If you're investing in non-UK shares, make sure you're up to speed on the tax issues involved.
We live in a global society these days. It is as easy to invest in US or European stock as UK companies, opening up a world of choice for investors.
As with UK companies, foreign companies may pay dividends to shareholders -- but what are the international tax issues that could bite you on the investing bottom?
Withholding tax
Often, where dividends or interest are paid, the tax authorities in whichever jurisdiction require the payer to withhold a percentage of the gross payment to account for tax -- in simple terms think of the bank interest paid (or not) on your savings accounts -- the amount you receive is net of 20% UK tax.
A similar principle works for dividends in many countries (although not in the UK). The problem that arises, however, is that most investors are both not liable to tax in the country withholding the tax and liable to tax in the UK, at a different rate.
Availability and deductibility of withholding tax may be affected if you own more than 10% of the share capital of the paying company.
Double Tax Relief and Double Tax Treaties
In order to get around this problem, the first step was for the UK to allow double tax relief on tax suffered in another jurisdiction.
If the UK were the highest taxing nation (no, actually, it isn't) this would work perfectly in practice. However, some countries deduct a withholding tax at a higher rate than the investor is charged UK tax, and generous as HMRC may be, they are not going to have to potentially pay out a refund of tax that they have never actually collected.
This left investors in a quandary. There was no scope for obtaining a refund from the paying company as the withholding tax collected was accurate under the tax laws of that country. An investment doesn't look so great if you are suffering an irrecoverable additional 15% tax, say.
So the double tax treaty (DTT) was born. A DTT is basically an agreement between two countries on the taxing rights of each country and the amount of tax chargeable on various sources of income. Separate agreements can cover capital taxes.
The aim of DTTs is to make the tax fairer for the individuals (or companies) with cross border issues, and it is probably easier to look at an example.
US tax
When it comes to direct investment, US companies are probably the most popular choice among private investors.
Unfortunately, once you are in the clutches of the US tax regime, it is notoriously hard to get out of it. If you have ever been a US resident, it is likely the IRS will come after you for US tax. For the rest of your life.
Fortunately, however, there is a DTT between the UK and the US. The UK/US DTT was actually revised and rewritten in 2003, so is one of the most up-to-date agreements in force. Article 10 of the new treaty, which took effect in the UK from 1 May 2003, deals with dividend income. The treaty limits the withholding tax levied by US companies paying dividend to non-US resident investors to 15% instead of 30%.
From a practical perspective, as an investor, you need to complete a W8-BEN form, which certifies you as a non-US resident claiming treaty rules. The form is issued by the IRS, but should be returned to the dividend payer rather than the IRS themselves.
Clearly if you have an extensive US portfolio, completing numerous W8-BEN forms could be a bit of a bind. Some brokers will deal with the administration of these forms as part of their service, and is you are considering investing in US companies, it may be wise to enquire of your broker.
W8-BEN forms are valid for 3 calendar years, including the year of declaration -- so, if you complete your W8-BEN in July 2010, 2010 is year 1, 2011 is year two, and the final year of effect is 2012. Again, if your broker deals with administration of W8-BEN, they should remind you when your new declaration is required.
Next week's article will look at situations where withholding tax may not be subject to treaty protection, even if you have filled in forms like your W8-BEN correctly…
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