As institutional investors increase exposure to global markets, withholding tax on cross-border income has become a material concern due to the magnitude of tax leakage. For pension funds, investment managers, and other asset owners, reclaiming this tax is a practical way to improve returns without altering investment strategy.
To navigate withholding tax on cross-border income effectively, institutional investors must understand the primary recovery mechanisms: double tax treaties, domestic exemptions, and legal precedent established in court cases ruled on by the European Court of Justice (ECJ).
Each offers a pathway to reduce tax leakage and improve investment returns, but a detailed technical understanding of these reclaim methodologies is essential to realise their full benefit.
What is withholding tax?
Withholding tax applies when an investor in one country earns dividend or interest income from a foreign entity and the source country withholds a portion of this income as a tax before payment. Since the investor’s home country may also tax the same income, this often results in double taxation.
To recover overpaid tax, investors can generally follow one of three routes:
- Claiming relief under a double tax treaty
- Relying on domestic exemptions in the source country
- Using ECJ legal precedent to challenge discriminatory tax treatment
Each route has distinct criteria, time frames, and documentation requirements, often varying by jurisdiction. Pursuing recoveries are particularly important for South African pension funds due to their inability to obtain any relief from foreign withholding taxes through foreign tax credits on local returns.
Navigating double tax treaties
Double tax treaties are bilateral agreements that limit withholding tax on certain types of income. They are designed to prevent double taxation and promote cross-border investment by providing reduced rates for eligible investors.
For example, a South African investor receiving dividends from a Swiss company may face a 35% withholding tax. However, under the South Africa–Switzerland double tax treaty, the applicable rate may be reduced to 15%, allowing the investor to claim back the excess 20%.
Treaty-based reclaims are available to a wide range of investor types, including pension funds, asset managers, corporations, and non-profit organisations. A typical reclaim requires evidence of tax withheld and proof of eligibility, such as a certificate of tax residence.
While the principle behind double tax treaty relief is simple, execution is often not. Investors without the necessary expertise and processes may face delays, rejections, or missed reclaim opportunities.
Accessing relief through domestic tax law
Many jurisdictions also provide withholding tax relief under their own laws, often targeting specific investor types such as pension funds or regulated funds.
For example:
South African pension funds can take advantage of full exemption from Belgian withholding tax on dual listed securities
These exemptions can offer significant financial benefit and are often based on the investor’s legal status or public interest role, such as that of a pension fund. In many cases, pension funds are recognised in legislation as low-risk or tax-neutral entities and are therefore eligible for full or partial exemption.
Domestic exemptions are often more straightforward than treaty-based claims, as they follow statutory rules rather than bilateral agreements. As such, they can present a more predictable and efficient recovery route.
However, they still require detailed compliance with local documentation standards and tax authority processes. For pension funds, consistently leveraging domestic exemptions across jurisdictions can materially reduce tax leakage and improve fund returns on a recurring basis.
Leveraging European Court of Justice (ECJ) Rulings
Within the EU, investors may rely on ECJ case law where national tax treatment discriminates between resident and non-resident investors. The ECJ enforces EU law, including the principle of free movement of capital, and has ruled against several member states for withholding tax practices that violate this principle.
These legal precedents are often used to support reclaims where treaty or domestic exemptions are not applicable and can be relied upon by both EU and non-EU investors, provided the relevant conditions are met.
In some cases, they may also be applied in addition to a treaty-based claim, enabling investors to reduce withholding tax beyond the treaty rate — in some instances, down to 0%.
Incorporating tax recovery into long-term fund strategy
As cross-border allocations increase, recovering overpaid withholding tax is becoming a critical part of return optimisation. Institutional investors that fully leverage treaty benefits, domestic exemptions, and legal precedent are better positioned to minimise tax leakage and protect performance. Navigating these rules effectively can turn unrecovered tax into a consistent source of added value.