Withholding tax: purpose and change
Evolving business models and tax governance are driving demand for attention to managing unintended withholding tax consequences.
Taxes are a primary source of revenue for governments to fund public expenditure and social programmes sustainably. A well-developed infrastructure, strong law enforcement, and good education and health care systems are crucial to create an ecosystem for businesses to operate effectively.
Withholding tax (WHT) is a tax collection mechanism whereby tax is deducted at the source of income by the payer and remitted to tax authorities on behalf of the recipient. It is commonly applied to payments to non-residents, as tax collections from an overseas income recipient would be administratively challenging. Besides reducing the risk of non-compliance and underreporting of income, by putting the onus on payers to withhold tax, it allows tax authorities to collect taxes in a timely and efficient manner. In summary, WHT allows a country to collect its share of taxes, especially from foreign parties, without going outside of its jurisdiction.
It is worth noting that some countries, such as Thailand and Indonesia, also have WHT on domestic (i.e., local payer to local recipients) payments. But this is not common.
Overall, the WHT mechanism is an effective way of attributing taxes to the location that provides the ecosystem for businesses to operate and generate income.
Fundamentals of WHT
There are three key questions to consider in determining whether WHT is applicable and the obligation of payers.
- What is the nature or character of payment?
Not all income attracts WHT. Tax laws specify the types of payments – typically passive income – that fall within the scope of WHT provisions. Common examples include interest, dividends, royalty, rental, management or technical service fees, directors’ fees and capital gains. - Do tax authorities have the right to impose and collect taxes?
If the nature of income falls within the scope of WHT provisions, the next consideration is the nexus to the country of source. For instance, WHT is typically applicable to technical service fees, where the services are performed in-country. For other payments like interest and royalty, the income is generally regarded to be sourced in a country if the payment is borne by a tax resident of that country. - When and how much to withhold?
The final step is the reporting and payment of the WHT. While it appears to be an administrative process, it is critical to understand the nuances, otherwise it could impact cashflow and attract penalties. For example, in Singapore, the payer is required to file and pay WHT to the Inland Authority of Singapore (IRAS) by the 15th of the second month from the date of payment to the non-resident. Due to the definition of the term “date of payment”[1], which is often overlooked by taxpayers, WHT may be applicable even before actual payment is made to the non-resident.
Depending on the tax laws and practices of each country, WHT may be imposed differently. Businesses with a multi-jurisdictional footprint should be mindful of the potential WHT exposure in countries they operate in. If the income recipient is a tax resident of a country that has a double tax agreement (DTA) with the country of the payer, preferential tax treatment may be available. The definition of income covered in DTA is often different from domestic tax laws, and careful analysis is required to ensure compliance with tax rules.
Move to decentralisation – what this means from a tax perspective
In the past, a single entrepreneur model (single-hub model) has been preferred for various reasons such as cost savings, attractive tax incentives in popular hub locations, reduction in duplicative efforts and sharing of best practices that are associated with the scale and synergies made possible with centralisation.
This has evolved in recent years. Geopolitical factors, supply chain disruptions and ongoing implementation of phase two of the base erosion and profit shifting (BEPS) initiative have called to question whether a centralised operating model remains fit for purpose. Businesses are exploring a distributed operating model (multi-hub model), whereby high value, entrepreneurial business functions are located in multiple countries.
With a shift in functional profiles of group entities, businesses should review their intercompany transactions – whether there has been a change in characterisation. For instance, a company may be providing tangible goods and/or routine services to its overseas related companies where its income currently does not attract WHT. However, under the multi-hub model, if the company starts to perform high-value activities that create intellectual property rights (irrespective of whether they are registered or capitalised), the intercompany charges may be seen to have a royalty element, which would attract WHT.
Besides potential recharacterisation of income, businesses can expect greater scrutiny from a transfer pricing perspective. If taxpayers cannot substantiate that their intercompany charges are beneficial to the recipient and not duplicative in nature, or if the charges are not at arm’s length, there could be reduction of deductible expenses. Where the charges were subject to WHT, such WHT may already have been filed based on the higher amount accrued or actually paid earlier. Any request for refund of WHT is likely to be met with resistance from the tax authorities.
Withdrawal of WHT administrative concession
The IRAS has withdrawn the administrative concession that previously provided for a waiver of WHT on payments made on a cost reimbursement basis (i.e., without a profit element) to a non-resident related party for services rendered in Singapore under a cost-pooling arrangement. This took effect on 1 November 2022.
In other words, WHT will be applicable to any cost reimbursement payment liable to be made on or after 1 November 2022 to a non-resident related party, if the services are rendered in Singapore. This is not a final tax – the non-resident can submit its certified accounts and income tax computation to the IRAS to request a refund of the tax withheld in excess of net income (which in this case is none). However, requesting a refund may be easier said than done.
The removal of the concession creates administrative challenges for businesses, as the company pooling the costs will need to clearly track the nature of recharges and allocation methodology applied, and on top of that, where the services are performed. This is not a straightforward administrative assessment. In this digital age where the performance of services is no longer confined to a physical presence, coupled with remote working, the location of where services are rendered is often complicated. Businesses need to revisit whether their current processes can adequately address the requirements of the change in tax authority practices.
As business models evolve and tax rules change, it is timely for businesses to review how its WHT risk management is performed, and whether it is still fit for purpose. An alignment between business, operations and tax is necessary to ensure its relevance and efficiency.
The article was co-authored by former EY partner Russell Aubrey and Low Wai Ling, Director, International Tax and Transaction Services from EY Corporate Advisors Pte. Ltd.
