Withholding Tax

Withholding Tax Analysis

Withholding tax (WHT) is levied at source on cross-border payments — dividends, interest, royalties, and service fees. Understanding the interaction between domestic WHT rates, treaty relief, and anti-abuse provisions is essential for structuring international payments efficiently and compliantly.

Payment Classification

Correct classification of cross-border payments is the starting point for any WHT analysis. Misclassification can lead to incorrect tax treatment and potential penalties.

Dividends

Distributions from company profits to shareholders. Includes deemed dividends and constructive distributions in many jurisdictions.

Interest

Payments for the use of money — loan interest, bond coupons, and certain guarantees. Hybrid instruments may blur the line with dividends.

Royalties

Payments for the use of, or the right to use, intellectual property — patents, trademarks, copyrights, know-how, and software licenses.

Service Fees

Payments for technical, management, or consultancy services. Treatment varies significantly between OECD and UN Model conventions.

Domestic WHT Rates

Each country sets its own statutory withholding tax rates on outbound payments. These domestic rates apply in the absence of a tax treaty or when treaty benefits are denied. Domestic rates can range from 0% to over 30% depending on the payment type and jurisdiction.

Meridian maintains a current database of domestic WHT rates for all covered jurisdictions, updated as legislative changes occur. The applicable domestic rate serves as the starting point — treaty relief may reduce it.

Treaty Relief

Tax treaties typically reduce or eliminate WHT through specific articles:

Art. 10 — Dividends

Usually provides a reduced rate (e.g., 15% general, 5% for substantial holdings of 25%+ direct ownership). Some treaties provide 0% for pension funds or sovereign entities.

Art. 11 — Interest

Typically reduces WHT to 10% or lower. Many modern treaties provide 0% on interest, particularly within the EU under the Interest and Royalties Directive.

Art. 12 — Royalties

OECD Model provides exclusive taxation in the residence state (0% source WHT). UN Model allows source state taxation — treaty rates vary widely.

Beneficial Ownership

Treaty benefits (reduced WHT rates) are only available to the beneficial owner of the income. A recipient that acts as a mere conduit — with no real economic substance, discretion, or control over the income — will not qualify as the beneficial owner and treaty relief may be denied.

The OECD Commentaries (updated in 2014) clarify that beneficial ownership is not to be used in a narrow technical sense but should be understood in light of the object and purpose of the treaty — to avoid double taxation and prevent fiscal evasion.

Anti-Abuse Assessment

Even where beneficial ownership is established, treaty benefits may be denied under anti-abuse provisions:

Principal Purpose Test (PPT)

Benefits are denied if obtaining the benefit was one of the principal purposes of an arrangement or transaction, unless granting the benefit would be in accordance with the treaty's object and purpose.

Limitation on Benefits (LOB)

An objective test requiring the recipient to meet specific qualifying conditions — qualified person test, active trade or business test, derivative benefits test, or discretionary benefits.

Risk Matrix

Meridian categorizes WHT risk into three levels based on the analysis outcome:

Low Risk

Clear treaty entitlement, beneficial ownership established, no anti-abuse concerns.

Medium Risk

Treaty relief available but with conditions — substance requirements, potential PPT scrutiny, or classification uncertainty.

High Risk

Treaty relief uncertain or denied — conduit indicators, PPT/LOB failure, or domestic anti-avoidance rules triggered.

Best practice

Always verify the beneficial ownership status before applying reduced treaty rates.