When doing business with overseas companies, tax may not be first on your list of issues to cover. But it is important that tax is considered, otherwise, you may be hit with unwelcome tax retentions. Tax always offers traps for the unwary, and this is doubly true when two tax authorities are involved! Today’s Insight considers how withholding taxes work and how they may be mitigated.
I have just received the first payment from my new overseas customer and they have deducted 30% withholding tax. Can I reclaim it?
The first action to take is to check whether the withholding tax has been correctly deducted. No tax authority will repay tax that has been wrongly deducted. Sometimes we find that an over-zealous purchase ledger clerk has just deducted tax to be on the safe side. It’s worth finding out exactly why it has been deducted and confirm it is correct.
So in what cases will withholding tax be correctly deducted?
The most common examples are royalties, technical services performed overseas and loan interest. Goods are not generally subject to withholding tax,
I have entered into a licence agreement with US customer who has deducted 30% withholding tax on their payments. What should I do?
Fortunately, the UK has a Double Tax Agreement with the USA that says that royalty income from the USA should only be subject to tax in the UK. However, to avoid US tax, a claim has to be made under the Double Tax Agreement. There are two action points here. First, to recover the withholding tax, a claim will need to be made to the Internal Revenue Service (IRS) in the USA.
Second, to prevent it happening again, you should complete the infamous IRS form W8 BEN E, and send it to your customer.
Do Double Tax Agreements always reduce the withholding tax to 0%?
No. Every country’s Double Tax Agreement is different, but many reduce the country’s standard rate of withholding tax to a lower “treaty rate.” This is often in the range 5% to 15%.
That all sounds quite onerous. Won’t HMRC give me relief for overseas tax against my UK tax bill?
The UK will only give relief for the treaty rate. If the tax withheld is 25% and the treaty rate is 10%, HMRC will give relief for 10% and expect you to reclaim the other 15% from the overseas tax authority. Much better to get the lower rate authorised in advance!
And do I get credit for the overseas tax against my corporation tax bill?
Yes, although credit is not always available in full.
Relief is given against the UK corporation tax on the overseas profits. The withholding tax is then deducted from the UK tax on the same profits, but it cannot be reduced beyond zero.
For example, if the contract price is £10,000 and the contract profit is £1,000, the UK corporation tax at 25% would be £250. As the withholding tax would be £1,500, the whole contract profit is wiped out by withholding tax. And if you are not a taxpayer (e.g. because you are loss making or exempt) you will not be able to recover the tax.
How do I stop this happening?
As ever, include tax in your considerations before signing contracts. You could consider a gross-up clause in the contract, providing that the payment made must be grossed up by withholding tax where it applies. It might not get agreed, but it will flush out the issue and prevent an unwelcome shortfall when you get paid.