Part 3: Regulatory Oversight and Policy Response
In this final instalment of our three-part series, we assess the (in)aptitude of the regulatory bodies during the peak period to properly monitor dividend-related trading strategies and therefore limit their financial impact on the tax authorities. We conclude with a look at the belated policy response by the EU, FASTER, eDective from 2030.
Market Infrastructure
To begin it is worth reminding our reader that certain features of financial market infrastructure, coupled with regulatory challenges, both contributed to the persistence of these trading strategies over more than two decades. For example:
- Settlement periods of T+2/T+3 (or longer if desired), created a temporal distortion of ownership claims, facilitating potentially opaque WHT refund applications.
- Custodian utilisation of omnibus accounts further mired the chain of custody, making it diDicult to trace individual dividend payments directly back to the issuing company.
- High-speed algorithmic trading masked suspicious activity by rapidly executing trades that mimicked legitimate market behaviour.
- Cross-border trading complicated regulatory oversight, as dividend withholding tax refund applications were processed separately in diDerent jurisdictions.Further challenges remained for the regulators, who struggled to detect any real-time misconduct, even if the trades were reported to national Stock Exchanges and National Competent Authorities (NCA) in accordance with market conventions.
The NCA prioritised market abuse regulations over potential tax fraud monitoring, while tax authorities lacked direct oversight of equity trading, thus creating a regulatory blind spot. With minimal collaboration between these entities, this gap enabled these schemes to go undetected for years.
Regulatory Response
Regulatory and policy responses have focused on enhancing cooperation between tax authorities across jurisdictions to prevent single or duplicate fraudulent refund claims. The UK’s Financial Conduct Authority (FCA) has collaborated with European regulators to prevent future abuses of dividend arbitrage strategies. At a broader level, the European Union has introduced measures aimed at tightening cross-border financial oversight to curb similar practices in the future.
- Recent investigations and enforcement actions by financial regulators (such as BaFin in Germany, the FCA in the UK, and the AMF in France) have highlighted concerns about pre- arranged trades facilitating fraudulent withholding tax claims.
- Stronger enforcement measures are being pursued against financial institutions that facilitate abusive tax schemes, holding them accountable for their role in enabling misconduct.
- Real-time monitoring of withholding tax refund applications is being introduced to identify suspicious patterns at an early stage.
FASTER, Better, Stronger?
The European Union has recently taken a significant step toward modernising and securing its withholding tax (WHT) procedures with the introduction of the FASTER Directive (Faster and Safer Tax Relief of Excess Withholding Taxes). ODicially adopted by the Council on 14 May 2024, this new framework is designed to combat tax fraud while streamlining the process for investors seeking tax relief on cross-border dividends and interest payments. Against the backdrop of the dividend arbitrage strategies, responsible for an estimated €150 billion in tax losses over two decades, the directive aims to create a more eDicient, transparent, and fraud-resistant system across the EU.
At the heart of the reform is the introduction of a common EU Digital Tax Residence Certificate (eTRC). Traditionally, tax residence certificates have been paper-based and subject to cumbersome administrative delays. With the eTRC, investors will now be able to obtain certification almost immediately. The directive also introduces a relief-at-source mechanism, whereby the correct withholding tax rate is applied at the time of dividend payment. Finally, another key aspect of the FASTER Directive is the enhanced role of financial intermediaries, who will now have standardised reporting obligations.
Conclusion
Ironically, the directive only requires EU member states to transpose its provisions into national law by 31 December 2028, with the new rules set to apply from 1 January 2030. One could cynically observe that the implementation of this Directive, circa 15-20 years after the period that remains the subject of ongoing litigation, is a sign that the regulations did indeed contain loopholes, and that the Cum-Ex and WHT reclaim prosecutions are more a politically motivated, face-saving exercise by national tax authorities, admitting they had fallen asleep at the wheel.
We hope you have found this series of posts informative and enjoyable to read. Should you have any further enquiries about all-things Cum-Ex and WHT Schemes, do not hesitate to contact srb@objectivus.com or kmt@objectivus.com