Withholding Tax

Withholding Tax for International Contractors

International contractors enjoy a certain amount of autonomy when structuring their work and payments.  This independence is one of the benefits of contracting, but it also comes with a compliance burden. 

If you are an independent contractor, you are self-employed, and responsible for all of your tax reporting and filing.  This may be a surprise to contractors who are former employees, and relied on their employer for accurate tax calculation and withholding

You might think that as a contractor you can skip the withholding and just pay your tax bill at year-end. 

That could actually be true, depending on your country’s tax rules.

But what happens when you are contracting in a foreign country, and are unfamiliar with the tax laws? 

How will you know how much to withhold and pre-pay in income tax, and what if you under report? 

Thomas, a UK contractor, was facing this issue while considering contracting in the US.  He was used to working in the UK for clients, where IR-35 imposed more scrutiny on how contractors were paid. 

Although he was self-employed in the UK, his client was required to make withholding from his earnings to avoid non-compliance with the UK tax law. 

Now that he was going to be working in the US, Thomas was unsure of how to handle his tax withholding, or whether it was even required.  To answer this question, Thomas first needed some background on withholding tax.

Tax Withholding for Individuals

In most countries, PAYE (pay as you earn) is used to withhold taxes for employees.  The employee receives their net monthly pay minus withheld taxes, all done by the employer. 

The reason for this is simple: it allows tax authorities to easily collect estimated taxes, and relieves employees of the burden of ongoing income tax calculation.  

If you are a contractor, you might wonder how your individual tax withholding works and if there are extra steps involved.  Some countries do impose PAYE on independent contractors, and your client would have to withhold income taxes from your monthly payment. 

This is the situation that Thomas had become used to in the UK as a non-payroll worker, but now he was going to be in the US as a contractor. 

If he is hired as an employee, his withholding would be the same as a US resident, regardless of his nationality.  But how is foreign contractor withholding treated in the US?

How Withholding Taxes are Calculated

In general, withholding taxes are calculated based on the applicable estimated income tax rate for the compensation level.  Withholding tax can also include statutory contributions and self-employment or payroll tax. 

The rates vary among countries, and are imposed on contractors at times so that both the client and the contractor are unable to avoid owed taxes and contributions.  

This is all done by the client or employer (or their payroll provider) and applied in each monthly payslip. 

If a contractor uses an umbrella company when working abroad, they are technically an employee of the agency, so standard withholding rates would be used. 

Independent contractors or limited companies may have different rates withheld, or be obligated to make their own quarterly estimated tax payments.

Case Study: US Withholding Tax for an Expat Contractor

As Thomas was planning to be a new expat contractor to the US, he was a bit confused about the withholding rates.  He knew that he would have to file a US income tax return with the Internal Revenue Service, even if there would be credits due under the UK-US tax treaty.  

For a US resident contractor, the self-employment tax is 15.3% plus the applicable income tax rate (employees only pay 7% employment tax.) 

Foreign contractors pay a flat 30% total withholding on their earnings, and their US client is obligated to withhold this amount.  But how often are these expanded withholding tax rates really used?

The issue is that Thomas as a foreign national would need a work visa.  If he obtained it through his client as sponsor, he would probably be their employee. 

Thomas could use an umbrella company and try to vie for the coveted H1B visa, in which case he would be the umbrella company’s employee.  

In both cases, Thomas’s withholding rate would be the same as US resident employees.  The only way the 30% rate would be applied is if Thomas had his own company, and obtained all the permits and registrations to operate in the US. 

This is a difficult path for a single self-employed contractor, simply because of the work visa hurdle.  For example, the Treaty Investor visa for entrepreneurs requires a certain number of employees, so it won’t work for sole traders or self-employed.

What are the options available to Thomas if he cant obtain a US work visa, yet still wants to work for the US client?

There is a good chance that Thomas won’t be able to obtain a US work visa, even as an employee of his client.  In that case, he could be hired as a remote worker while living in his home country of the UK, an option that has become increasingly popular.  How will the earnings from his US client be treated for tax purposes?

Under US tax rules, foreign contractors that perform all of the work outside the US have no obligation for US tax withholding or payment.  In addition, the client does not have to file any forms or make any withholding.  Thomas would pay his UK taxes as usual, except the US sourced-income would not be subject to UK PAYE rules.

How Does Contractor Taxation Help You Calculate Withholding Tax?

When you begin contracting, compliance will be a paramount concern.  Whether its work permits, tax withholding or banking, it really helps to have a local partner involved in the process. 

This is where an umbrella company can be invaluable, as they are already set up and ready to facilitate your client contract, invoicing and payments. 

They will calculate all the correct tax withholdings for you, and issue a payslip with your net earnings.

This takes the guesswork out of the most important part of your contracting journey–Receiving accurate and timely client payments into the account of your choice, while in full local compliance.

Umbrella companies help you:

·  Manage all client payments, tax withholding and any social contributions

·  Issue you a payslip each month, to a local or foreign account

·  Sponsor work permits

·  Set up the contract with the client

·  Moderate any disputes with your client

·  Advise on access to totalization and double taxation treaties

If you have questions about how an umbrella company can help you as an international contractor, please contact us at Contractor Taxation.

Withholding Tax FAQs

Do you get withholding tax back?

Withholding tax can include both estimated income taxes as well as self-employment tax, which is used for social contributions and pensions.  If your withheld income taxes is more than your year-end tax liability, then you can receive a refund.  

Is withholding tax an expense?

Withholding tax is not a business expense for individual contractors, as it is imposed on net earnings as a statutory obligation.  However, some countries like the US, allow a self-employed worker to deduct 50% of the self-employment taxes they paid from their gross income.  This is offered because self-employed essentially pay both the employer and employee portions of self-employment tax.

Is withholding tax the same as income tax?

Withholding tax includes estimated income taxes, but can also include statutory contributions and self-employment taxes.  Also, withholding may not be the actual tax liability as it’s only an estimate, so the final tax can be higher or lower.

Is it better to withhold taxes or not?

If you are not required to use PAYE as a contractor, your client won’t have to withhold taxes.  But many countries will want you to make estimated tax payments during the year instead.  That is the contractor’s responsibility to make correct payments, and if not then penalties might apply, plus interest.

How much should a contractor withhold for taxes?

If the country does not require PAYE for contractors, then you will have to calculate your own withholding or estimated payments.  Of course, no one wants to make tax payments, but if you fail to make any estimated payments during the year, you might face some penalties.  The best approach is to calculate your annual tax liability, and then make estimated payments based on that amount. If you don’t want to do your own withholding, you can always work through an umbrella company in the host country who will do it for you.