What is “Withholding Tax”?
Most people only think of one, in some cases two layers of tax.
In fact, we generally, have three layers of tax to consider whenever we’re doing international tax planning and structuring.
The first layer is corporate income tax, which is what most people are trying to reduce by going to a low or zero tax jurisdiction.
After earning these profits and paying tax on them the company pays dividends to the shareholders.
Of course, most people are aware the shareholders will pay some sort of tax in most cases when they receive those dividends. Generally, avoiding these taxes is one of the reasons a person will shift their residency.
If these dividends are paid outside of the country you might have to pay the third layer of tax, which is withholding tax.
In other words, the income is earned at a company level and the company pays tax.
Then the company distributes a dividend and the company withholds a tax from that income, which is payable to the government of the country where the company is resident
And then the shareholder who receives the dividend pays a tax on those dividends in the country where they are resident.
Withholding tax in Different Countries
Now, not all countries have withholding taxes and those taxes will vary based on the treaties that might apply.
Up till now we’ve talked only about the withholding taxes applicable to dividends but there are several types of income that might be subject to withholding tax:
- Dividends
- Royalties
- Interest
- Capital gains
- Rent
- Director’s fees
- Technical service fees
The first 3 are almost universal. The fourth is usually only applicable on the sale of real property, the others, as well as various permutations based on local law, will vary.
Note, how something like royalties or interest withholdings could affect your business adding a potential fourth layer to the three layers we discussed.
Examples of Withholding Tax
Say a company in Country A is licensing IP to a company in Country B.
The income from this licensing is royalties income and therefore could be subject to withholding tax in Country B. In other words company in Country B pays royalties to the company in Country A but withholds a certain portion for taxes payable to country B.
Company in country A then pays taxes on the royalties received (they might receive a tax credit for taxes already paid depending on local laws).
They then might distribute to a shareholder in Country C.
This might mean taxes are withheld in Country A before the dividends are finally taxed in Country C.
The same principle would apply to interest income and in some cases technical service fees and some other classes of income depending on the country’s rules and source income rules.
The rates of withholding will be determined by a combination of country-specific local laws and the applicable tax treaties between countries.
The idea behind withholding taxes is because you earned money from a particular country you should pay tax there but they have no way to tax you once the money has left the country so they withhold the tax from the payment up front.
You need to look at withholding taxes on a country by country basis because some countries have none at all and others such as China and Brazil have very strict rules.
If someone has a structure that works perfectly well for them, doesn’t mean that it will work for you as well. In fact, it might be extremely bad for your situation and you might end up having lots of issues.
We help clients legally reduce their tax through international tax planning, as well as help with company formations, bank account openings, residency, citizenship, and payment processing. Have a question you want answered? Book a consultation now!
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