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Withholding tax

From Wikipedia, the free encyclopedia

A withholding tax, or a retention tax, is an income tax to be paid to the government by the payer of the income rather than by the recipient of the income. The tax is thus withheld or deducted from the income due to the recipient. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require withholding tax on payments of interest or dividends. In most jurisdictions, there are additional withholding tax obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties, rent or even the sale of real estate. Governments use withholding tax as a means to combat tax evasion, and sometimes impose additional withholding tax requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.

Typically the withholding tax is treated as a payment on account of the recipient's final tax liability, when the withholding is made in advance. It may be refunded if it is determined, when a tax return is filed, that the recipient's tax liability to the government which received the withholding tax is less than the tax withheld, or additional tax may be due if it is determined that the recipient's tax liability is more than the withholding tax. In some cases the withholding tax is treated as discharging the recipient's tax liability, and no tax return or additional tax is required. Such withholding is known as final withholding.

The amount of withholding tax on income payments other than employment income is usually a fixed percentage. In the case of employment income the amount of withholding tax is often based on an estimate of the employee's final tax liability, determined either by the employee or by the government.

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Transcription

Hi, welcome to this short video briefing. Today I'm going to explain the basics of withholding tax. If you're a prime broker, a custodian, a registered investment advisor or a private wealth advisor, cross-border withholding tax may be relevant to you and your clients. So where do I start? Well, it depends! That may sound humorous, but actually, given the complexity and the nuances that exist in this space 'it depends' is often the first part of every answer. Anyway, let's get started. Withholding tax is a tax imposed by a foreign government on cross-border investment income such as dividends (on shares) or interest (on bonds). For the purpose of keeping it simple in this briefing I'll focus on dividends but similar rules also apply to bonds. 'Cross border' simply means that the ultimate recipient of the income - the investor or ultimate beneficial owner is resident in a different tax jurisdiction to the company distributing the dividend - for example a US resident might invest in Novartis, Nokia and Microsoft. Novartis is a Swiss company, Nokia is Finish, but Microsoft is based in the US. So Novartis and Nokia are both cross-border investments for this investor. Microsoft is not. All three companies are called 'Issuers' because they all issue securities that generate investment income like dividends and bond interest. When an issuer in one country distributes investment income to investors in another country, the tax authorities in both countries will tax the income under their respective tax laws - starting in the country of the Issuer. Without any information to the contrary the Issuer or their designated agent will have to withhold tax from the payment, based on the laws of their country. This is called the 'statutory' rate of tax and it's often quite high but varies market to market. The investor's own tax authority will also want to tax this income when it's received. Governments understand that this 'double taxation' would likely reduce foreign investment income into their market. To avoid this, pairs of countries have signed 'Double Tax Treaties'. These treaties remove or reduce double taxation by allowing beneficial owners in one country to have an entitlement to be taxed at the lower treaty rate on investment income received from the other country. There a more than 5,700 treaties in force today and each treaty has different rules for the entitlements of different kinds of beneficial owner and even different kinds of income. A common response to this problem is 'surely I can just offset all this foreign tax on my domestic tax return?' Unfortunately, most countries only allow investors to take a deduction on the portion of the foreign tax that can't be recovered. So if Novartis distributes a dividend to a US investor, it will be taxed at the Swiss statutory rate of 35%, all of which is in the hands of the Swiss tax authority. The investor can only take a deduction a 15% on their US tax return because the remaining 20% is 'recoverable' from the Swiss government under the rules of the treaty. In some markets, if investors can show that they have an entitlement to the lower treaty rate of tax before the income is distributed, the Issuer's agent bank will be allowed to withhold the correct amount of tax - the treaty rate, instead of the higher statutory rate. This is called Relief at Source. Relief at Source usually involves getting information and documentation to the issuer's agent bank. The information and documentation needed varies by market and by withholding agent. The fact that Relief at Source is technically available, does not mean that any investor will automatically get their entitlement through this method. There are three main reasons an investor might not be able to benefit from Relief at Source. First there may well be several entities between the Issuer and the ultimate beneficial owner. The investor will only benefit from Relief at Source if the information and the documentation can get all the way up the financial chain in the few days between the record date and the pay date, or they miss the window of opportunity. Second, in many cases securities will be held in omnibus accounts, where the underlying beneficiary has not been disclosed to the issuer or their paying agent. They may be investing through a third-party entity such as a hedge fund. Third, they may have their assets with an intermediary which doesn't support relief at source from foreign tax. In all these cases, Relief at Source is not possible. But all is not lost. When Relief at Source is missed or simply not available, one often has the ability to file for a tax reclaim. Where the high statutory rate of tax has been withheld, if there is a treaty, the investor will need to reclaim their entitlement from the foreign government using a 'post pay date' or tax reclaim. To do this, either the investor or their financial intermediary will need to prepare all of the information and supporting documentation required to file a reclaim. Each market has its own forms and its own procedures, which can vary each year. Each market allows a certain length of time for claims to be filed. This is called the Statute of Limitations. This Statute is usually at least a year and often much longer. However if your reclaim is not filed within the statute period then your money is no longer yours. You just effectively gave a non tax deductible free cash gift to a foreign government. The message is simple: If you invest cross-border or you manage relationships with clients who do, doing nothing is not really an option. Where does GlobeTax fit into all this? Well, we've been helping our customers to get Relief at Source and filing reclaims since 1992 We're the largest single filer of claims into every market our reclaim volumes alone are over two million a year. The difference we make to an average investor's portfolio can be up to 2.5%. In today's security markets that's a big impact. Even better, we align our interests with our customers - we don't charge anything until we've successfully recovered entitlements. We can be engaged by investors directly or through an introduction from a financial intermediary or an adviser. We've also been engaged by many financial institutions directly to help them provide a withholding tax service to their clients. All we need to do our job is data and documentation. With these two, we can apply our knowledge and experience and help our clients. We offer a simple solution to a complex problem. Withholding tax is not just about filling in forms and sending them to tax authorities. It's about continuous research in over 230 global markets to understand the 90 plus new treaties that come into force each year and the hundreds of changes in existing treaties. It's about understanding the rules, the procedures the information and the forms as they change in each market. It's about understanding the changing requirements of tax authorities and meeting with them regularly. And it's about investing in technology to make all these processes more efficient. There's a lot more to withholding tax than I can give you in this brief video, but hopefully this has given you a basic understanding of some of the issues at stake. I hope you enjoyed this video briefing. If you'd like to know more about this subject and how GlobeTax can help, or if you'd like a quote, contact your nearest GlobeTax office. You'll find other information on this subject and other short video briefings on our website.

Contents

Basics

Some governments have written laws which require taxes to be paid before the money can be spent for any other purpose. This ensures the taxes will be paid first and will be paid on time, rather than risk the possibility that the tax-payer might default at the time when tax falls due in arrears.

Typically, withholding is required to be done by the employer of someone else, taking the tax payment funds out of the employee or contractor's salary or wages. The withheld taxes are then paid by the employer to the government body that requires payment, and applied to the account of the employee, if applicable. The employee may also be required by the government to file a tax return self-assessing one's tax and reporting withheld payments.

Income taxes

Wage withholding

Most developed countries operate a wage withholding tax system. In some countries, subnational governments require wage withholding so that both national and subnational taxes may be withheld. In the U.S.,[1] Canada,[2] and others, the federal and most state or provincial governments, as well as some local governments, require such withholding for income taxes on payments by employers to employees. Income tax for the individual for the year is generally determined upon filing a tax return after the end of the year.

The amount withheld and paid by the employer to the government is applied as a prepayment of income taxes and is refundable if it exceeds the income tax liability determined on filing the tax return. In such systems, the employee generally must make a representation to the employer regarding factors that would influence the amount withheld.[3] Generally, the tax authorities publish guidelines for employers to use in determining the amount of income tax to withhold from wages.

The United Kingdom[4] and certain other jurisdictions operate a withholding tax system known as pay-as-you-earn (PAYE), although the term "withholding tax" is not commonly used in the UK. Unlike many other withholding tax systems, PAYE systems generally aim to collect all of an employee's tax liability through the withholding tax system, making an end of year tax return redundant. However, taxpayers with more complicated tax affairs must file tax returns.

Australia operates a pay-as-you-go (PAYG) system, which is similar to PAYE. The system applies only at the federal level, as the individual states do not collect income taxes.[5]

Other domestic withholding

Some systems require that income taxes be withheld from certain payments other than wages made to domestic persons. Ireland requires withholding of tax on payments of interest on deposits by banks and building societies to individuals.[6] The U.S. requires payers of dividends, interest, and other "reportable payments" to individuals to withhold tax on such payments in certain circumstances.[7] Australia requires payers of interest, dividends and other payments to withhold an amount when the payee does not provide a tax file number or Australian Business Number to the payer. India enforces withholding tax also on payments between companies and not just from companies to individuals, under the TDS system. (Since April 2016, the United Kingdom has discontinued withholding tax on interest and dividends, though in some cases this income will become liable for taxation through other means).[8] Rwanda charges withholding tax on business payments unless the paying company obtains proof that the recipient is registered with the tax administration and that they have a recent income tax declaration.[9]

Social insurance taxes (social security)

Many countries (and/or subdivisions thereof) have social insurance systems that require payment of taxes for retirement annuities and medical coverage for retirees. Most such systems require that employers pay a tax to cover such benefits.[10] Some systems also require that employees pay such taxes.[11]

Where the employees are required to pay the tax, it is generally withheld from the payment of wages and paid by the employer to the government. Social insurance tax rates may be different for employers than for employees. Most systems provide an upper limit on the amount of wages subject to social insurance taxes.[12]

International withholding

Most countries require payers of interest, dividends and royalties to non-resident payees (generally, if a non-domestic postal address is in the payers records) withhold from such payment an amount at a specific rate.[13] Payments of rent may also be subject to withholding tax or may be taxed as business income.[14] The amounts may vary by type of income. A few jurisdictions treat fees paid for technical consulting services as royalties subject to withholding of tax.[citation needed][citation needed] Income tax treaties may reduce the amount of tax for particular types of income paid from one country to residents of the other country.

Some countries require withholding by the purchaser of real property. The U.S. also imposes a 10% withholding tax on the gross sales price of a U.S. real property interest unless advance IRS approval is obtained for a lower rate.[15] Canada imposes similar rules for 25% withholding, and withholding on sale of business real property is 50% of the price, but may be reduced on application.

The European Union has issued directives prohibiting taxation on companies by one member state of dividends from subsidiaries in other member state,[16] except in some cases,[17] interest on debt obligations, or royalties[18] received by a resident of another member nation.

Procedures vary for obtaining reduced withholding tax under income tax treaties. Procedures for recovery of excess amounts withheld vary by jurisdiction. In some, recovery is made by filing a tax return for the year in which the income was received. Time limits for recovery vary greatly.

Taxes withheld may be eligible for a foreign tax credit in the payee's home country.

Remittance to tax authorities

Most withholding tax systems require withheld taxes to be remitted to tax authorities within specified time limits, which time limits may vary with the withheld amount. Remittance by electronic funds transfer may be required[19] or preferred.

Penalties for delay or failure to remit withheld taxes to tax authorities can be severe.[20] The sums withheld by a business is regarded as a debt to the tax authority, so that on bankruptcy of the business the tax authority stands as an unsecured creditor; however, sometimes the tax authority has legislative priority over other creditors.

Reporting

Nearly all systems imposing withholding tax requirements also require reporting of amounts withheld in a specified manner. Copies of such reporting are usually required to be provided to both the person on whom the tax is imposed and to the levying government.[21] Reporting is generally required annually for amounts withheld with respect to wages. Reporting requirements for other payments vary, with some jurisdictions requiring annual reporting and others requiring reporting within a specified period after the withholding occurs.

See also

References

  1. ^ See U.S. Internal Revenue Service (IRS) Publication 15, which includes withholding tables for income tax. State requirements vary by state; for an example, see the New York state portal for withholding tax.
  2. ^ See Canada Revenue Agency Publication T4001. Canada Revenue Agency also provides significant online guidance accessible through a web index, including an online payroll tax calculator.
  3. ^ See, e.g., IRS Form W-4.
  4. ^ See HM Revenue and Customs (HMRC) PAYE for employers: the basics
  5. ^ See the Australian Tax Office's PAYG withholding web page for details and tools.
  6. ^ See Irish Tax & Customs Deposit Interest Retention Tax.
  7. ^ 26 USC 3406, Backup Withholding. Withholding applies to individuals who have not provided the payee a tax identification number or failed to certify that they are is subject to backup withholding or with respect to whom the IRS has notified the payee that backup withholding applies. The rate of withholding tax is the fourth lowest rate of tax for individuals.
  8. ^ Dividend Allowance factsheet ] HMRC, 17 August 2015
  9. ^ "PwC Global Tax Summaries: Rwanda, Corporate – Withholding taxes". 26 July 2018.
  10. ^ See for example 26 USC 3111; ATO Publication 71038, Super: What employers need to know. Some systems, for example, New South Wales, Australia levy a payroll tax independently of a social insurance system.
  11. ^ See, for example, 26 USC 3102.
  12. ^ These limits may vary by country and year. For 2009, the U.S. income limit on the retirement portion (6.2%) of social security tax was $106,800, versus $102,000 for 2008, and there was no limit on the medicare portion (1.45%) of the tax; see Publication 15, supra. Canadian wages subject to Canada Pension Plan were limited to $46,390 of the excess over $3,500 for 2009, at a tax rate of 4.95%; see Publication T4001, supra. UK National Insurance contributions are due for earnings above the Earnings Threshold (£110 weekly) up to a limit that varies depending on other coverage.
  13. ^ See, e.g., 26 USC 1441–1446, IRS Publication 515, CRA Publication T4061.
  14. ^ For example, U.S. rules provide that rentals that rise to the level of a trade or business are not subject to withholding taxes, but other rental income may be subject to 30% withholding tax. An election may be available under 26 USC 871(d) or an applicable tax treaty.
  15. ^ 26 USC 897 and 26 USC 1445. The lower rate of withholding is requested by filing IRS Form 8288-B by the sale closing date.
  16. ^ The parent/subsidiary directive.
  17. ^ Parent Subsidiary Directive, by Salvador Trinxet Llorca
  18. ^ The interest and royalties directive.
  19. ^ The U.S. requires remittance electronically within no later than the following business day when the balance of unremitted amounts exceeds $100,000, and other thresholds apply; see IRS Publication 15, supra, p. 23. Canada requires remittance within three business days of the end of the quarter-monthly period in which withholding occurs for Threshold 2 remitters; see CRA Publication T-4001, supra., p. 3.
  20. ^ Penalties of up to 100% may be assessed against a withholding agent under 26 USC 6672 for intentional failure to withhold and remit. The penalty may be assessed against any person, including a corporate officer or employee, having custody or control of the funds.
  21. ^ See, for example, IRS Form W-2 and CRA Form T4 with respect to employees, and IRS Form 1042 and CRA Form NR4 with respect to payments to foreign persons.

External links

This page was last edited on 15 October 2019, at 00:44
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