Navigating challenges and solutions of securities and transaction taxes

Financial institutions must navigate a complex and constantly evolving environment of securities and transaction taxes that differ not just for each region, country, and asset class but also with client type, trading frequency and channels. Institutions are under obligation to comply with tax regimes such as FATCA, Financial Transaction Taxes (FTTs), Security Transaction Taxes (STTs) to name a few.

These taxes are not new and are implemented by various countries globally. In 2011 there were 40 countries that had some form of transaction taxation in operation, raising US $38 billion and in the past decade many more countries have joined the league, recent examples include EU member states Hungary, Portugal and Spain. Each jurisdiction has its own tax regime which has different rules and regulations like Transfer Tax (Belgium, Poland, Philippines), Security Transaction Tax (India, South Africa, South Korea, Taiwan, etc.), Financial Transaction Tax (Finland, France, Italy, Brazil, Venezuela, etc.), Stamp Duty (Ireland, Switzerland, United Kingdom, China, Singapore, Hongkong).

It is therefore not a surprise that a number of financial institutions are still developing and using spreadsheet-based tools and deploying specialist resources to meet country-specific tax rules. This approach is difficult to scale up to cope with the volume growth, evolving regulatory requirements and complying with new tax regimes. Even large and sophisticated financial institutions struggle to effectively navigate a multitude of options that best leverage available resources, both human and in technology, as there is no “one-size-fits-all” operating model or a commonly-adopted, market-leading digital platform for the tax function in the industry.

Although the capital markets industry is diverse, its participants face similar challenges in their tax functions which are driven by operational inefficiency, technical debt and the absence of robust data management framework:

Tax Function Operating Model

• There are 150 different markets with different rules and regulations and each country has its own tax regime making availability of regional or local tax expertise a key concern. This drives the need for additional specialist resources to ensure compliance with the relevant tax laws in each jurisdiction and to re-engineer the process accordingly, some examples:
  • Transactions can be treated differently like in case of short-term trades vs long positions leading to different taxations;
  • Tax reclaims processes vary from market to market making it hard to have a standardized SLA across tax regimes.
• Tax regulations are dynamic and keep on getting stricter, thus requiring capital markets participants to constantly adapt their tax function operating model to mitigate the risk of non-compliance and errors in tax processing or risk losing their clients’ trust necessary for the business to expand.

Tax Function Technology & Infrastructure

• Systemic lack of investment in tax function and infrastructure often holds financial institution behind the competition and limit service and product offering. Many organizations are using resource intensive spreadsheet-based solutions with no front-end user interface or have developed in-house platforms which are expensive to adapt and difficult to scale up and automate. These tools are unable to cope with the transaction volume growth along with reconciliations and evolving regulatory requirements.  
• Tax processing is heterogeneous in nature and includes tax calculation, processing, and reconciliation, where inconsistent internal and external data may lead to discrepancies between tax engine calculation and other internal records.

Tax Function Data Management

• Security and maintenance of tax-related data is another major challenge, where offshoring operations to a 3rd party vendor may compromise the requirement for confidentiality of the client data hence making it difficult, if not impossible, to outsource certain sensitive operations like these. 
• Decentralized legacy systems often lead to fragmentation and mismanagement of data, making it very difficult to integrate a tax operation solution with other business applications or activities. These legacy systems and architecture, while more costly to run as fragmented infrastructure often and needing manual intervention, usually lead to errors or delays where a client may lose the right to reclaim the tax.

These challenges result in raising operating and infrastructure costs and an inability to meet increasing client expectations of services provided by the capital markets firms. This additional cost burden needs to either be compensated through higher or ‘tiered’ pricing, where some markets or asset classes attract higher pricing due to their added complexity, or offset through higher efficiency. This underpins the client profitability work which most financial services firms have still not solved for.

Profitability concerns drive the need for a fundamental change in the business model and many capital markets firms are seeking to understand the steps that can be taken to streamline tax processes and improve efficiency for their tax function to alleviate the pressure to contain costs. This may involve implementing new technology solutions, improving data management, consolidating tax functions, and establishing clear policies and procedures. If the situation demands, this may even lead to completely re-thinking the tax function operating model and a myriad of options to choose from: from hiring specialists to outsourcing the tax function to a 3rd party managed services provider; from in-house development to COTS products; from deploying an on-premises solution to using a SaaS product; Etc.

While the list can be long, there are a few key considerations to bear in mind for tax function transformation.

Optimisation of tax operating model would require a comprehensive understanding of the firm’s business strategy, its priorities, and challenges. It is important to think beyond just meeting regulatory requirements to create a future tax function operating model that also supports business objectives. A tax function operating model needs to align with more digitally-enabled business operations and focus on how processes and technology could be made more scalable and sustainable. It also needs to respond to the pressure to contain costs, operate more efficiently and meet growing expectations for the tax team to contribute more strategic value to the organization.

As part of the operating model transformation to best leverage technology and digital solutions, firms can look at various approaches and their respective pros and cons:

• Cloud solution with a web-based interface will ensure quick set-up, intuitive user experience and scalability, streamline the tax process by optimizing tax engines and modules without investing in on-premise infrastructure which would minimize cost.
• Digital technology like RPA (Robotic Process Automation) can automate the processing of security transaction taxes, reducing the need for manual intervention and minimizing errors.
• Tax architecture needs to allow for easy maintenance and upgrade to suit granular taxation requirements by country, e.g., Reynders Tax in Belgium, Church Tax in Germany, etc., to name a few.
• Digital solutions can provide robust security measures to protect sensitive data and prevent unauthorized access or cyberattacks. Robust and auditable controls must be integrated within the tax processing application.
• “build vs buy” decision can consider using the technology solution of a 3rd party tax service provider which could be a cost-effective option in certain markets or geographies.

A well-designed tax platform can provide significant benefits for data management:

• Tax platform integration with existing internal systems will enable seamless trade flow, client, and reference data to fulfill tax obligations and provide easily accessible data for reporting, reconciliation, and extraction.
• Available data products like BI tools can be used to help organizations to manage and analyze the securities and transactions related data in a cost effective manner and detect the anomalies which could prevent potential fraud, monitor, and report the tax liability in real-time.
• A Configurable Rules Engine will support the different rules of each tax regime that must be managed in the system, including start and end dates, with the ability to make controlled and audited changes.

Overall, as tax regimes are continuously evolving, the challenge of managing tax operations is expected to increase. Hence, to deal with the growing challenges, financial institutions would need to streamline the processes and leverage digital solutions for tax functions. Digital technologies like cloud computing and SAAS can offer many benefits by enhancing efficiency, accuracy, and transparency in tax operations; it is vital for financial institutions to recognize the need for innovation and invest in digital solutions now to stay ahead of the competition. With the right technology and approach, it is possible to establish efficient tax operations and meet growing expectations for the tax team to contribute more strategic value to the organization.