Withholding tax
Encyclopedia
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax
from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment
income. Many jurisdictions also require withholding tax on payments of interest
or dividend
s. In most jurisdictions, there are additional withholding tax obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties
, rent
or even the sale of real estate
. Governments use withholding tax as a means to combat tax evasion
, and sometimes impose additional withholding tax requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.
Typically the withholding tax is treated as a payment on account of the recipient's final tax liability. It may be refunded if it is determined, when a tax return
is filed, that the recipient's tax liability to the government which received the withholding tax is less than the tax withheld, or additional tax may be due if it is determined that the recipient's tax liability is more than the withholding tax. In some cases the withholding tax is treated as discharging the recipient's tax liability, and no tax return or additional tax is required.
The amount of withholding tax on income payments other than employment income is usually a fixed percentage. In the case of employment income the amount of withholding tax is often based on an estimate of the employee's final tax liability, determined either by the employee or by the government.
Typically, withholding is required to be done by the employer of someone else, taking the tax payment funds out of the employee or contractor's salary or wages. The withheld taxes are then paid by the employer to the government body that requires payment, and applied to the account of the employee, if applicable. The employee may also be required by the government to file a tax return self-assessing one's tax and reporting withheld payments.
, Canada, and Switzerland
the federal and most state, provincial or cantonal governments, as well as some local governments, require such withholding for income taxes on payments by employers to employees. Income tax for the individual for the year is generally determined upon filing a tax return after the end of the year.
The amount withheld and paid by the employer to the government is applied as a prepayment of income taxes and is refundable if it exceeds the income tax liability determined on filing the tax return. In such systems, the employee generally must make a representation to the employer regarding factors that would influence the amount withheld. Generally, the tax authorities publish guidelines for employers to use in determining the amount of income tax to withhold from wages.
The United Kingdom (UK) and certain other jurisdictions operate a withholding tax system known as Pay as you earn (PAYE), which is more comprehensive. PAYE systems generally aim to collect all of an employee's tax liability through the withholding tax system, making an end of year tax return redundant. However, taxpayers with more complicated tax affairs must file tax returns.
Australia operates a pay as you go
(PAYG) system, which is similar to PAYE. The system applies only at the federal level, as the individual states do not collect income taxes.
for deposit interest. The U.S. requires payers of dividends, interest, and other "reportable payments" to individuals to withhold tax on such payments in certain circumstances.
A few jurisdictions treat fees paid for technical consulting services as royalties subject to withholding of tax. The U.S. also imposes a 10% withholding tax on the gross sales price of a U.S. real property interest unless advance IRS approval is obtained for a lower rate. Furthermore, income tax treaties may reduce the amount of tax for particular types of income paid from one country to residents of the other country.
The European Union has issued directives prohibiting taxation by one member nation of dividends from subsidiaries, interest on debt obligations, or royalties received by a resident of another member nation. See also European Union withholding tax
.
Procedures vary for obtaining reduced withholding tax under income tax treaties. Procedures for recovery of excess amounts withheld vary by jurisdiction. In some, recovery is made by filing a tax return for the year in which the income was received. Time limits for recovery vary greatly.
Taxes withheld may be eligible for a foreign tax credit
in the payee's home country.
Where the employees are required to pay the tax, it is generally withheld from the payment of wages and paid by the employer to the government. Social insurance tax rates may be different for employers than for employees. Most systems provide an upper limit on the amount of wages subject to social insurance taxes.
Penalties for failure to remit withheld taxes to the government can be severe. Some such penalties are increased for longer periods of nonremittance.
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment
Employment
Employment is a contract between two parties, one being the employer and the other being the employee. An employee may be defined as:- Employee :...
income. Many jurisdictions also require withholding tax on payments of interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
or dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s. In most jurisdictions, there are additional withholding tax obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties
Royalties
Royalties are usage-based payments made by one party to another for the right to ongoing use of an asset, sometimes an intellectual property...
, rent
Renting
Renting is an agreement where a payment is made for the temporary use of a good, service or property owned by another. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from landowners...
or even the sale of real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
. Governments use withholding tax as a means to combat tax evasion
Tax evasion
Tax evasion is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability,...
, and sometimes impose additional withholding tax requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.
Typically the withholding tax is treated as a payment on account of the recipient's final tax liability. It may be refunded if it is determined, when a tax return
Tax return
A tax return is a tax form that can be filed with a government body to declare liability for taxation in various countries:* Tax return * Tax return * Tax return * Tax return...
is filed, that the recipient's tax liability to the government which received the withholding tax is less than the tax withheld, or additional tax may be due if it is determined that the recipient's tax liability is more than the withholding tax. In some cases the withholding tax is treated as discharging the recipient's tax liability, and no tax return or additional tax is required.
The amount of withholding tax on income payments other than employment income is usually a fixed percentage. In the case of employment income the amount of withholding tax is often based on an estimate of the employee's final tax liability, determined either by the employee or by the government.
Basics
Some governments have written laws which require taxes to be paid before the money can be spent for any other purpose. This ensures the taxes will be paid first, and will be paid on time as the government needs the funding to meet its obligations.Typically, withholding is required to be done by the employer of someone else, taking the tax payment funds out of the employee or contractor's salary or wages. The withheld taxes are then paid by the employer to the government body that requires payment, and applied to the account of the employee, if applicable. The employee may also be required by the government to file a tax return self-assessing one's tax and reporting withheld payments.
Wage withholding
Most developed countries operate a wage withholding tax system. In some countries, subnational governments require wage withholding so that both national and subnational taxes may be withheld. In the U.S.Tax withholding in the United States
Three key types of withholding tax are imposed at various levels in the United States:*Wage withholding taxes,*Withholding tax on payments to foreign persons, and*Backup withholding on dividends and interest....
, Canada, and Switzerland
Switzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
the federal and most state, provincial or cantonal governments, as well as some local governments, require such withholding for income taxes on payments by employers to employees. Income tax for the individual for the year is generally determined upon filing a tax return after the end of the year.
The amount withheld and paid by the employer to the government is applied as a prepayment of income taxes and is refundable if it exceeds the income tax liability determined on filing the tax return. In such systems, the employee generally must make a representation to the employer regarding factors that would influence the amount withheld. Generally, the tax authorities publish guidelines for employers to use in determining the amount of income tax to withhold from wages.
The United Kingdom (UK) and certain other jurisdictions operate a withholding tax system known as Pay as you earn (PAYE), which is more comprehensive. PAYE systems generally aim to collect all of an employee's tax liability through the withholding tax system, making an end of year tax return redundant. However, taxpayers with more complicated tax affairs must file tax returns.
Australia operates a pay as you go
Pay-as-you-go tax
Pay as you go is a system for businesses and individuals to pay installments of their expected tax liability on their income from employment, business, or investment for the current income year...
(PAYG) system, which is similar to PAYE. The system applies only at the federal level, as the individual states do not collect income taxes.
Other domestic withholding
Some systems require that income taxes be withheld from certain payments other than wages made to domestic persons. The UK requires withholding of 20% tax on payments of interest by banks and building societies to individuals. A similar requirement is imposed in IrelandIreland
Ireland is an island to the northwest of continental Europe. It is the third-largest island in Europe and the twentieth-largest island on Earth...
for deposit interest. The U.S. requires payers of dividends, interest, and other "reportable payments" to individuals to withhold tax on such payments in certain circumstances.
International withholding
Most countries require that payers of certain amounts, especially interest, dividends, and royalties, to foreign payees withhold income tax from such payment and pay it to the government. Payments of rent may be subject to withholding tax or may be taxed as business income. The amounts may vary by type of income.A few jurisdictions treat fees paid for technical consulting services as royalties subject to withholding of tax. The U.S. also imposes a 10% withholding tax on the gross sales price of a U.S. real property interest unless advance IRS approval is obtained for a lower rate. Furthermore, income tax treaties may reduce the amount of tax for particular types of income paid from one country to residents of the other country.
The European Union has issued directives prohibiting taxation by one member nation of dividends from subsidiaries, interest on debt obligations, or royalties received by a resident of another member nation. See also European Union withholding tax
European Union withholding tax
The so-called European Union withholding tax is a withholding tax which is deducted from interest earned by European Union residents on their investments made in another member state, by the state in which the investment is held....
.
Procedures vary for obtaining reduced withholding tax under income tax treaties. Procedures for recovery of excess amounts withheld vary by jurisdiction. In some, recovery is made by filing a tax return for the year in which the income was received. Time limits for recovery vary greatly.
Taxes withheld may be eligible for a foreign tax credit
Foreign tax credit
Income tax systems that tax residents on worldwide income generally offer a foreign tax credit to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction...
in the payee's home country.
Social insurance taxes (social security)
Many countries (and/or subdivisions thereof) have social insurance systems that require payment of taxes for retirement annuities and medical coverage for retirees. Most such systems require that employers pay a tax to cover such benefits. Some systems also require that employees pay such taxes.Where the employees are required to pay the tax, it is generally withheld from the payment of wages and paid by the employer to the government. Social insurance tax rates may be different for employers than for employees. Most systems provide an upper limit on the amount of wages subject to social insurance taxes.
Remittance to government
Most systems require that taxes withheld must be remitted within specified time limits, which time limits may vary with the total amount so held in trust. Remittance by electronic funds transfer is often required.Penalties for failure to remit withheld taxes to the government can be severe. Some such penalties are increased for longer periods of nonremittance.