09 Jan Withholding Tax in Cross-Border Contracts
The incidence of cross-border services and transactions has increased exponentially particularly over the past century. It is now quite commonplace for businesses and individuals who are resident within Trinidad and Tobago (‘T&T’) to transact business with entities that are located and operate wholly outside of the jurisdiction. It is critical for these T&T based entities to appreciate the withholding tax risk which they may be exposed to when transacting with foreign entities, remitting payments to these foreign entities or recipients for services, and the ways that these risks can be managed.
What is Withholding Tax?
Withholding tax is a tax that is levied on various income payments that are made to non-residents. Section 50(1) of the Income Tax Act, Chap. 75:01 imposes withholding tax on payments and distributions that are made to any person or company that is not resident in T&T. In the case of payments, the person or company must also not be engaged in business in T&T, and the payment must not arise within T&T.
The type of payments upon which withholding tax is levied is defined in Section 51 of the Income Tax Act as being:
- Interest payments, discounts, annuities and other annual or periodic sums;
- Rental payments;
- Management charges or charges for personal services, technical skills, and managerial skills; and
- Premiums (other than premiums paid to insurance companies and contributions to pension fund schemes), commissions, fees, and licences.
Understanding what the nature of the payment or remittance is, is critical, as this will affect the rate of withholding tax that will be levied. For example, while distributions are taxed at 3% when paid to a parent company and 8% when paid other than to a parent company, payments to a company within the meaning of Sections 50(1) and 51 are taxed at the rate of 15%.
By way of illustration, in the business context, two common examples of transactions where the payment will attract withholding tax are:
- A transaction in which a resident of T&T (‘A’): (i) Enters into a lease agreement with a foreign counterparty (‘B’) for the leasing of certain machinery to be used by A’s business; (ii) The machinery is delivered to A and used in T&T; and (iii) A makes rental payments to B who remains in a foreign jurisdiction; and
- A licensing agreement scenario where: (i) Foreign entity B grants a license to A, to use software in A’s business in T&T; (ii) B owns the software; and (iii) A pays B for the right to use this software.
Is Relief from Withholding Tax available?
The applicability and rate of withholding tax levied on payments may be varied by a double taxation treaty that has been concluded between T&T and the country of residence of the foreign entity or recipient of the payment. T&T has entered into double taxation treaties with numerous countries including Canada, France, Germany, Norway, Switzerland, the United Kingdom, the United States of America, and with certain CARICOM Member States.
Double taxation treaties provide relief from withholding tax levied on certain types of payments such as interest payments, royalties and technical fees. For example, while rental payments for industrial equipment paid to a foreign counterparty are ordinarily subject to withholding tax at the rate of 15%, the UK-T&T double taxation treaty restricts the rate of withholding tax on such a payment made to a resident of the United Kingdom, to 10%.
However, notwithstanding how the payment is classified under Section 51 of the Income Tax Act, the payment may be reclassified as a different type of payment under the double taxation treaty, based on the definitions provided within the treaty. This reclassification may change the type of relief that is provided, as well as the requirements to be satisfied to access the relief.
In a business transaction between T&T and a foreign entity resident in one of the jurisdictions which T&T has entered into a double taxation with, in order to obtain relief, the T&T entity will be required to reasonably satisfy the Board of Inland Revenue (the ‘BIR’) that relief from withholding tax applies, by showing that the requirements to access relief under the respective treaty have been satisfied.
Some double taxation treaties may also contain provisions which may limit the benefits from applying if certain circumstances exist, or may restrict the amount of relief to be granted, if by reason of a special relationship existing between the T&T entity and the foreign counterparty, the amount of the payment exceeds the amount that would be payable if such a relationship did not exist.
Practical Considerations for Withholding Tax
Understanding the circumstances when a withholding tax liability exposure exists is also important, as the obligation to account for and pay the withholding tax will be on the T&T entity, who is required to do so within 30 days of the payment being made.
A T&T entity may find itself in a situation where, having remitted the full amount of the service price to the foreign counterparty, it is now required to account to the BIR for up to an additional 15% on the remittance, depending on the country in which the foreign counterparty is resident and any applicable double taxation treaties, in addition to penalties of 25% and interest at the rate of 20% per annum. Given that the BIR has up to 6 years after the income year to raise an assessment to tax, then not only may the T&T entity be ill-prepared for such an assessment, but it may find itself saddled with a potentially exorbitant tax bill with little prospect of recovering the amount from the foreign counterparty (especially where the business relationship was limited to a one off transaction or otherwise has ceased to exist).
Conversely, a T&T entity who deducts withholding tax from the contracted price may find itself in a dispute with the foreign counterparty as to whether the contract has been properly honoured or not.
To mitigate these risks, T&T entities who are contracting with foreign counterparties should:
- Get professional advice as to whether the payments to be made under the contract are likely to be subject to withholding tax, and whether any relief may be available;
- Ensure that the contract expressly addresses the deduction of withholding tax issue, such as by identifying the party who will be responsible for remitting the withholding tax and confirming the impact, if any, that such tax will have on the contract sum; and
- Consider any practical implications (such as the use of escrow accounts) where appropriate.
Disclaimer: This Document Provides General Guidance Only And Nothing In This Document Constitutes Legal Advice. Should You Require Specific Assistance, Please Contact Your Attorney-At-Law.
This blog post was authored by Miguel Vasquez, senior associate in the Firm’s Taxation and Dispute and Risk Management groups. For more information, contact Miguel at MiguelV@trinidadlaw.com.