TREATY RELIEF AND COMPLIANCE ENHANCEMENT
Finland adopts TRACE-procedure - What are the implications for financial institutions?
As a pioneer among OECD countries, Finland officially introduced the TRACE (Treaty Relief and Compliance Enhancement) procedure on January 1, 2021. Financial institutions across the globe may now participate in the TRACE-procedure in order to exempt their investors from withholding taxes on Finnish dividend payments.
Find out what custodians and financial service providers need to know about TRACE.
What is TRACE?
TRACE is part of an implementation package adopted by the Organization for Economic Cooperation and Development (OECD) in 2013. TRACE was created in order to make financial transactions more transparent and standardize the withholding tax process among member states. What is new with TRACE is the role of an authorized intermediary (AI), i.e. an organization that acts as an intermediary to reclaim withholding tax claims on portfolio investments. Both the custodian and the depository banks themselves can act as an AI. Consequently, if financial service providers wish to apply relief at source via TRACE, they must either register as authorized intermediaries themselves or appoint an AI (such as the custodian or another registered financial institution).
Which countries participate in TRACE?
Finland is the first, and so far only, OECD country to incorporate the TRACE guidelines into its applicable law. However, participating in TRACE has not been made mandatory. Financial intermediaries and investors may still make use of the existing alternatives to TRACE: the downstream refund procedure (standard refund) and the Finnish Tax at Source Card.
Is participation in TRACE mandatory for countries?
For OECD members, TRACE constitutes a guideline, not an obligation. Whether or not other OECD countries will follow the Finnish lead has not yet been announced. However, it can be assumed that other countries will soon follow, adhering to the EU’s economic stimulus package adopted in 2020.
Why was TRACE developed?
TRACE was developed by the OECD in cooperation with tax authorities and financial industry stakeholders in order to standardize the double taxation process in OECD countries. As such, TRACE aims to eliminate administrative hurdles, minimize administrative costs for all parties and ensure data protection through fewer numbers of parties involved. Last but not least, TRACE also serves to prevent the abuse of cum-cum and cum-ex transactions and the associated unlawful recovery by third parties.
How does TRACE work?
If financial institutions want to exempt their investors from Finnish withholding tax in advance or apply for quick refund, they must now follow two steps:
- Registration as an authorized intermediary (AI): custodians or depository banks wishing to participate in the TRACE process must register as an AI with the Finnish tax authority once in advance.
- Transmission of the annual report: In a tax reporting to the country of the issuer (i.e. Finland) the AI is obliged to disclose all (Finnish) dividend income paid to its custody clients once a year or alternatively deliver a so-called Nil-reporting. In order to be allowed to transmit this information to Vero Skatt, i.e. the Finnish tax authority, the consent of the investor is required.
What are the implications of TRACE for custodians?
For custodian banks, TRACE brings simplifications but also risks, as the AI closest to the beneficial owner bears sole responsibility for the accuracy of the collected data. Time will tell whether depository banks will actually register as authorized intermediaries or rather insist that custodians register as such, for the latter will position custodians closest to the beneficial owner and thus assume responsibility for the accuracy of the information.
Starting January 1, 2021, TRACE has led to various changes for custodians: First, the Finnish taxation principle has changed: If application for relief at source is not filed, the withholding tax withheld by Finland will increase from previously 30% to now 35%. The applicable tax rate is generally based on the information about the beneficial owner available to the Finnish authorities.
Furthermore, custodian banks participating in TRACE must now prepare a tax report in which investor-related data is provided as specified by the Finnish authorities. In order to being able to fully collect all the required data, Finland recommends the use of an investor self-declaration (ISD), which is used to query the data of the beneficial owner. The ISD should thus serve as a basis for tax reporting. Transmission of data to the tax authorities can only start when banks or custodians have obtained all the information needed.
What happens if custodian banks do not participate in TRACE?
If a custodian bank does not participate in TRACE, this means that a higher tax rate of 35% will initially be levied on its investors. However, the custodian bank can exempt the high taxation in advance with the help of either a standard refund or the Tax at Source Card (yet, this involves a time-consuming process that custodian banks often prefer to refrain from).
How can RAQUEST help?
RAQUEST is an automated software for reclaim, relief at source and quick refund of foreign withholding tax. RAQUEST enables a secure and digital transfer of all information between the core banking system and the relevant tax authority. Banks thus benefit from a software that can map the complete reclaim process digitally, transmitting all necessary data without errors and in a timely manner. A special benefit of the application with RAQUEST is the unlimited traceability in the application process.
Our withholding tax experts are always fully informed about the current developments of the TRACE procedure and will be happy to advise you.