Taxing times

UK investors have rather forgotten about withholding tax because of the impression that there is no longer such a tax on the dividends that companies pay to their shareholders. There used to be. It was somewhat euphemistically called ‘advance corporation tax’ and pretty well the first thing that Gordon Brown did when he became chancellor back in 1997 was to scrap it. Thereby – and at a stroke – he cut the UK-derived income of pension funds by about a third and helped speed the collapse of defined-benefit pension schemes that is still playing out today. True, private investors were sheltered from this measure and even today they get a dividend tax credit that, in effect, substitutes for claiming back tax on dividends that would have been fatter if the withholding tax still existed.

Enough of the history lesson. The point is that UK investors may have forgotten about withholding tax on dividends, but it is still very much a fact of life in most parts of the world and dealing with it is a pain in the you-know-where – a pain that’s likely to get more intense if investors pursue the need to work acceptable amounts of ‘Brexit-free’ capital and income into their portfolios. In practice that’s likely to mean holding shares in companies listed on overseas exchanges, which pay dividends under foreign tax regimes and in currencies other than sterling.

As Table 1 indicates, almost all advanced economies where investors are likely to put investment capital have a withholding tax regime for dividends; the only notable exception is The Netherlands. That means dividends are received net of tax that is charged at rates shown in the table.

Of course it’s not as simple as that because the world is also full of ‘double taxation treaties’, which are exercises in fiscal back-scratching agreed between any two countries and in which the UK is the world leader with, apparently, more such treaties than any other nation. In effect, these treaties reimburse taxpayers in country A – wholly or, more likely, in part – for taxes paid on income derived from country B so long as country A treats country’s B’s taxpayers in the same way.

Table 1 also shows the refund rates, the proportion of the tax that can be claimed back. So, if I receive $70 of dividend income from a holding in a US-listed company, that amount would have been paid net of $30 tax of which the tax treaty would allow me to claim back $15. Ditto the same rates of tax and refund for dividends received in euros from France and Belgium and – coincidentally or not – the net rate of tax after refunds is 15 per cent not just for those in the table but pretty well for every country with which the UK has a treaty. Don’t ask me why.

So far, so simple. But it’s in the process of actually claiming back the tax that things become time-consuming and potentially messy. That messiness may be mashed up further by the fact that nowadays most UK investors are likely to have most of their equity investments in an individual savings account (ISA) and therefore their beneficial ownership is hidden inside a nominee account administered by an ISA manager. So an important element in claiming back withheld tax is the amount of input provided by the ISA manager.

That is likely to vary. In the case of capital invested in US or Canada-listed equities, the matter seems fairly straightforward. ISA managers are used to processing the W-8BEN form that an investor must complete to claim a refund. Considering that the US tax code is a study in unnecessary complication, the form is pleasantly simple. It’s just a one-page affair that goes to the paying agent, lasts for three years and should mean that the tax is refunded with little effort from the investor.

Would that the process were as simple for other countries. Not that it’s necessarily dauntingly complicated. For example, the claim to rebate German withholding tax is also simple enough and the form automatically fills itself out in triplicate (one copy for the UK’s tax authorities, one for Germany’s and one for yourself). The tedium may be in proving that the claimant is, indeed, the beneficial owner of the stocks on which the dividends have been paid, sending a copy of the form to the HMRC, getting it back, then forwarding the certified form to Germany’s tax office. But, generally speaking, that’s what must be done.

The form to reclaim dividends paid by some of Switzerland’s world-class companies – Form 86 – is similarly simple and comes in a qdf format that makes it easy to import data. But the award for the simplest and most accessible claim form – in my very limited experience – goes – wouldn’t you know it? – to Norway. Is it just a coincidence that the world’s best-run country on so many measures also manages to make refunding withholding tax so straightforward? The sad thing is that the Oslo stock exchange isn’t bursting with household-name companies and it has an understandable bias towards the energy sector. Still, it trades shares in at least 40 companies whose equity is valued at £1bn-plus, so it may well be worth sniffing around.

Meanwhile, what got me started on this trawl through the withholding tax forms of the developed world was my intention to buy shares in Belgian wire maker Bekaert (BE:BEKB) for the Bearbull Income portfolio. Miserably, Belgium’s refund form – form 276 – may be one of the most complicated, hindered by the fact that it juggles four languages through its six pages; happily English is one of them. It’s hardly an exaggeration to say that my broker broke out in a cold sweat and began to jabber uncontrollably when I told him of my intention to buy shares in a Belgian company. Then he steeled himself and told me in his most resolute terms that the responsibility to claim the tax rebate on Bekaert’s dividends was mine and mine alone.

He also added – and this serious point applies to all dividends from overseas-listed securities – that the refunded tax could not go into an ISA account. In other words, that little slice of dividend income would lose its tax-free wrapper forever, unlike the dividend income paid by London-quoted companies.

I haven’t completely given up on putting Bekaert’s shares into the income portfolio, but the obscurity of bits of Form 276, the potential that creates for incorrect answers, and the problems that’s likely to present to my HMRC office, which must authenticate the claim, all mean that I need some specialist advice before I proceed.

Inevitably, there is also this thought: this pursuit of overseas capital and income, is it worth the candle? That applies not just to Bekaert’s shares, but to shares in all overseas-listed companies. After all, if the primary motive is, in effect, to park capital clear of the fallout that will accompany whatever form of Brexit the UK finally gets, then – as Table 2 indicates – there are plenty of funds on offer that will do much the same job but without the hassle of the form filling and the loss of ISA benefits. The six investment trusts shown in the table, for instance – they all offer an acceptable dividend yield from income generated from holdings almost wholly outside the UK. Even the lowest yielding one – Scottish American (SCAM) – offers a 3.0 per cent yield, which is the equivalent of 3.5 per cent from an overseas-listed stock where the tax refund has been secured. That’s because – let’s remind ourselves – there will still be a 15 per cent withholding tax that can’t be claimed back.

As to which of the six I would choose, that involves the perennially-difficult question: how, exactly, do you select a collective fund? The record of JP Morgan Global Growth and Income (JPGI) is clearly the best and its shares still offer the second-highest dividend yield. That’s a recommendation of sorts, but it tells us nothing about the fund’s future. Nor does its basic stock selection, where its portfolio is fairly evenly divided across a broad range of sectors – although banks and pharmaceuticals have the biggest weightings – and the two biggest holdings – Alphabet (US:GOOG) and Microsoft (US:MSFT) – are a rather conventional choice.

Actually, it’s refreshing that the six are not clones of one another. Only Microsoft and Coca-Cola (US:KO) crop up more than once as a top 10 holding and the geographical exposure of each is usefully different even if – understandably – exposure to Europe and North America features large in most portfolios. The exception to that is Murray International (MYI), whose portfolio looks the most idiosyncratic; it has a substantial exposure to developing economies and to fixed-income securities.

Perhaps happily, I don’t have to choose between the six. None is going into the Bearbull portfolio. The point, however, is that each of these – and many other funds – would do a job in the Brexit-diversification game, which is a game that investors really must play. And such funds certainly sidestep all that aggravation about managing withholding tax that the direct route entails.

For the record, however, the Bearbull portfolio has taken a holding in The Williams Companies (US:WMB) – see Bearbull, 10 August 2017, buying 850 shares at $29.87 each. And for those who want to know more about withholding tax, the HMRC’s Double Taxation Relief Manual is valuable, as is typing the following into a search engine’s browser: “reclaim (nationality) withholding tax on dividends” for each relevant country. That simple step will quickly bring you as much information as an expensive tax specialist.