Put simply, double taxation occurs when two countries tax the same income.
For example, in the context of international equity investments, when a domestic resident derives dividend income from a foreign investment country, the foreign tax authorities tax the income, based on the fact that it is considered to be taxable in their jurisdiction. In addition, the domestic resident is usually also liable to pay tax on the dividends in their domestic country as residents are generally taxed on their worldwide earnings. Hence, the dividend income may be taxed twice.
Double taxation agreements (otherwise referred to as double taxation treaties) have been enacted between countries to, among other functions, eliminate or reduce this cross-border double taxation.
A double tax treaty (DTT) is an agreement between two countries’ that facilitates the reduction of double taxation on cross-border transactions.
Tax authorities around the world have signed hundreds of treaties to avoid double taxation, often based on the model provided by the OECD(Organisation for Economic Cooperation). In these treaties, nations agree to limit their taxation on international business, to increase trade between the two countries and to avoid double taxation.
These treaties set out different rules for different types of income streams such as dividends, interest, assets and royalties. They may also agree to exempt some income or gains from tax or allow a set-off of tax paid in one country against tax due in the other.
A withholding tax refund opportunity exists when there is a differential between the investment country’s standard (withholding) tax rate and the tax rate agreed upon between two countries in their double tax agreement.
For example, when a foreign (e.g. Swiss) company pays a dividend to a domestic (e.g. US) resident, the Swiss tax authorities may withhold 35% of the dividend while the domestic US-resident investor receives the net income of 65%.
However, where a double taxation agreement exists between the domicile country of the company paying the dividend and the domicile country of the non-resident, it may unlock a refund opportunity. The double tax treaty between the two countries may prescribe a maximum tax rate of 15%, due to the foreign tax authority. Therefore, the domestic investor should be entitled to a refund of the excess tax (20%) which was withheld initially.
Double tax agreements may even prescribe a tax rate of 0%, which often applies to pension funds. In this case, a pension fund investor would be entitled to a full refund of the 35% withheld.
The following are a few examples of investor types which may be entitled to seek withholding tax refund opportunities using double tax treaties:
Click here for more information about separately managed accounts.
While still adhering to the principles of the double taxation agreements, Relief at Source allows an investor to obtain treaty benefits (and suffer tax only at the treaty rate as opposed to the statutory rate) at the time of the payment of the dividend, whereas a ‘longform reclaim’ claim is filed subsequent to the income event, once tax has been withheld at the source.
Relief at Source entails that the paying agent, subject to certain requirements being met, withholds the taxes at the correct treaty rate. For this process to be successful, action is required before a dividend is declared and the correct supporting documentation needs to be provided through the custody chain. Often the timeframe to provide the documentation is short and many miss the deadline, resulting in having to claim withholding tax retrospectively via a reclaim mechanism. The documentation required, as well as the timeline to submit those documents, are specific to each jurisdiction.
This article has covered the basics of understanding double tax treaty WHT claims. However, there are other WHT reclaim mechanisms to explore, namely European Court of Justice (ECJ) claims and domestic exemptions. Click here for more details on ECJ claims.
WTax offers end-to-end assistance for all withholding tax refund opportunities. Get in touch with us today to see how WTax improves investment returns through tax optimisation.