Glossary term
Withholding Tax
Subject: Legal, Tax and Reporting, Tax Compliance and Governance
Also known as: TDS, tax deducted at source, WHT
Withholding tax is tax that a payer deducts from certain payments, such as salary, interest, dividends or fees, and sends directly to the tax authority on behalf of the person receiving the money.
Explanation
Instead of waiting for the recipient to declare income and pay later, the law makes the payer collect the tax at the moment of payment. This lowers the chance of non-payment and gives the government earlier cash. Rates and covered payments vary widely: domestic salaries, contractor fees, rent and interest in many countries, and royalties, dividends and interest paid abroad. For cross-border payments, a double taxation agreement may cut the rate, and the recipient may need to supply a residency certificate. In India the system is called tax deducted at source (TDS). The payer must deduct at the right rate, deposit on time, file statements and issue certificates. Payers who miss a deduction usually pay the tax from their own funds, with interest, so finance teams build the check into every payment run.
Example
A software company in one country pays a 100,000 licence fee to a foreign supplier. Local law requires 10% withholding on royalties, and the supplier's country has a treaty rate of 5%. After checking the supplier's residency certificate, the payer deducts 5,000, pays 95,000 to the supplier and deposits 5,000 with the tax authority before the monthly deadline.
Not to be confused with
- Value Added Tax (VAT)
- VAT is a transaction tax on goods and services passed to consumers. Withholding tax is deducted from a payment of income at source.