Securities taxation: Why custodians must adapt

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Dennis Burgers: Hi, you're listening to Market Matters, our market series here on J.P. Morgan's Making Sense Podcast. I'm Dennis Burgers, co-head of EMEA Security Services Sales. And I'm joined by Rebecca Willmott, an executive director in our Security Services Tax Custody Product Team. Welcome Rebecca.

Rebecca Willmott: Glad to be here, Dennis.

Dennis Burgers: In today's episode, we're going to be focused on the Securities Taxation Landscape in EMEA from a custodian perspective. The securities taxation industry seems to be at something of an inflection point. The rapidly transforming tax regulatory environment requires a heightened focus on data, but also on technology and tax risk management. Global custodians, now more than ever, must strengthen their positive and productive partnership with tax authorities and clients alike to ensure the continued delivery of an optimal tax service offering. There is, of course, no shortage of regulatory changes pertaining to taxes. Now, zooming out just a bit, as global authorities have introduced further measures to combat tax abuse. Rebecca, I'm just curious how exactly has the world of custodian tax grown in complexity?

Rebecca Willmott: It's an instance of simple cause and effect, Dennis. On the one hand, we see institutional investors have been swinging for the fences in trying to generate alpha. And to that end, they've been diversifying their investments, which means, and you can probably see what's coming next, an increased demand for tax services in new jurisdictions, and therefore consideration of new rule sets. Transparency is absolutely in. The reporting burdens have been augmented, but in parallel, there's been an ongoing uptick in the volume and complexity of tax market change. So custodians are no longer simply concerned with withholding taxes, but we're faced with now administering a wide range of other tax types. And not only that, new anti-abuse mechanisms have also required an agile response. So in a nutshell, global custodians and clients alike are experiencing heavier tax compliance obligations.

Dennis Burgers: Got it. And I imagine that part of experiencing heavier tax compliance obligations means providing good tax data, right? That means cracking down on bad actors, and I'm not talking about C-list Hollywood actors. I'm talking about those engaging in adversarial tax behaviors.

Rebecca Willmott: Absolutely. Through this increase in regulatory requirements, tax authorities are also calling on financial services to support their policing of these types of tax behaviors and that's happening more and more. We're increasingly required to deliver well-governed client tax data. So to the point just being discussed, reliable data should always be the beating heart of sound tax compliance, and arguably inaccurate data in the context of tax can result in a bit of a logistical dumpster fire. So it's no longer enough to simply pay the right amount of tax. Tax authorities are now demanding detailed information on the claimants themselves. And the expectation is that that will in part be delivered by the custodial community as the holders of the CBOR, the Custody Book of Record. Therefore, having robust client tax data, and not only that, an efficient and seamless mode to extract and deliver that data to both clients and tax authorities has become paramount.

Dennis Burgers: That makes sense, Rebecca. Thanks for that. Custodians must seamlessly and reliably deliver client tax data. It's out with the bad actors and it's in with transparency and compliance. Now, let me ask you this. Whenever I hear seamless or frictionless, I wonder what tech enhancements are helping custodians deliver their client needs? So tell me, what's the role of technology on custodians in terms of tax?

Rebecca Willmott: Yeah, so custodians are focused on ensuring that the investor appetite for this real-time data we've been talking about and technology expectations of the moderators of our world are met. The purpose should be viewed as twofold. On the one hand, to enhance the client support model in an area that can be prone to risk, as we've discussed, but also to assist in ensuring compliance with this ever-expanding tax rule set referred to above. The critical question, as always, is where do we get the biggest technology yield associated with the delivery of our tax service offering? And not only that, that will help us further streamline and optimize the end-to-end tax processes. So to give you some examples, in the last few years, a common challenge in the space for custodians has been the need to respond to the ever-increasing trend of reclaiming inquiry letters. So what do I mean by that? This is where we submit tax reclaims on behalf of our clients to tax authorities, and rather than refund those tax reclaims straight away, the tax authorities send inquiry letters. So they send detailed questions, in some instances, in relation to the reclaims, which we have to respond to. So devising efficient ways to manage those types of demands from an internal perspective has to be the priority. Ditto, when it comes to devising technology solutions in tax documentation, a critical space. The ability to be able to digitally consume, review, record, and store tax documentation, within our walls, also in a secure streamlined fashion is the way forward. So in all cases, when we're thinking about tax and technology now, a key priority is looking at the range of technology options available. It might be OCR, workflow, application programming interface and more.

Dennis Burgers: And what about AI and other newer forms of technology, how are they figuring in these discussions and how are we seeing the tax authorities response?

Rebecca Willmott: It's a good question, Dennis and highly topical. Custodians, such as us, have found value in some cases partnering with technical providers and fintechs alike. AI has already played a role for some time in our space, particularly in the regulatory horizon scanning space, but we continue to look at it in terms of how it can ease operational burdens. So removing those non-complex repetitive tasks enabling us to equally redeploy partners, likewise in the case of blockchain, another newer technology you could argue, the business case is sound. Having an immutable tamper-proof record in the context of tax absolutely makes sense, but the industry just isn't there yet in terms of being able to create a blockchain-enabled withholding tax ecosystem. But those efforts continue. It's also worth highlighting, and this might be a surprise to some people, that the need for a sound tax technology strategy has been equally driven by the tech transformation on the parts of the tax authorities themselves. That in turn has clearly enabled them to more deeply scrutinize the data that they're getting at their hands, which has also resulted in an easier path to investigations. So to keep up with the moderators of our world, the fiscal authorities of our world, we need to be at a minimum on an equivalent technology path.

Dennis Burgers: That seems inevitable. AI is pervasive. With all of these advances, how do custodians mitigate risk?

Rebecca Willmott: Yes. All of this has to be considered now more than ever, against the backdrop of requiring a really strong tax risk management focus. It must be acknowledged that there's an incontrovertible need in the current tax domain, compounded by a more hostile enforcement environment to build a resilient response to mitigate the tax risks present. The response has to demonstrate a clear articulation, not only of the tax risks there are, but accompanied by an efficient and practical plan to respond. So in that way, we recall the OECD's pronouncement, the concept of a tax control framework. It absolutely makes sense. Housing in one place, all the tools, techniques, and organization arrangements needed to ensure that not only are tax risks identified, they're assessed and duly mitigated.

Dennis Burgers: So Rebecca, what can we expect ahead? Will risk management and increased vigilance get easier? I know there's been a lot of recent regulatory work, including the FASTER directive that was approved last year, the new piece of legislation out of the European Commission.

Rebecca Willmott: Dennis, I'm glad you mentioned FASTER, which stands for Faster and Safer Tax Relief of Excess Withholding taxes. I'm going to come back to that more in a minute. But we're continuing to see EU efforts to streamline existing withholding taxes across the region. We've long acknowledged that a key barrier to efficient withholding tax relief processing really derives from a lack of harmonization in the EU. So as a region as well, not only did EU jurisdictions comprise the critical mass of a typical world index, but they also represent where the most withholding tax activity is generally required. So as a result, the current disparate rule set has been a common source of concern across the industry for many years, but it's not gone unnoticed, and there've been a number of efforts over the years to try and really improve the situation. And that's not just born out of concern around taxing, the current status quo. Also hinders cross-border investment, but also increases the cost of cross-border trading and generally acts as a barrier to achieving a single European market. So the position was arguably the genesis for the OECD's TRACE package. That stands for Tax Release and Compliance Enhancement Package, which sought to provide a standardized approach to withholding tax processes. Finland was the first jurisdiction to Go-Live in '21, and others suggested they would follow. Then in 2017, again, we saw the European Commission come forward with a code of conduct on withholding tax. Again, really seeking to address the current unrecognized inefficiencies in the system. Fast-forward to 2020 and the commission set out proposals yet again to deliver a streamlining of withholding tax processes as part of the Capital Markets Union Action Plan. Then followed a publication of a results and impact assessment in 2021 and the release of a public consultation in April 2022. And matters really came to crescendo last year with the fast directives that we mentioned at the beginning. It's a substantive EU tax directive, and fair to say, it's going to change the face of withholding taxes in the region over the next few years. So there's a huge amount of work already underway for successful implementation before Go-Live in 2030.

Dennis Burgers: Well, it certainly sounds there's lots going on in the EU in this regard. Any final words, Rebecca?

Rebecca Willmott: I just want to reiterate that the world of securities taxation is in a state of flux. Custodians have to be ready to deploy an agile approach in the face of the myriad of activity described, but clients also have to remain vigilant in order to maximize performance whilst at the same time maintaining a rigorous compliance standard.

Dennis Burgers: Well, that all sounds very great. Thank you, Rebecca.

Rebecca Willmott: Thank you, Dennis.

Dennis Burgers: And thank you everyone out there for listening to Market Matters, our market series here on J.P. Morgan's Making Sense podcast.

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