Rightful returns
December 10 2005, 2:10 pmA GOAL Report on losses sustained by UK private investors through unreclaimed withholding tax on cross border securities
Key Findings
- UK private investors are missing out on almost a quarter of a billion pounds (£251m) because they do not reclaim tax on dividends from their foreign securities. This represents a loss of around 13-14% of overall dividend returns.
- Of the £278m reclaimable tax on holdings of overseas shares, 90% lies unreclaimed because of complex red-tape
- This unreclaimed tax rightfully belongs to the investor, and not to the tax regime benefiting from these very low reclamation levels
- This contrasts with the shareholdings of institutional investors, where their custodian banks manage to reclaim over 70% of tax on foreign securities
- With the continued popularity of dividend payouts, losses through non-reclamation of tax on foreign securities is expected to escalate
- Accountants, stockbrokers, banks and other asset managers are missing out on a valuable element of customer service that would allow clients to achieve better return on investment
- UK private individuals own over £250bn in domestic and foreign stocks
Equities – a return to popularity with retail investors
After the millennium, world stock markets saw a major correction. By mid-2003, the market capitalisation of global equities markets had fallen by some 18.9%. US markets, which represent around half of all world markets saw capital values fall a full 20%. Over the same period, the global bond market grew strongly as capital fled to lower yield, lower risk instruments. Since 2003, however, markets have recovered sharply. According to figures from the International Federation of Stock Exchanges, equities markets had seen recovery growth of some 39% globally, and almost a doubling of value in Europe, between the nadir of 2003 and summer 2005. Recovering markets have encouraged not only institutional investors, but also private individuals to return to the stock markets in order to take advantage of these extraordinary gains.
As the market crash of 2003 decimated capital values, it also focused investor minds on the dividend as the other available source of yield. Following the many corporate scandals and accounting irregularities of recent years, the straight hard fact of a cash dividend payment is more than appreciated by investors. As they are mainly paid in cash, they are not subject to adjustments or alterations – whether attributed to seasonal variations or inflation changes – or attempts by the managing board to put a gloss on the profit statement. Moreover, dividends also have a self-generating momentum. Managements loathe cutting dividends. To do so is usually seen by the markets as a negative event, perhaps triggering a decline in the share price, and not unconnectedly, the value of management share options. Bolstering this idea of forward momentum, therefore, companies only tend to raise dividends when they are reasonably sure of revenues and margins in at least the medium-term. In this way, they carefully try to avoid the embarrassment of a dividend cut even in a cyclical downturn.
As a result, more companies are issuing higher dividends. Average mid-year yield in 2005 for FTSE 100 companies was 3.2% and rising, despite improvements in earnings and capital values. After steadily losing importance throughout the 1980s and 1990s, when average dividend yields for European companies fell from around 6% to some 2%, the slump in share prices has sent yields back up again to between three and four percent, levels not seen for a decade.
Looking at the US markets, Standard and Poors noted that 1,745 dividend increases were reported by companies in 2004, up 7.2 percent from the prior year and the highest for any year since 1998. It was the third consecutive year that the number of increases rose, after plunging to 1,326 in the recession year of 2001. S&P sees a continuation in both dividend increases and initiations. At the end of 2002, only 351 issues in the S&P 500 paid a dividend. There are now 378 issues in the S&P 500 paying dividends, with additional constituents having significant ability to increase and initiate.
Foreign equities
Given that dividend yields have become a far more significant and popular element of the private investor’s, it is extraordinary that up to 13-14% of dividend returns on foreign stocks that could be reclaimed from withheld tax are simply being thrown away.
Foreign securities holdings average around 20% across all world markets. This compares with US investors who hold an average 12% in foreign stocks. Bearing in mind the global average portfolio proportion in cross-border equities at 20%, this tells us that the non-US investment community a typical foreign equity holding of nearer 30%. According to the UK Shareholders Association, foreign owners hold 33% of UK shares, up from 16% in 1994. Even these averages often mask individual portfolio balances that are highly exposed to the non-tax-reclamation problem. For instance, in Switzerland, the withholding rate is 35% and the reclamation rate 20%. A portfolio biased towards this geography could therefore suffer a considerable loss of earnings if withholding tax is not efficiently and effectively reclaimed.
Shareholders with foreign securities holdings tend to be higher net worth individuals with an active interest in the markets in which they invest. A quick review of the private shareholder demographics in the UK investment community helps illustrate this point. There are around 10 million UK private shareholders, but around 5.5 million are simply the beneficiaries of privatization or demutualisation windfall holdings. This community should not be ignored, especially now that Banco Santander owns Abbey, instantly creating a high volume swathe of investors in foreign shares. Nevertheless, those with a significant overseas holding will be rather fewer. 40,000 people have a personal account with Crest, the share trading transaction system, and this is indicative of the size of investor community we are discussing.
Losses due to non-reclamation of tax
The losses incurred by investors through non-reclamation of tax on foreign securities is hardly unrecognized. Proshare, the private shareholders community organization, is quoted as saying, “Depending on where you invest, you may be liable to local taxation charges. This could mean you are going to pay tax twice (in the country where you made your investment, AND in the UK on your income and gains received here). You, hopefully, will receive benefit for the overseas tax through double taxation relief, but you need to be very aware of this. Your stockbroker should be able to outline the taxes that are specific to the country where you want to invest, but you must make yourself aware of them before you start to invest.”
Dividends on foreign shares are typically taxed twice – once in the country where the asset is registered and once in the country of the owner of the asset. Double Taxation Agreements between governments allow some of that tax to be reclaimed. They even give a period, often years, over which that tax can be successfully reclaimed. If, however, an investor fails to make a reclaim or fill in the proper form correctly within the time frame, then the rule is simple. The foreign Government keeps the cash to be spent on road building, housing or any other purpose. Investors with a social conscience who feel making a contribution to the tax payers of a foreign country is a worthy cause, may want their income to be used in this way. However, they and their professional advisors are more likely to want to achieve the best returns possible.
Our research, however, has shown that over 90% of reclaimable tax is not reclaimed by private investors, amounting to a total wastage of annual returns of some £251m. This is, we believe, mainly because the process of making a reclaim is laborious, and requires an in-depth knowledge different tax regimes and reclaim formats across many different geographies and legislatures. Financial advisors, stockbrokers and accountants would find it impossible to deliver a return on investment for assuming this plehtora of knowledge and detail. However, for institutional investors, the sums do add up, because the amounts available for reclaim are far higher. Our research in 2003 showed that 73% of reclaimable tax was being successfully retrieved by custodian banks on behalf of their clients – yet despite this high success rate, the remaining unreclaimed 23% still represented a loss of over €5bn. For the UK, the lost cash stood at €621m for all investors’ unreclaimed tax on foreign shares.
There is good news for the private investor, though. The processes and systems developed for the fund manager/custodian bank marketplace are now being scaled down to come within the reach of private individuals, their accountants and their stockbrokers. The knowledge-base used to process claims, automatically generate the right forms, and ensure that they are filled in correctly, are just the same for private individuals as for investment funds and their underlying investor-customers.
Summary
Unreclaimed withholding tax remains a problem for private investors, and their financial advisors, amounting to losses of over £0.25bn per annum. In the region of 13-14% of dividend returns are being lost due to non-reclamation, and those losses are being disproportionately shouldered by larger private investors who make up the majority of foreign equity investors. Financial advisors, stockbrokers and accountants need to be managing the reclaim process for their clients, in order to provide a valuable additional customer service, and to improve the financial return their clients are obtaining on their equity portfolios.
Dividends are growing as an important element of investor returns. And awareness of the financial importance of effective tax reclamation on foreign securities earnings is rising appreciably amongst investors keen to maximise the return on their investments after the unfortunate experience of the early years of the millennium.
Key Facts Table
|
Component |
|
| Number of UK private shareholders |
10.12m |
| Number of personal Crest accounts |
40,000 |
| Market value of equity holdings – UK private shareholders |
£260,500m |
| Market value of domestic equity holdings – UK private shareholders |
£208,400m |
| Dividends from foreign equities |
£1,856m |
| Tax withheld |
£445m |
| Tax reclaimable |
£278m |
| Tax unreclaimed |
£251m |
Methodology:
Using its comprehensive knowledge of international taxation laws and treaties, plus its own proprietary data on investor behaviour, along with a variety of third party sources (listed below), GOAL Group derived an accurate model of UK private investors’ current holdings in foreign stocks.
Teleresearch amongst a balanced sample of shareholders and their financial advisors established that over 90% of reclaimable tax on foreign shareholdings goes unreclaimed.
A complex model of withholding and treaty rates was then applied to UK private shareholder foreign holdings to calculate the tax sum lying unreclaimed on behalf of UK private investors.
Sources:
- The Federation of International Stock Exchanges
- Proshare
- The UK Shareholders Association
- The Office of National Statistics
- The Bank of England
- The International Monetary Fund
- The World Bank
- NYSE
- LSE
- Moody’s
- Bloomberg
- Standard and Poors
- Merrill Lynch
- Citytext
- Deutsche Börse
- Euronext
- International Financial Services Association
- Institute of International Finance
