Romania: Taxation of Investment Income – How to Apply Limited Tax Rules to Complex Transactions?
→ Oana Manuceanu
→ Mihaela Popescu
Non-resident investors face many challenges when it comes to assessing the tax impact of their financial transactions and complying with tax rules in Romania.
Attractive returns, a low degree of correlation, and contagion with world markets, as well as the emerging market status, have made the Romanian capital market attractive for foreign investors, in particular since the EU accession in 2007. The Romanian financial market has had the potential to generate robust returns for investors even during the global financial crisis of 2007-2008 and in the years that have followed.
Within this context, we have seen an increased interest from private and institutional foreign investors to trade in Romanian securities and thus having to deal with tax rules in Romania.
The tax legislation in Romania has simple but very general rules that are not tailored to easily accommodate very complex financial investment structures or products that may appear in the real world. At first glance, tax rules in Romania are clear, and as a matter of principle any financial investment income – be it capital gain, dividend, or interest – ends up being subject to a 16% Romanian tax, unless the benefits of a double tax treaty can be claimed.
Briefly, among the challenges that an investor in Romanian securities faces are the qualification of income for tax purposes, investment structures, and compliance requirements.
Qualification of income for tax purposes
Qualification of income for tax purposes may become an issue once the financial investment is not made in a traditional instrument, such as a plain stock or in coupon bonds. For example, qualification and tax treatment of income derived by non-resident investors from derivative instruments is often a delicate matter as the tax law has limited rules addressing taxation of derivatives. Some guidance is included in the secondary legislation (methodological application norms) only for resident individuals. Therefore, one has to use general taxation principles and specific limited guidance when analysing the taxation regime of such complex investment instruments.
Similar tax issues arise as to the qualification of income for structured products. Likewise for repo transactions and zero-coupon bonds, the fiscal law does not offer a clear answer as to whether the resulting income should qualify as interest or capital gain.
In practice, all investor circumstances and the terms of the financial transactions should be evaluated to be able to make a qualification for tax purposes that could be defended before the tax authorities.
The investment structure is critical in analysing the beneficial owner of the structure, being able to apply a double tax treaty to reduce taxation cost in Romania, and effectively dealing with potential double taxation issues. In the financial investment world, investments are often made via brokers or pooled accounts (eg, omnibus accounts), in which case the identity or tax residence of the ultimate beneficial owners often remains undisclosed. In such circumstances, the applicability of a double taxation regime becomes practically difficult and the 16% tax in Romania cannot be overcome.
But the Romanian law provides certain exemptions meant to address the possibility of applying a double tax treaty to pooled or collective investments. In particular, capital gains derived by non-resident transparent collective investment vehicles (open-end collective investment funds), as well as dividend and interest derived by pension funds within the EU, are tax exempt in Romania.
Although limited, these exemptions can be used by investors to structure investments in a more tax efficient way. For example, to get capital gain exemption, a foreign investor could consider the option of investing in a non-resident collective investment fund having exposure to the Romanian capital markets rather than directly investing in Romanian stocks.
Compliance is another area of debate when it comes to investments made by non-residents in Romania. Under the current rules, there is a general requirement for non-residents deriving capital gains from Romania to register for tax purposes in Romania via a Romanian resident tax agent. But there are exceptions to this rule.
An example that may seem unusual is when a non-resident investor buys shares in a non-listed Romanian company from a Romanian resident individual. In this case, the buyer must register for tax purposes, declare, and pay any capital gain tax that may be due on the transaction. Without this tax registration, it would be difficult to pay the relevant capital gain tax in Romania, to carry forward fiscal losses (seven years), or to duly claim the tax benefits for capital gains under the double tax treaty.
To conclude, the current Romanian tax rules lack clear regulations on the tax treatment applicable to complex transactions with financial instruments. This often creates uncertainty about the tax treatment applicable to a specific financial instrument, and about compliance obligations.
Non-residents investing on the Romanian financial market should carefully plan the investment strategy from a tax perspective and duly evaluate potential tax costs and tax compliance costs. In this way, they can use the current tax rules to their advantage and maximise after-tax returns.