Three steps to future-proofed customer tax withholding and reporting

Step 1: Adopt an end-to-end approach to tax documentation and reference data processing

At the core of any efficient withholding and reporting operation lies the capture of accurate customer tax documentation and reference data.

The key here is to take a step back and carefully consider all the regulatory requirements an organization may be subject to before creating a single, centralized system of record. This system of record should be used to store all the customer data needed to achieve compliance across the jurisdictions in scope. The more an organization is committed to a single view of the truth, the stronger the organization will be in determining compliance with applicable withholding and reporting regulations.

This customer data includes the relevant data points from each tax form that impact and support withholding and reporting decisions in downstream processes, payment systems and tax reporting applications. Regulatory requirements typically fall into two categories: US and non-US withholding and reporting obligations; and customer tax information reporting under Foreign Account Tax Compliance Act, Intergovernmental Agreements and Common Reporting Standard regulations.

But collecting relevant client reference data is not a one-off task. Regulation dictates that this information should be systematically monitored for changes in customer circumstances which could impact the validity of tax documentation in the weeks and months following the initial withholding. There may also be a need to update underlying beneficial owner information and ownership percentages.

Tax documentation and reference data processing should, therefore, be flexible and agile enough to cope with all these changes without adding unnecessary complexity. The reference data system of record should provide all reporting classifications needed, including the presumption of classification for undocumented accounts.

Customer onboarding is effectively ground zero for both data capture and customer experience, so it makes sense to ensure this process is as streamlined and efficient as possible, integrating anti-money laundering (AML) and Know Your Customer (KYC) requirements with tax document and reference data processes.

With the vast majority of onboarding still a paper-based activity, optical character recognition (OCR) technology and digital tax onboarding tools can be leveraged to speed up data capture, minimize or eliminate manual data entry and increase data accuracy.

Step 2: Integrate payment processing with a central system of record

To apply tax withholding correctly and in a cost-effective manner, end-to-end data flows should be integrated into customer payment systems. In most organizations, withholding and remittance processing are typically embedded within the product payment systems used to transmit funds to counterparties. In the most efficient systems, each product payment type will also be categorized to determine which tax regulations it may be subject to.

Financial service companies typically use several payment systems, each linked to a different product or line of business. To withhold and remit efficiently, these systems should be able to:

• Receive regular updates on the validity of client tax documentation and reference data from the organization’s centralized system of record — these updates can be used to ensure the correct withholding occurs at the time of payment. It is common, for example, for previously valid tax documents to become invalid between account opening and the time of payment due to a normal change in customer circumstances.
• Apply the applicable client treaty rates or presumption logic for undocumented accounts
• Define what income is subject to withholding, and clearly show how withholding has been calculated – by source, type, payer classification and so on
• Use payer codes to tie remittances to the product payment system which is used to transmit funds to counterparties so that these payments are continually reconciled to the general ledger to ensure accurate annual reporting
• Process withholding adjustments whenever income is reclassified —  withholding adjustments are usually made during the first quarter of the year following payment.
• Process withholding at the underlying beneficial owner (UBO) level for W-8 IMY clients, including the necessary withholding adjustments required as a result of changes in ownership percentages and/or documentation status, after payment occurs

While the beginning and end points of customer tax reporting - data collection/validation and compliance reporting - are relatively straightforward to outsource as a managed service, withholding and remittance processing are generally deemed more tricky and expensive to outsource.

Part of the challenge here is that withholding is required at the time of payment, and determining and adjusting withholding for large volumes of different payment types can be cumbersome and involve multiple manual processes and controls. 

While tricky, there are still improvements that can be made to the withholding and remittance process. Analyzing and documenting each payment system’s withholding calculation methodology will provide the foundation for future standardization and centralization efforts. For example, the centralization of some payment processes may be beneficial and provide a platform to standardize controls (payments related to non-cash products - loans, derivatives, etc.). There may also be an opportunity to implement centrally maintained tax withholding rate tables to determine changes in regulations are addressed consistently. 

Regardless of the size or shape of a business, tax teams are well advised to conduct a thorough cost/benefit analysis before adopting or discounting managed services as an option for withholding, or before decommissioning existing processes and systematically linking withholding and remittance processing to their payment systems.

Step 3: Aggregate and report financial data

Before customer financial data, such as customer payments, incomes and balances, can be shared with customers and submitted to tax authorities, it should be aggregated according to a clearly defined and widely agreed set of rules.  

This process of aggregation is necessary because organizations with multiple payment systems typically have multiple reporting processes, and many reporting entities. This can add complexity to the aggregation process and the ultimate filing submissions. While many organizations employ centralized submission services, the aggregation process is typically decentralized and linked to the payment systems or account balance system of record.   

Ideally, each of these individual reporting processes will have strong processes and controls in place to ensure the correct data are aggregated in an accurate, timely and efficient manner. Failure to do so raises the risk of fines, sanctions and considerable reputational damage, at a time when regulators are pursuing ever-greater levels of tax transparency.

Accurate tax reporting relies on a series of closely integrated processes, including customer onboarding and AMC/KYC processing, tax documentation validation, reference data processing and monitoring, and client reporting classification. An organization’s central customer tax data strategy and processes should therefore aggregate all the specific tax reference data requirements needed to achieve reporting compliance.

Understanding the definition of a “financial account” is another key factor in tax information reporting compliance. Financial institutions should determine that each financial account is classified correctly, according to the tax documentation held by the carrying entity, and that the appropriate aggregation method is employed for each type of financial account, as defined by each tax jurisdiction.

Financial data required for both US and non-US withholding regulations are typically aggregated from the same payment systems used to ensure withholding is accurate. Ideally, these payment systems will access the same centralized system of record originally used to help ensure the proper withholding occurred. Financial data required for FATCA and CRS information reporting include both payment data and balance information. Payment and balance data aggregation must be done for each client’s financial account.    

Documenting the source of all client data in each report submission – also known as reporting data lineage – is a recommended first step in ensuring clients are classified correctly and the appropriate financial data is aggregated and submitted for each jurisdiction.