What is withholding tax?

Withholding tax is a tax applied to income. This means, that it is applied by the company which is paying money to its employees, beneficial owners or other companies in form of dividends, salary, etc. Withholding taxes might impact effective tax rates significantly.

Here’s an example: an individual is a tax resident in Dubai and has a company in Europe. When the European company distributes dividends, it applies a withholding tax rate based on the distributed dividends determined by the treaty for avoidance of double taxation between the United Arab Emirates and the European country in which the company is incorporated. In Dubai, there is no personal income tax, however, due to withholding taxes, the individual does not fully benefit from the favorable Dubai taxation regime, i.e., individual pays taxes not only in Dubai, but in the European country in which his dividend-paying company is based.

In most cases, withholding taxes are applied to dividends, if dividends are received by an individual. If the recipient is a company, a participation exemption might be applied. It all depends on the country in which the paying entity is established.

Withholding tax rates might be applied for all passive income: dividends, interest, royalties. However certain countries (mostly in South-East Asia) apply withholding taxes not only to passive, but to active income as well.