What on Earth’s withholding tax? Why has no one told me about it before? WTF? These and other questions beginning with W bounced around my mind when I first discovered this mysterious cost of investing abroad.
The number of parties tapping your investments for a percentage is unending, up to and including shadowy foreign agencies (aka tax authorities).
Withholding tax is paid on income you’ve earned overseas. For investors in shares, equity funds, and ETFs, it can have an outsized impact on your dividend income, because it’s highly likely that you’re paying more tax than you should.
The amount taken varies:
- France deducts 25%
- The United States takes 30%
- Switzerland relieves you of 35%
It gets worse. Once you’ve got that dividend income back to the UK, Her Majesty’s Revenue & Customs (HMRC) wants another piece of it – usually another 25%/36% if you’re in the higher/top-rate bands.
Even the taxman can see this double-tax whammy is unfair. But it’s up to you to do something about it, and that means understanding the system…
Claim back withholding tax
The US should only take 15% off your gross dividends, not 30%. That’s according to the Double Taxation Agreement (DTA) in force between the UK and Uncle Sam.
The UK has similar agreements with many other countries around the world, which theoretically reduce the amount of withholding tax UK investors pay to foreign powers.
I say theoretically, because you have to actively claim your 15% back from the US Internal Revenue Service (IRS). They don’t just hand it back with their compliments. Quelle surprise. The same goes for any other country that deducts withholding tax at a higher rate than agreed in the DTA. In most cases you shouldn’t be paying over 15%.
To reclaim or stop the deduction at source, you must fill in a tax form. Which form, how torturous it is, whom you send it to, and how often depends on the country you invest in.
It’s basically a Kafka-esque labyrinth and the best advice is to find a broker who will handle the paperwork for you.
If you’re the kind of masochist who fills in forms for kicks then:
- Stop excess US withholding tax with a W-8BEN.
- W-8BEN guidance notes here.
- Claim back 10% from the French by filling in a 5000. And a 5001.
- Skip the 5001 by following the simplified procedure outlined in the guidance notes.
Get foreign tax credit relief
You can reduce the impact of withholding tax further by offsetting it against UK tax due on your foreign dividends.1
HMRC state in their foreign tax guidance:
You’ll get relief on the lower of:
• the foreign tax payable under the terms of the [double tax] agreement
• the amount of UK tax due
So in the case of US dividends, you can offset the 15% withholding tax you’ve already paid over there against the UK tax due:
- Basic-rate taxpayers – no action necessary. US dividends come with a 10% tax credit attached already.2
- Higher-rate taxpayers – liable for 32.5%/42.5% can offset the entire 15%.
You offset foreign withholding tax against UK tax by filling in a self-assessment tax return.
Two routes are open to you at this stage, one of which is far better than the other:
- Foreign tax credit relief
Whatever you do, choose foreign tax credit relief. Relief offsets your entire withholding tax payment against your UK tax liability.
Deduction only reduces the amount of taxable income. It’s far less cost-effective, although it may be the only option available in a few cases.
If your investments are shielded from UK tax by an ISA/SIPP then there’s no need to claim the foreign tax credit relief.
Beware that ISAs don’t protect you from withholding tax. The IRS and their ilk don’t give two hoots for subtleties like that.
Avoid the whole palaver
SIPPs qualify for a zero rate of withholding tax from certain countries including the US.
However, not all brokers structure their SIPPs to enjoy this freebie so check with your broker first if the extra 15% off is a deal-breaker.
ETF and fund investors can also duck withholding tax on their dividends by investing in the right funds.
Funds/ETFs domiciled in Ireland and Luxembourg do not levy withholding tax on dividends paid to UK investors. You only pay regular UK rates of tax, or nothing at all if your investment is tucked away in an ISA or SIPP.
There are thousands of funds, so you’ll have to do some research to see where yours are domiciled. But as a passive investor in ETFs and index funds, I can tell you the market-leading trackers available to UK investors are based in the following countries:
|No withholding tax||Withholding tax|
|db x-trackers ETFs||Ireland and Luxembourg||–|
|iShares ETFs||Ireland and Luxembourg||–|
|HSBC ETFs / index funds||Ireland / UK||–|
|Vanguard Europe ETFs / index funds||Ireland and UK||–|
|Vanguard US index funds / ETFs||–||US|
Say no to withholding tax
Interrogate your dividend statements to find out if you’ve paid too much withholding tax. You can find out the rate you should have paid by checking an individual country’s DTA with the UK.
- If you’ve overpaid, then get your broker onto the refund case.
- If you’re thinking of diversifying into foreign shares or funds, then check the withholding tax rate that applies.
- Choose a broker who will handle the recovery paperwork for you or offers a SIPP that pays US dividends gross of tax.
- Plump for UCITS funds domiciled in countries that don’t charge withholding tax.
- ISAs and fund reporting status are no defense against withholding tax.
That ends another broadcast against the evils of hidden costs.
Take it steady,