Foreign Withholding Tax: A Lost Opportunity?
The ability to invest globally is available to a wide range of investors, including tax-exempt entities and government institutions. Greater investment opportunities come with greater complexities and costs, including foreign taxes on investment income withheld at source. This tax cost doesn’t always have to be a reduction to the return on investment, and BKD can help.
What Does That Mean?
Many tax-exempt organizations invest dollars offshore in various securities, such as publicly traded stock or other alternative investments. These investments typically generate foreign-sourced income to the investor, usually in the form of dividend and interest income. The foreign payer is often required to withhold tax at source on income paid to foreign payees, such as a U.S. tax-exempt investor. The rate at which taxes are withheld is typically a standard, default rate with no regard to the U.S. tax status of the investor. If the income is paid from countries that have a bilateral income tax treaty with the U.S., the withholding tax rate for tax-exempt organizations may be substantially reduced or, in some cases, eliminated altogether.
A typical tax-exempt investor may be a retirement system, government pension fund, college or university, hospital system, or other philanthropic organization.
Similarly, investment funds formed to accommodate tax-exempt investors may have the ability to reclaim foreign taxes withheld on foreign source investment income at the fund level in certain foreign jurisdictions.
Consider the following example. A U.S. tax-exempt investor purchases shares of stock in a publicly traded company domiciled in Canada. The Canadian company pays dividends to its shareholders and is required to withhold Canadian tax at a rate of 25 percent of the dividend paid to non-Canadian investors. The U.S. tax-exempt investor may be able to rely on Article XXI of the income tax treaty between Canada and the U.S., which provides for reciprocity in tax-exempt status among the two countries. As a result, the U.S. tax-exempt investor shouldn’t be subject to Canadian income tax on its investment income from Canadian sources. To obtain a refund in Canada, the U.S. tax-exempt investor may first wish to apply for exempt status with the Canada Revenue Agency (CRA). Once the exemption is granted, the U.S. tax-exempt investor may then request a refund of tax withheld from the CRA.
A similar process may be followed for U.S.-based investment funds with tax-exempt shareholders. In order for the fund to apply for a refund, the fund must provide documentation to the CRA evidencing the exempt status of its investors.
If you’re unsure of whether you have opportunities to reclaim foreign tax credits, contact your financial custodian to determine what reclaim services the custodian may be providing, if any. In addition, it’s important to evaluate reclaim opportunities on foreign investments held directly and outside of your custodial accounts, such as direct investments or foreign alternative investments. This may include partnerships and foreign blocker and/or feeder corporations. Compiling a summary of taxes withheld by country will help determine where the greatest opportunities exist based on U.S. income tax treaties and ultimately assist in the overall cost benefit analysis of the exercise.
How Can BKD Help?
With our extensive network of international professionals through Praxity, AISBL, BKD can help provide proactive, tailored guidance and resources required to file a claim for refund, such as:
- Reclaim analysis: Identify and quantify refund claim opportunities
- Documentation preparation and assistance: Analyze relevant income tax treaties and prepare country-specific documentation necessary to help support refund claims in each jurisdiction
- Preparation and submission of claims: Use our global alliance of tax professionals to prepare and submit refund claims in accordance with local country requirements
- Claim denial and resolution: Investigate denied claims and help develop a resolution plan
If you would like to discuss the topics explored in this article, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.