Withholding Tax Examples
In order to understand the above concepts, I am going to provide a set of examples that help to put these relatively abstract themes into common situations for the consulting industry. As a disclaimer, it is important to note that each situation is based on a particular set of facts and circumstances.
- US firm sending consultants to China
- US recruitment firm places workers in Saudi Arabia
- UK firm providing technical services to Tanzania
A US resident consulting firm has recently been hired by a Chinese company to provide management consulting services to them for a period of 6-12 months. A team of three consultants will be sent to Shanghai for the project.
According to Article 5 of the DTT between the US and China, a permanent establishment is deemed to have been created when a US company furnishes services, explicitly including consulting services, for a period of 6 months within a 12 month period. As a result, the income derived from the permanent establishment will be taxable in China at a rate of 25% (income tax) and 5% (business tax). This should be figured into the margin from the invoice.
In order to receive your payment for services, the local Chinese buyer will be required to provide the service contract and the invoice to the local tax authorities, as well as withhold the assessed amounts from the payment. The tax authorities will then issue a tax clearance certificate which can be supplied to the withholding agent. Only once this documentation has been received will the outbound transfer be able to be processed. Please note that the liability for the WHT falls on the company that receives payment.
A US resident recruitment firm has been successful in placing two workers to work on an oil rig in Saudi Arabia. The recruitment firm will be paid a fee for its consulting services and was originally planning on invoicing the Saudi client from the US, but realized that a 5% WHT will be due upon the transfer of the payment. Moreover, since there will be many technicalities with the local laws regarding employment and payroll taxes, the US company decided it would be best to simply hire the independent local firm and have them do the invoicing for the original recruitment fees.
As a result of using a local office, the foreign company will be able to cover the local costs of business while reducing the amount of income subject to WHT by deducting costs and expenses. Under Section 901(b)(1) of the IRC, a US resident corporation should be entitled to a credit for any paid amounts of tax to a foreign country. With the assumption that the US recruitment firm is the one with the legal liability for such tax, the amount of WHT paid would be deductible on Form 1118 and would reduce the domestic tax burden (subject to FTC limitations, which are beyond the scope of this article). Please note that the US does not have a DTT with Saudi Arabia and would not be entitled to any reduction in payment.
A UK engineering firm has a project in Tanzania and is sending consultants there to begin work with the client. For the provision of services, the client is paying the UK firm directly. The UK engineers will be in Tanzania for less than three months.
There is not a DTT between the UK and Tanzania. Because of this point, the income paid by the client in Tanzania for the services will be subject to a final WHT of 15%.
The important consideration for the UK engineering firm is that the payment that it receives will be 15% less than what it could have been expecting. There would be no possibility to reduce this amount and should the margin only be 10%, the UK firm would have a loss on the project. Therefore, it is important to consider this in advance or come up with an alternative that would make sense (see below).
About the author: Christian Wunderley, LL.M. is an international tax consultant and Managing Partner of the U.S tax firm, CD Tax Associates. He has a number of years of experience working in both financial services and international tax, including firms such as PricewaterhouseCoopers, BDO, and Citigroup. His specializations include withholding tax, particularly for non-U.S. businesses and investors that want to invest in the United States.