2.6 Accounting for Withholdings on Certain Payments (e.g., Dividends, Interest, Royalties, or License Fees)
In some tax jurisdictions, dividends to owners and other payments (e.g., interest,
royalty, or license payments) may trigger a tax obligation to the tax authority in
the payor’s jurisdiction (sometimes referred to as a “withholding tax”). Such a tax
may be required to be withheld from the payment by the payor and remitted to the
taxing authority. It is not always clear whether the payor or the recipient should
account for the tax as an income tax, and careful consideration is often
required.
2.6.1 Accounting for a Withholding Tax by the Payor
Treatment of the withholding tax by the payor of the dividend will depend on
whether the tax is assessed on the payor or on the payee. This is a legal
determination in the jurisdiction of the payor.
In some jurisdictions, a tax based on dividends distributed is assessed directly
on the dividend payor. In these cases, remittance of the withholding tax should
be accounted for in equity as a part of the dividend (rather than as an expense
of the payor) only if both of the conditions outlined in ASC 740-10-15-4(b) are
met. ASC 740-10-15-4(b) states, in part:
A tax that is assessed on an entity based on dividends distributed is, in
effect, a withholding tax for the benefit of recipients of the dividend
and is not an income tax if both of the following conditions are met:
- The tax is payable by the entity if and only if a dividend is distributed to shareholders. The tax does not reduce future income taxes the entity would otherwise pay.
- Shareholders receiving the dividend are entitled to a tax credit at least equal to the tax paid by the entity and that credit is realizable either as a refund or as a reduction of taxes otherwise due, regardless of the tax status of the shareholders.
If either of these criteria is not met, a tax assessed directly
on the dividend payor should not be considered a withholding for the benefit of
the recipient. Instead, it should be accounted for by the payor as either an
income tax within the scope of ASC 740 or as a non-income-based tax, depending
on the substance of the tax.
If the tax is accounted for by the payor as an income tax within the scope of ASC
740, any tax benefit to the payor resulting from payment of the withholding tax
should be recognized as part of tax expense or benefit from continuing
operations.
2.6.2 Accounting for a Withholding Tax by the Recipient
Most taxes on dividends are assessed on the recipient of the dividend but are
required to be withheld and remitted to the taxing authority by the payor. In
these instances, the remittance of the withholding tax to the tax authority by
the dividend payor is accounted for by the payor in its financial statements as
a reduction to equity (i.e., as a part of the dividend). The withholding tax may
still, however, be viewed as an income tax from the point of view of the
recipient of the dividend since the tax is paid on behalf of the recipient.
ASC 740 does not provide guidance on determining whether recipients of certain
payments (e.g., dividends or royalties) should account for withholding taxes as
income taxes within the scope of ASC 740.
ASC 740-10-55-24 states the following regarding taxes withheld from dividends:
Deferred tax liabilities and assets are measured using enacted tax rates
applicable to capital gains, ordinary income, and so forth, based on the
expected type of taxable or deductible amounts in future years. For
example, evidence based on all facts and circumstances should determine
whether an investor’s liability for the tax consequences of temporary
differences related to its equity in the earnings of an investee should
be measured using enacted tax rates applicable to a capital gain or a
dividend. Computation of a deferred tax liability for undistributed
earnings based on dividends should also reflect any related
dividends received deductions or foreign tax credits, and taxes that
would be withheld from the dividend. [Emphasis added]
It can be inferred from this guidance that the FASB intended withholding taxes on
dividends to be a component of income taxes. However, ASC 946-220-45-3 discusses
the presentation of certain items in the statement of operations of an
investment company and suggests that withholding taxes might, in fact, be
considered as “other taxes.” ASC 946-220-45-3 states, in part:
All of the following expenses are commonly reported separately: . . .
g. Federal and state income taxes (these expenses shall be
shown separately after the income category to which they apply,
such as investment income and realized or unrealized
gains)
h. Other taxes (foreign withholding taxes shall be deducted
from the relevant income item and presented parenthetically or
shown as a separate contra item in the income section).
Accordingly, the recipient of a dividend or other payment that is subject to
withholding tax should account for the withholding tax on the basis of its facts
and circumstances. Relevant questions (not all-inclusive or individually
determinative) include the following:
-
If the recipient had qualifying expenditures in the local jurisdiction or had established a local presence, would the withholding tax be adjusted accordingly (i.e., would it not apply, or would it be reflected as an estimated tax payment on the income tax return)?If the recipient filed an income tax return in the payor’s jurisdiction, the fact that the taxable income could be adjusted if there were qualifying expenditures and any withholding tax could be claimed as an estimated payment would be a strong indicator that the withholding tax should be considered an income tax.
-
Is the payment effectively a distribution from the earnings of the paying entity? That is, is it a dividend and not a return of capital or other expense?If the amount was paid out of earnings of the paying entity, the withholding tax may represent an incremental layer of tax, imposed on the recipient, on the income of the payor. For example, although a dividend itself may seem to be revenue rather than income to the recipient (i.e., the recipient has not been able to directly reduce the dividend by expenses), the withholding tax is assessed on a net income figure (i.e., the paying entity has incurred expenses on its revenues) at the time of distribution. Therefore, the recipient has indirectly been allowed a deduction for the expenses associated with the revenue upon which the dividend is based given that the paying entity has taken these deductions before making the dividend.
-
Is the withholding tax creditable on an income tax return filed by the receiving entity or by the receiving entity’s parent?While the ability to take a credit for the tax on an income tax return would not itself indicate that the tax is an income tax, many of the criteria used to evaluate whether the tax is creditable would most likely be relevant in the determination of whether the tax is an income tax for U.S. GAAP purposes.