What is withholding tax?
Withholding tax must be paid to government authorities by the payee of the income. This means that the entity disbursing the funds has to pay the tax directly to the authorities. In most cases, the collecting authority is the tax authority. Withholding tax can also be referred to as retention tax and can apply to payments made to residents and non-residents in a country. In some countries, it can be applied to payments that cross state or city line of jurisdiction lines.
The question of withholding tax can come up in supply chain networks when royalty payments, vessel charter or equipment rental is involved. Finance teams may want to consider withholding tax when determining transfer pricing strategies.
The following types of payments to a non-resident of a country can require withholding tax:
- Payments of interest on loans
- Payments of dividends on investments
- Payments for services rendered
- Payments on royalty
- Payments on rental of equipment
- Payments made to Directors of companies such as management fees
- Payments made to public entertainers or professional artists
- Payments made on certain types of real estate investments
- Charter fees for vessels
- Charter fees for aircraft
Retention tax payable for residents of a country will usually refer to employment payments.
Not all countries follow the same practices in levying withholding tax. Hence, the amount of retention tax to pay for similar transaction can vary across countries, even across states.
How to calculate withholding tax?
Before calculating how much with holding tax you have to pay, you need to check the following:
- Are you required to pay withholding tax or is your residency status exempt?
- Is your employer required to withhold tax on payments to you or is your residency status exempt?
- Is the specific transaction subject to withholding tax?
- Are there any waivers or exemptions available on paying withholding tax to the transaction?
- Does the authority provide any official tools to calculate how much tax I should withhold?
If you determine that you do need to pay withholding tax, it is usually levied on a fixed percentage for a particular transaction type.
Do not blindly reapply retention tax rules that you are familiar with in another country to transactions that occur in a different country.