Types of Withholding Tax

A withholding tax, in an international context, is imposed on a cross-border payment of income from a source in one country to a resident in another country.  While some types of income (such as dividends) are much more likely to have a WHT obligation, other types such as business income generated from a permanent establishment are almost exclusively taxed under domestic laws as if the company were a resident.  There are a number of types of WHT and in this section, we will provide additional detail about some of the most common to the consulting industry.

  1. Dividends

    Dividends are income from a corporation in which the beneficiary owns equity (shares, or other forms of participation) in a company.  In general, any repatriation of profits from a subsidiary to a parent company will be in the form of a dividend.  Even with sophisticated tax planning techniques that include multiple loans, depending on the jurisdiction, a payment of interest can be reclassified as a dividend. 

    Withholding tax on dividends

  2. Royalties

    According to Article 12 of the OECD Model Convention, the payment of royalties includes consideration for the use of intellectual property such as scientific works, patents, designs, models, or for “information concerning industrial, commercial, or scientific experience.”  Royalties can also arise in conjunction with technical services, particularly when using software developed by the firm providing the services.  However, the treatment is often ambiguous. It can be very jurisdiction-specific and advance planning should be considered. Within the pretext of consulting services, royalties would become more common under agreements that regard the use of technical information.

  3. Technical Services

    Technical services may, but do not necessarily include, IT consulting, management consulting, and software development.  In some jurisdictions, technical services are closely linked to services in which royalties would arise (for example, through a patent or license).  Under other treaties, special provisions apply to managerial, technical, and consulting services.

    It should be noted that there is not an international consensus on what constitutes “technical” and each jurisdiction should be considered on a standalone basis. In particular, developing countries have extended the interpretation of the UN Model Convention to include the right to tax technical services that are supplied within their borders.   Unfortunately, the harmony stops there.  In a UN position paper prepared by Brian J. Arnold [4], he notes that when considering the definition of technical services, there is “no clear definition available. 

    From the standpoint of an international consulting firm, this can be problematic.  Whereas there is great effort being expended to create a more authoritative definition, the provision of the same services in one country may have a completely different interpretation (and consequence) in another country.

    Withholding tax on technical services

  4. Personal Services

    Personal services are divided into two key categories:  independent personal services and dependent personal services.  The main difference is that independent services are provided by a contractor that does not have an employee relationship with the foreign company.  Dependent services, in contrast, are performed through an employer-employee relationship and consist of income from employment.

    The distinction between independent and dependent personal services can sometimes be vague and unfortunately, can be extremely important within the context of international tax.  For example, a contractor that has no other clients than the foreign company and lacks discretion in the performance of duties is more likely than not going to be considered as an employee, regardless of whether the hiring company classifies them as independent.

    Withholding tax on branch remittances

  5. Branch Remittances

    To understand branch remittances, it is important to understand that a branch is considered the same legal entity as the parent company.  Since the entities are considered the same from a tax standpoint, any distribution of income is equivalent to taking money from one pocket and putting it in another.  Companies were quick to establish a branch, rather than a subsidiary, because any payments avoided classification into a dividend.

    Times have changed.  Tax authorities are more sophisticated and have recognized that branch remittances were in consequence nearly identical to a dividend.  As a result, many governments (including the UK and the US) have created a “branch remittance tax” or “branch profits tax” to ensure that the repatriated amounts would be taxed in a similar manner as a dividend.  

  6. Business Income

    Business income, in a general sense, is any income that is attributable to a permanent establishment.  The complex concept of permanent establishment will be discussed in more detail in the proceeding section.

Withholding tax on royalties

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.

[4] Arnold, Brian J. “Taxation for fees for technical and other services under the United Nations Model Convention.”  2012, Committee of Experts on International Cooperation in Tax Matters.