is the Spanish Association of Collective Investment Schemes and Pension Funds, which represents more than six thousands collective investment schemes and 1,400 pension funds, with more than EUR 303 billion in assets under management. INVERCO highly appreciates this extremely important and timely initiative from the European Commission, that ideally should end up in the adoption of a regulatory step to harmonize this issue across Europe and to eliminate the inefficiencies caused by the coexistence of very different systems for the levying an crediting of withholding taxes on dividends payments to non-resident portfolio and individual investors in each Member State. Both European bodies in charge of regulation, and in particular European Commission, as well as financial industry in general, and specially that involved in collective portfolio management, have made a great effort in the last 25 years to allow the single market to become true. The regulation of the initial and on-going conditions for service providers (investment firms), the establishment of requirements for the issuance of securities (both as regards public offers of securities and requirements for securities to be listed on a stock exchange), the ensuring of efficient financial markets infrastructures (such as well-functioning cross-border clearing and settlement processes), the co-ordination of the conditions applicable to undertakings for collective investment in transferable securities (UCITS) or the strengthening of the supervision in the financial sector in Europe are only a little sample of the huge regulatory framework which has been adopted to this goal. These regulations have contributed to harmonize the regulatory landscape applicable to financial markets across Europe, to reach a more efficient allocation of capital and to enhance the framework for the investor protection. But it should not be forgotten that those policies tending to improve the single market in financial services should also be designed and assessed from the perspective of the investor s economic rights, which must be protected against any unnecessary levy which rest attractive and reduce the effective rate of return on his/her investments. Avoiding not only discrimination but also double taxation and costly and time-consuming procedures to claim refunds of tax withheld play a major role in the smooth functioning of the internal market and therefore any initiative undertaken by the European Commission aiming to these goals will be welcomed. Besides the completion of the questionnaire in Section 4 of this document, a brief description of the Spanish legal tax regime for Investment and Pension Funds is provided in Section 2, together with some figures about the importance of the investment in European equities by those entities in Section 3. -1-

2.- LEGAL TAX REGIME FOR SPANISH INVESTMENT AND PENSION FUNDS In Spain, both Investment Funds (either corporate or contractual forms) and Pension Funds have the condition of taxpayer of corporate tax, although they are levied at the rate of 1% and 0%, respectively, instead of at the general rate (30%). The condition of taxpayer determines the following consequences for Investment and Pension Funds: These vehicles are not subject to a fiscal transparency regime. Investors do not have to include the capital gains, interests and dividends obtained by the vehicles on their own annual tax return. Rather, they will include them when they sell the Fund (in the case of Investment Funds) or perceive the benefit (in the case of Pension Funds), for the positive difference between the selling price and the buying price. Compared to the direct investment in the underlying assets, this regime is completely neutral for Pension Funds investors (who are not subject to any additional indirect tax, as the Pension Fund is levied at a rate of 0%) and almost neutral for Investment Funds investors (as, besides their personal direct tax, the investors support the corporate tax charged to the Fund which, as stated before, is levied at a rate of 1%). Investment and Pension Funds have periodical information duties to comply with tax authorities. As levied at a rate of 0% or 1%, Investment and Pension Funds do not benefit from any deduction or exemption in the taxable income to avoid double international taxation. Investment and Pension Funds are eligible for the application of Double Tax Conventions (DTCs). Most of them limit Source State taxation rate on the dividends to 15% and require the State of residence to grant relief for source State taxation through a credit or exemption mechanism, but, as Investment and Pension Funds are subject to a 1% or 0% rate, at the end this withholding tax becomes a final tax. Capital gains, interests and dividends of Investment and Pension Funds investments are subject to withholding at a rate of 19%, when appropriate. At the end of the year, these vehicles have to present an income tax return, which allows them to obtain the refund of all the withholdings in those investments where the Source State is Spain (in the case of Pension Funds) or of the remaining amount, once discounted taxable income at the rate of 1% (in the case of Investment Funds). On the contrary, when the company which distributes the dividends is resident in a State other than Spain, the withholding applied to Spanish Investment and Pension Funds which will be calculated according to the Source State rules, at a rate which normally ranges between 19% and 21%- cannot be deducted from the final tax. As DTCs in force use to establish a lower rate (commonly, 15%) only the difference between the general rate and 15% is claimed, so the rate established in the DTC becomes a final tax. -2-

3.- FIGURES ON THE IMPORTANCE OF EUROPEAN EQUITIES ON SPANISH INVESTMENT AND PENSION FUNDS PORTFOLIOS According to statistics published by the Spanish Securities Commission (jun-2010) and by the Directorate General of Insurance Companies and Pension Funds (dec-2009), total investment of Pension and Investment Funds in European equities amounts to around EUR 18,000 million. Notwithstanding, the previous figure only includes direct investment, but it must be considered that these vehicles also invest a considerable volume of their assets in other domestic or foreign Investment Funds, which in turn hold European equities in their portfolios and which face the same withholding tax problems in case of receiving cross-border dividends. This indirect investment in European stocks through Investment Funds is calculated in EUR 5,300 million. 4.-ANSWER TO THE QUESTIONNAIRE I. General identification of the stakeholder Name: INVERCO State of residence: Spain Contact details: Ángel Martínez-Aldama. Managing Director. mailto: am-aldama@inverco.es Are you: An individual investor An organisation representing such shareholders Tax administration of a Member State Tax advisor or tax practitioner A portfolio shareholder An equity fund An academic Other (please specify) II. Problems encountered 1) Which problems, if any, have you encountered due to the EU cross-border levying and refunding of withholding taxes on dividends? Double taxation Discrimination Other (please specify) -3-

The main problem reported by our members is related to the difficulties in obtaining the refund of foreign withholding taxes. These procedures are often very long, expensive and full of red tape. It is not easy to ascertain if under these complicated procedures double taxation or discrimination issues underlie, although it seems reasonable to consider that citizens or portfolios resident in the Source State are not subject to so many requirements nor to so long periods to obtain the refund (please see examples provided on the answer to the next question). 2) What was the source of the problem? Denial of credit for foreign withholding tax Higher taxation of foreign dividends than in purely domestic situations Difficulties in obtaining a refund of foreign withholding taxes the procedures were (please specify): too complex, costly, time-consuming Other (please specify) III. Additional costs 1) Have you suffered any additional costs due to the cross-border investment in dividends? Yes No 2) What is the amount of these additional costs and what were they due to? In the following lines, some figures are provided, but please note that there is not available aggregated information for the whole industry. Figure 1. Real data collected from Spanish management companies. A number of Spanish management companies of both Investment and Pension Funds are currently claiming EUR 21 million withheld to Funds whose total assets amounts to EUR 4,225 million to tax authorities from France, Netherlands, Italy and Germany. This means that these withholdings are impairing the performance of the Funds in 0.50% in average, although in certain cases this impairment exceeds 1.30%. Figure 2. Expenses incurred to obtain the refund of withholdings from tax authorities. In order to obtain the refund of withholdings, Spanish management companies have to enter into complicated procedures, of which costs vary from 10% to 60% of the amount refund, depending on the Member/s State/s of Source of dividends, the number of issuers (i.e. certain tax authorities only allows to claim the refund of withholdings regarding two issuers for application) and the amount to be refunded (as economies of scale are very important on these procedures, and legal assistance tends to be cheaper the bigger the refund claimed). -4-

Figure 3. Estimation of the likely impact for the whole Spanish industry. It has been estimated at around EUR 260 million per year. For this estimation, the following data have been used: - Total investment of Pension and Investment Funds in European equities: EUR 18,000 million (source: Statistics of Spanish Securities Commission and of the Directorate General of insurance companies and Pension Funds). - Average rate levied to withholding on dividends: 23.125 % (source: simple average of withholding on dividends rate, considering only the relevant Source Member States according to the portfolio composition of Spanish Investment and Pension Funds, which are Belgium, Finland, France, Germany, Italy, Ireland, Netherlands and Portugal). - Average dividends yield of Eurostoxx 50 index in the last five years: 4.25 % (source: Bloomberg). - Average expenses incurred by the management companies to obtain the refund: 35% of the withholdings claimed (source: weighted average obtained from the information provided by our members). Other additional costs not included in the previous estimation are those related to the requirement of non standardized documents by the competent tax authorities of the Member State of source of the dividend (i.e. a translation into English of the articles of incorporation of the Pension Funds which claim the refunding) or certain certificates to be issued by the tax authorities of the Member State of residence which cannot always be obtained, as they do not respond to habitual templates and demand an ad-hoc action. 3) Have these additional costs dissuaded you from investing cross-border? These issues constitute a major obstacle to the cross-border investment, although most members report that the main effect of taxation problems when dividends are distributed across borders is to reduce the effective rate return of the Funds rather than to dissuade the investment. 4) Which was the Member State of source of the dividend (please indicate for each separate case in which you have suffered additional costs) The main countries where the Spanish Funds have faced problems are Belgium, Finland, France, Germany, Italy, Ireland, Netherlands and Portugal. In the table below, they are shown, in percentage, the amounts pending of refund related to dividends paid in the period 2004-2010. Please note that these percentages are referred to a little sample of Spanish Funds and to procedures in different countries, and the terms are not the same in all of them. In particular, most of our members have reported special problems with Italy, where the time to get the refund is too long, even exceeding 7 years. -5-

Year Already refunded Pending of refund 2004 99,30% 0,70% 2005 62,66% 37,34% 2006 95,74% 4,26% 2007 23,93% 76,07% 2008 38,80% 61,20% 2009 4,53% 95,47% 2010 0,00% 100,00% Total 33,10% 66,90% 5) Which is/ was your Member State of residence All the Investment and Pensions Funds included in the scope of this answer are registered in Spain. IV. Possible solutions 1) Which (combination) of the above outlined solutions do you consider most appropriate to tackle any taxation problems that arise when dividends are paid across border to individual investors or to companies that are portfolio investors? Why do you prefer that option? The preferred solution is the abolition of withholding taxes on cross-border dividend payments to portfolio/ individual investors (option 1). This measure could be combined with exchange of information between Member States tax authorities to avoid risk of tax evasion by non-resident investors who do not report their income in the residence state, although this risk is non-existent in the case of Spanish Pension Funds, or insignificant in the case of Spanish Investment Funds, as they are exempt or levied at a reduced rate of 1%, respectively. If this solution would not be feasible, it would also be acceptable the application of a general EU-wide reduced rate of withholding tax with information exchange (option 4). Probably this is the most realistic option, as it would have a minor impact over tax revenues of Member States since it does not requires abolition of withholdings, is more respectful with Member States fiscal sovereignty and with the principle of subsidiarity in the European Union. 2) Would you prefer a completely different solution and if so what solution do you suggest? No, options 1 or 4 would solve appropriately the issue. -6-

3) What, if anything, else do you think could be done at EU level to overcome any difficulties that exist in the area of cross-border withholding taxes on dividends paid to individual and portfolio investors? Besides the adoption of one of the measures mentioned in question 1, and while its full implementation, it would be necessary to improve and harmonize the procedures to: - reduce the withholding tax rates at source, when the non-residents are entitled to a lower withholding tax rate or to a exemption in the Source state pursuant to Double Tax Conventions and to - claim refund of tax withheld, which, as stated in the Commission Recommendation of 19 th October 2009 on withholding tax relief procedures and shown in the examples provided on previous questions on this questionnaire, are often complicated and vary considerably among Member States. Inverco fully agrees on the improvements proposed in the aforesaid Commission Recommendation that could be introduced in the current procedures, and in particular, with the following measures: - permission for information agents or withholding agents to submit refund applications to the tax authorities of the source Member State on behalf of the investors; - use of a single contact point for the introduction and handling of all the refund applications and publication of the relevant information on refund procedures on a website, in at least one language customary in the sphere of international finance; - use of common formats for refund applications which would be able to be filed electronically; - allowing alternative proofs of the entitlement of investors to tax relief, besides certificates of residence, such as self-certification and the identification information held by financial intermediaries under the duties set by Council Directive 2004/39/EC of 21 April 2004 on markets in financial instruments - refunding in a reasonable period of time and normally, at least, within 6 months of receipt of the refund application by the relevant tax authority, provided that all necessary information is available. It should also be very welcome an harmonization across Europe of the procedures and documents to be presented for the reduction of the withholding tax rates at source and for the claiming of refunds, and the adoption of templates, as long as this measure would not have economic impact for the tax revenues of Member States, while increasing the efficiency and simplicity of these procedures. 4) Are you aware of any statistics or legal or economic studies which could further contribute to the analysis of the costs and benefits of implementing any of the above solutions? Unfortunately, we are not aware of any study on this issue. -7-

5) Do you have any other comment or thoughts to share as regards cross-border taxation of dividends paid to portfolio and individual investors? Member States have a legitimate right to protect their tax revenues and to adopt the necessary measures to enforce taxation, preventing tax avoidance and evasion by taxpayers. There are several tools to achieve this goal, but not all of them are equally respectful with investor s rights nor have the same effects on the smooth functioning of the single market. In the last decade, financial intermediaries have undertaken a great effort to improve their activities and procedures, in order to ensure investor protection, to foster transparency by a major disclosure of information, to reduce systemic risk by increasing capital requirements and improving the methods for its calculation and to promote internal control on their daily functioning. The same challenge has been put in place by the financial authorities in charge of the authorization, registration and on-going supervision of financial intermediaries, where, under the principle of mutual recognition, it has been established a framework of close cooperation among financial authorities. A similar process should be also applied to European tax authorities, which play a major role in the achievement of a single market, and that could make a great contribution by reducing red tape in those administrative procedures where they are involved, by sharing information with other tax authorities and by automating procedures; in short, by removing those obstacles of tax nature that reduce the efficiency of the single market. Madrid, 28 th April 2011-8-