Foriegn Tax Withholding
Since the US-Canadian Tax Treaty was signed in the early 1980’s, several brokerage firms have failed to act on client behalf. The treaty made retirement income exempt from foreign tax withholding bilaterally between the two countries. Upon treaty, millions of dollars in retirement investments became bilaterally exempt from taxation. But it posed a problem for the securities industry… How would they recognize the non-tax status of the majority of investment shares held by depositories? Some (non-retirement) investment income remained taxable, while the retirement shares were not. Depositories developed a method of polling individual financial firms upon record date of dividends. It required programming implementation by participating firms.
NEGLIGENCE ISSUE #1 - Negligent duty to client: Some firms, shying from the expense of programming opted to “hard code” responses to depository record date inquiries by sending electronic replies instructing depositories to advise dividend paying agents to withhold tax on all shares, even the exempt retirement shares. The brokerage firms did not physically withhold tax themselves from client retirement income, but rather wrongfully instructed dividend paying agents to do so, by reporting that all shares held by depositories in street name were fully taxable.
NEGLIGENCE ISSUE #2- Misinformation/Coverup: For the next decade and longer, some firms when questioned by clients why they were being taxed, would misinform clients that it was client responsibility to recover tax “correctly” withheld on client exempt retirement investments. This brokerage position was not truthful or disclosing to clients, because income and withholding on retirement shares held by a custodian are reported under the custodian tax identification number (TIN), not the individual investing client’s. Clients had no reporting statements to file for tax recovery, nor was it their responsibility. It was custodian responsibility to recover any tax wrongfully withheld on retirement accounts. Other taxes, such as UBTI taxes withheld by mutual fund investments were equally exempt and should have been equally recovered by custodians for retirement client benefit.
NEGLIGENCE ISSUE #3 - Negligent duty to client: There was no mandate that brokerage firms were required to participate in the depository programs to avoid taxation “at source”, or, stopping the withholding from occurring in the first place by reporting the shares non-taxable on record date. But, if a firm failed to participate, it did not relieve them of their obligation to file annually to recover tax on the exempt investments for client benefit. Several Brokerage firms failed to act in client interests for 15 years or longer. The drain on client investment returns had to be considerable and collectively, a drain to the US economy.
NEGLIGENCE ISSUE #4 - Mitigation: One brokerage firm, in 2001 (nearly 20 years after the treaty signing) finally correctly programmed to participate in the depository program to report shares as non-taxable on record date. Upon contacting the Canadian Tax Directorate, they learned that it was possible to recover the past 3 years of tax wrongfully withheld from client dividends. To do so, would breed further questions and client awareness of brokerage negligent actions and open the floodgates of litigation. The brokerage firm chose to cover up the incident and not recover any of the 3 years of client funds available for recovery.
NEGLIGENCE ISSUE #5 - Wire Fraud: By knowingly refusing to account for and list the missing funds on the client statements as client assets, brokerage houses intentionally falsified client account statements.