Withholding tax explained

What is withholding tax?

Withholding tax means some of your foreign payment is held back at the source, before you see the funds. If a company or bank outside your country pays out dividends, interest, or royalties, the government in their country may require that part of the money is deducted right away and paid to their tax authority.

So you get the rest, minus what they’ve withheld. The place where the payment originates is called the source country. Where you live and file taxes is considered your residence country. You can end up being taxed on that same income in both countries, unless you qualify for relief.

How rates are set and when they may drop

Each country sets its own withholding rates, these are built into tax law, and could also change if a double tax treaty exists between the two countries. Rates fluctuate, so always check the up-to-date amount for the specific payment you expect. Rates depend on what kind of income it is:

• Dividends: often held at a higher rate unless a treaty steps in.
• Interest: in some cases, certain lenders get a reduced rate or a full exemption.
• Royalties: can see the rate cut if a treaty covers the specific type of payment.

To use a reduced treaty rate, you're usually required to provide a certificate of residence (or something similar) to the payer before they release the money. If you skip this, the basic withholding rate applies. More about how double tax treaties work can be found at how double tax treaties prevent double taxation.

How withholding fits with your home tax

Withholding tax deducted abroad does not always settle your tax bill. Your home country may tax the income again, but will often give you a credit for the tax already paid overseas. That’s usually done by the credit method or the exemption method (explained further at foreign tax credit vs exemption).

Sometimes, the source country withholds more than your home country's rules would actually tax. Any extra is usually lost unless you submit a claim directly to the source country. It's always better to apply the correct rate early on if you can, to avoid having to reclaim excess tax later.

Example: receiving a foreign dividend

Let’s say someone living in country A receives a 1,000 dividend from a company located in country B. For illustration only: country B’s rules require 25 percent (so 250) to be withheld before you get the money. That leaves you with 750. Now, country A taxes those dividends at 15 percent, which is 150.

Your country lets you offset only as much foreign tax as its own tax on that income. So you get credit for 150, but not the extra 100. That can only be reclaimed from country B, if they permit it. Where a treaty reduces withholding to 15 percent, only 150 gets taken, and there’s nothing to reclaim.

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