Withholding taxes

When a company makes a payment to an individual or an entity, it may be required to withold a percentage of the amount and remit it to the tax authority. For example, when an employer pays out a salary, it withholds income tax (as well as payroll deductions) from the employee's paycheck. A company may also withhold taxes when paying out dividends, interest, royalties, rent, directors fees, and technical service fees. Other payments may be exempt from withholding (ex: payments for services to resident companies) or be subject to a lower (or zero) rate (ex: payments to parent companies or major shareholders, i.e. participation exemption).

WTH tax applies to domestically sourced income. For example, if a US company hires a remote contractor in Canada, it should not withhold any tax from payments because the income is not US-sourced (and the contractor is not a US person). In some countries (ex: US, Canada, UK), payments to residents are also exempt from withholding, meaning that they must declare the income and pay taxes later, when filing their tax return. In others (ex: Bulgaria, Mexico), the tax is withheld at the source for both residents and non-residents, therefore the residents do not pay the tax again at the individual level.

Non-resident WHT

When you earn foreign-source income, a non-resident withholding tax will typically be deducted before the payment is received. For example, when you, as a foreign person, receive dividends from a US corporation, it will withhold 30% to the IRS since the income is US-sourced. This rate can be reduced if the country you are a tax resident of has a tax treaty with the US (ex: 15% for Canadian residents, see WTH taxes in US) by submitting a W-8BEN form to the IRS. Rental income (along with REITs) is often subject to the standard WTH tax and can't be reduced by a tax treaty.

Unfortunately, the WTH tax is non-refundable. However, you may be able to claim a foreign tax credit to reduce your domestic tax when filing a tax return. Also, if the tax was withheld by mistake (ex: by a US client even though your service/product was not US-sourced) or at an incorrect rate (ex: a general rate was applied instead of a reduced rate based on a tax treaty), you could file a foreign tax return to claim a refund (ex: Form 1040-NR in US).

The rate of withholding depends on several factors:

• individual tax residency (and any applicable DTTs)
• company domicile (i.e. country of residence)
• stock exchange domicile (if different from the company's domicile)
• security domicile (if it's an ETF, mutual fund, etc.)
• type of investment account (margin, registered, etc.) (see taxes on investments)

Unfortunately, there may be multiple levels of WTH taxes:

• Level 1 WTH tax is levied by the country where the company is domiciled
  • ex: if you receive dividends from a US company listed on a US stock exchange, you will incur a US WHT of 10-30%
• Level 2 WTH tax is levied by the country where the security is listed
  • ex: if you receive dividends from a US-listed ETF that holds international stocks, the fund will incur WHT from its holdings at Level 1, and then you will incur an additional US WHT of 10-30% at Level 2

Read more in this article. For a US/Canada perspective, see this white paper.

Reducing non-resident WHT

1. Invest in contries with a zero or low non-resident WTH tax

• some countries don't have a WTH tax on dividends at Level 1, ex: UK (LON), Ireland (ISE), Hong Kong (HKG), Singapore (SGX)
• other countries have a low WTH tax, ex: 10% in China (SHG)
• NOTE foreign divs from interlisted stocks are still subject to WTH tax
  • ex: US company is listed on both NYSE (USD) and TSX (CAD)
  • Canadian residents will still pay 15% WTH tax even if they buy on TSX
  • WTH tax is applied based on where the company is domiciled (i.e. US)
  • which stock exchange the shares are traded on and in which currency is secondary
• BONUS companies in EM countries tend to have lower P/Es and higher div yield

2. Invest in funds domiciled in countries that don't levy WTH tax

• some countries don't tax dividends paid to non-residents at Level 2, ex: Ireland (ISE), Luxembourg (XLUX)
  • ex: dividends from a US-listed ETF are subject to 30% WTH tax unless covered by a tax treaty
  • the same underlying stocks could instead be held in an Ireland-listed ETF
  • divs would be taxed at 15% (under US-Ireland treaty, Level 1) and 0% (Ireland fund, Level 2)
• NOTE unlike US-listed ETFs, foreign-listed ETFs are not subject to US estate tax at 18-40%

3. Move to a country with a lower WTH rate based on a tax treaty

• some countries that signed DTTs have a lower WTH tax
• ex: US WTH tax is generally 30%, but is 10% for tax residents of Bulgaria, Romania, Mexico, etc.
• ex: Japan has a 20% WTH tax that can be reduced to 10-15%

4. Invest in domestic companies

• divs from local companies are often subject to lower tax rates and/or tax credits
  • ex: qualified divs in US, eligible divs in Canada, etc.
• in lower tax brackets, you may be exempt from tax and/or have a negative tax to offset other income
  • NOTE div income above a certain threshold may affect your pension (ex: OAS clawback in Canada)

5. Earn capital gains

• WTH tax is usually not applied to capital gains
• instead of dividends or interest, earn from capital appreciation
  • ex: invest in growth stocks (ex: US tech), sell shares when retiring
  • ex: sell call options for a premium, trade futures, etc.

Resources

• PwC WHT rates by country
• US WHT by tax treaty (select a country and navigate to Corporate, Withholding taxes)
• Deloitte Tax Guides (click on a country and scroll down to Withholding tax table)