Missing A Trick?

Tax reclamation is often swept under the carpet, but investors and fund managers should demand their dues.

Stephen Everard, Managing Director, GOAL
Originally published in the May 2006 issue

Tax reclamation is barely on the radar for many hedge fund managers and other financial intermediaries. But the reality is that 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 exist between governments to allow some of that tax to be 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.

Whether due to a lack of awareness or a willful disregard of the reclamation possibility, unreclaimed tax is having a massive impact on hedge fund investors. Back in 2002, we estimated that nearly 73% of reclaimable tax on overseas dividends was being successfully retrieved by custodian banks on behalf of their clients – yet despite this high success rate, the remaining unreclaimed 27% still represented a global loss of over €6bn. For the UK, investors’ lost cash in unreclaimed tax stood at €621m. In the last financial year, the figures become even more eye-watering. Even though reclamation rates have increased slightly, this has not prevented global losses hitting a staggering $10.5 billion of investors’ rightful returns. For UK investors, this represents around $1.19bn.

However, the reality is that reclamation levels amongst hedge funds are nowhere near the average for institutional investors. Some commentators go as far as claiming that virtually no tax is reclaimed. In the past, this was not of such significance because hedge funds had little interest in equity investments and were therefore isolated from stock market corrections, but this situation is changing. As hedge funds begin to show greater enthusiasm for equities, the issue of dividend taxation will certainly affect them. There are also clear market signs that sophisticated retail investors are placing a greater emphasis on hedge funds as the high-yield element of their investment portfolio. Furthermore, institutional investors with the longest view – pension funds – have fundamentally re-engineered their portfolio balance, and pension fund investment in hedge funds has also increased dramatically in recent years. For high net-worth individuals and profit-squeezed pension funds, non-reclamation means lost returns.

Changes ahead?

With the hedge fund industry on the rise, there is much debate over industry regulation. Certainly, both the Securities and Exchange Commission in the US and the Financial Services Authority in the UK appear to firmly set on the path towards regulation. Eurohedge’s annual survey recently estimated that there were over 330 new European hedge funds set up during the last calendar year, raising combined total assets of well over $27.82bn, which compares to $22.79bn raised by nearly 250 new funds in 2004. HedgeFund Intelligence Limited (HFI) stated in March that assets in global hedge funds have now reached more than $1.5 trillion, noting that “The passing of the $1.5 trillion mark shows how strongly the hedge fund sector is growing, particularly given the difficult market conditions encountered by many hedge fund managers in the past 12 months” . The combination of strong market growth, difficult market conditions and increasing regulation may well lead to tax reclamation becoming one area which comes under closer scrutiny.

It is also to be noted that many major mainstream financial institutions are becoming more interested in hedge funds, either by acquiring the funds or by setting up their own ‘in-house’. It could be argued that the involvement of large institutions with a long track-record of regulatory compliance will add weight to the regulation argument, as they are well used to presenting financial transparency to the market and are unlikely to resist any moves towards regulation. The increased transparency would undoubtedly facilitate greater awareness of tax reclamation and certainly boost returns from dividend income.

Demanding Their Dues

In many cases, fund managers are already under pressure from their clients to devote greater attention to maximise the dividend element of return in the portfolios they are managing. As a result, custodian banks as well as the fund managers themselves are now actively seeking automated methods of being able to predict investor portfolio returns, taking into account the effect of withholding tax reclamation cash flows. In fact, leading custodians have recognised the market opening represented by effective tax reclamation services, both for their FM clients, and as an interbank services opportunity. Automated reclamation facilities have now made the provision of such services highly profitable, in a market climate where other revenue streams are declining. Hedge fund managers who remain reticent to reclaim tax could be missing out on a substantial market opportunity.


For institutional investment globally, unreclaimed withholding tax remains a major – and growing – problem. In the region of $10.5 billion of investors’ returns are being lost globally due to non-reclamation, and those losses are being disproportionately shouldered by hedge funds, where reclamation rates are far lower than the average. But awareness is steadily increasing, driven by increasing regulation as the sector expands, and hedge fund managers and custodians now have the option of using third-party secure technology or services to manage the reclaim process for their clients, in order to provide a valuable additional client service, and to improve the financial return their clients are obtaining from dividend income.