Business, Legal & Accounting Glossary
Tax deducted at the source from dividends or other income paid to non-residents of a country.
A tax levied by a country of source on income paid, usually on dividends remitted to the home country of the firm operating in a foreign country.
Withholding Tax (noun) is tax deducted at the source from dividends or other income paid to non-residents of a country.
When there is a double taxation agreement between the country is which the income is paid and the country is which the recipient is based, this tax can be reclaimed.
Withholding tax is an amount withheld by the party making payment to another (payee) and paid to the taxation authorities. The amount the payer deducts may vary, depending on the nature of the product or service being paid for. The payee is assessed on the gross amount, and the tax to be withheld (the withholding tax) is computed in that assessment. The purpose of withholding tax is to counteract tax evasion and tax avoidance either by domestic or international taxpayers. In some jurisdictions, the purpose of the deduction is also to facilitate or accelerate the collection and no assumption about evasion is inferred.
Domestic withholding tax is applied to earned income in circumstances where the payee might otherwise avoid declaring the income earned, for example when people work on a contract basis – neither as a registered business nor as an employee. Some countries require the employer to withhold a certain percentage of that person’s income and submit it to the tax authority. In these circumstances, the payer is usually a business and would normally have to submit details of the identity of the person from whom this form of tax has been deducted.
Domestic withholding tax is also applied to interest and/or dividend payments, typically at the standard rate and paid directly to the Revenue authorities. This secures immediate payment of at least a substantial proportion of the tax due. Individuals whose total income does not exceed the higher rate tax threshold need not then complete a tax return (jurisdiction dependent).
In most jurisdictions, employers are required to deduct tax from salary. (See Tax withholding in the United States, PAYE and Internal Revenue Code 3401). This is often seen as inequitable where it is conventional for self-employed people to pay their taxes at the end of the year (although, in the United States, they are required to pay estimated tax each quarter or face interest, while in the Republic of Ireland, self-employed people get just half the basic tax credit of employed people). Furthermore, the cost to employers of acting as unpaid tax collectors is not trivial.
In some jurisdictions, basic rate taxation is withheld from contract and consultancy payments. The consultant may continue to be liable for higher rate tax on the remainder.
International withholding tax is applied in circumstances when the payer is making a payment to another party in another country and the payment either respect of financing or use of intellectual property. Payments in respect of financing are usually dividends or interest, while payments in respect of the use of intellectual property or expertise are royalties, licence fees and management fees. Most countries permit the payee to claim the amount of withholding tax deducted as a rebate off their business income tax.
A minimum rate of tax may be deducted at source from dividend payments, in addition to Corporation tax. In the USA, this is still seen as controversial. In the United Kingdom, tax is not withheld at source, but the recipient is given a “tax credit” on the dividend statement, which has the effect that a basic-rate taxpayer has no more tax to pay: higher-rate tax-payers have further tax to pay. The tax credit once represented advance corporation tax paid by the company, but since 1999 this is no longer the case.
The position that arises if the share-holder is not resident in the country concerned is complicated. The country where the dividend is paid may withhold tax and simply retain it, or it may permit payment gross but inform the tax authorities in the country of residence (though not in the case of tax havens). A double taxation treaty can partially or fully prevent a single gain giving rise to a tax liability in two different jurisdictions.
A minimum rate of tax may be deducted at source from savings interest payments. In the United Kingdom, tax is withheld at source unless the saver submits an R85 form (if a domestic non-taxpayer) or a R105 form (if a non-resident) to claim exemption. In the Republic of Ireland, the tax is explicit and is known as Deposit Interest Retention Tax or “DIRT”.
The position that arises if the saver is not resident in the country concerned is the same as for international dividend payments as described above. (In the European Union, some member states offer the saver a choice of method to apply).
The United States of America’s legislative body authorized the IRS to apply a withholding income tax on nonresident aliens and foreign corporations selling US real property interests.
The withholding tax will not apply to individual investors.
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This glossary post was last updated: 18th April, 2020 | 24 Views.