How to beat 'withholding tax' of global investing

Alan Reiter - Wed 21 Jun, 2006

...UK investors seeking to diversify their investments with overseas shares should be aware of the foreign withholding tax regime, particularly where dividend income is a principal attraction for making the investment. Use a large reputable broker for your international trades, to get the best administrative services if you need to reclaim taxes that were over-withheld...

What are the tax implications of global investing? It’s a problem faced by a growing number of smart British investors.

Angus Rigby, Chief Operating Officer of TD Waterhouse UK, wrote recently: “The popularity of international markets among retail investors has soared in recent years...international trading volumes have doubled over the past 12 months and now account for 10% of all trades.”

But if you are the beneficial owner of foreign equities, your dividend receipts will suffer from withholding taxes levied by the foreign countries involved. And in the absence of certain paperwork filed in advance, this can reduce your returns significantly. The amount of withholding tax on dividends retained by foreign governments may be as high as 30% of gross dividends, as is the case in Switzerland and the US.

How to beat 'withholding tax' of global investing: 27% of withholding tax goes
unclaimed each year

Few British investors know there is a system to beat, let alone how to beat it! Yet the law is quite clear. There are Double Taxation Agreements in force between the UK and most of the developed world. They stipulate, among other things, the maximum rate of withholding tax that a country can charge a UK resident on dividend income from that country. These treaties also determine that credit is given for taxes paid in one country against taxes paid on the same income in the other country.

Less fortunately, however, most overseas countries automatically hold back a portion of your dividends in taxation – known as “withholding tax” – at rates
higher than the treaty-agreed maximums! There is a way round this. Both the intermediary financial firm processing your dividends and also you, the foreign investor, must simply register with the relevant tax authority.

Investors who are unaware of the relevant treaty limits or who do not monitor their broker or dividend statements, run the risk of having too much tax withheld at source. One study by London-based Global Operations and Administration Ltd showed that 27% of withholding tax remains unreclaimed each year, leaving $6bn in foreign government coffers.

How to beat 'withholding tax' of global investing: How to claim your relief “at source”

The usual rate for stipulated withholding tax rates on dividends for the major countries is 15%, with a few exceptions. Check your dividend statements now, and if you discover you’ve paid foreign withholding tax at a rate higher than the tax treaty rate, you or your broker should approach each foreign tax authority for a refund of the extra tax you’ve paid.

For six of the countries listed, you can also obtain tax relief “at source” by writing to the relevant tax authorities when you set up your trading account. State that you are a UK resident, and you are entitled to the tax treaty maximum withholding rate. Investors trading in US shares, for instance, simply have to sign a “W8-BEN” form, and renew it every three years. They will then avoid the otherwise automatic US withholding tax of 30% on dividends, interest and proceeds of sales.

There are services available in the UK (from global custodian banks, brokers and clearing houses, for instance) that handle these details. They will ensure you are only charged the proper amount, and obtain refunds from the relevant tax authorities when you have been overcharged. Competition for your business ensures that these services are provided as promised. If your broker doesn’t offer this facility, or fails to look after your foreign dividends for you, find a new broker for your international trades.

The “withholding tax” services are usually outsourced to specialists, so the cost to your broker is minimal. And record-keeping is a nightmare to handle on your own, especially if you invest widely. Professional help is very useful here.

How to beat 'withholding tax' of global investing: Reduce your tax bill further with “credit relief”

Foreign source dividend income is taxed at the same rates as UK dividend income. That means 10% for basic rate taxpayers, and 32.5% for higher rate taxpayers. As a UK taxpayer, you can claim a credit for foreign withholding tax, up to the amount of your marginal tax rate. Any claim for relief against UK tax, however, is limited to the minimum tax payable under the relevant Double Taxation Agreement.

Take note: If there is no Agreement in force – such as with American Samoa, Andorra, Cambodia, Cayman Islands, Cuba, Bahamas, Bahrain, Bermuda, Equitorial Guinea, Liechtenstein, St Helena, Sao Tome, Tonga and Vanuatu – there is no tax relief available for your overseas dividends. But where an Agreement does exist, there is a way you can reduce your UK tax bill to maximise your savings.

Often, claiming relief by “credit” is more beneficial than by “deduction”, because the amount of foreign tax paid is offset against UK tax payable. The deduction method only reduces the amount of taxable income.

For example, imagine an overseas stockholding generated £1,000 in dividends. Most likely, at 15% withholding tax, you'd only be entitled to £850 gross. But you could offset the whole £1,000 against your UK taxable income, and claim that £150 back by “credit”. The upshot, paying 32.5% tax as a higher-rate UK taxpayer, would see you collect £825 net after-tax, rather than only £724 it you claimed relief by “deduction”.

In a few cases, tax relief is only allowed through the deduction method, due to restrictions in the relevant Double Taxation Agreements. And in case you were wondering, wrapping your foreign shares in an Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP) will not shield you from foreign withholding taxes on dividends.

An ISA or SIPP account only protects you from UK income taxes and capital gains taxes. As tax treaties evolve, there may arise special situations where foreign dividends from certain countries paid into SIPP accounts will be paid tax-free (because the dividends are going into a tax-deferred pension). Such a change is contemplated for the UK/US tax treaty, but pension managers I asked on your behalf for this report were not aware of any cases where zero withholdings from US dividends into SIPPs are currently allowed.

But in short, UK investors seeking to diversify their investments with overseas shares should be aware of the foreign withholding tax regime, particularly where dividend income is a principal attraction for making the investment. Use a large reputable broker for your international trades, to get the best administrative services if you need to reclaim taxes that were over-withheld.

And ask your financial advisor whether the “credit relief” route could prove more profitable for you. As our example above shows, it could add £101 to your post-tax returns on a £1,000 dividend, a 9.9% boost!


Regards,

Alan Reiter
for The Daily Reckoning

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