What Is Withholding Tax?

Withholding tax is tax deducted at source on cross-border payments. Learn how it works, when it applies, and how to reduce or reclaim it in the UK.

Withholding tax is a type of tax that is deducted at source on certain cross-border payments. It often applies to income such as interest, royalties or dividends that are paid from one country to a recipient in another. Rather than the recipient paying the tax later, the payer deducts it before the funds are transferred.

This guide explains what withholding tax is, when it applies, the risks involved, how the process works, and examples you may come across in the UK and abroad.

What Is Withholding Tax?

Withholding tax (WHT) is a tax retained by the payer of income on behalf of the recipient. The tax is withheld from the gross amount before payment and passed on to the tax authority.

It’s most commonly applied to:

  • Interest payments

  • Royalties

  • Dividends

  • Fees for services (in some jurisdictions)

For example, if a UK business pays royalties to a company in another country, the UK may be required to deduct withholding tax from the payment before sending it.

Why Does Withholding Tax Exist?

Withholding tax is designed to ensure that tax authorities can collect tax on income paid to non-residents who may not otherwise be taxed within the paying country’s system.

It helps prevent tax avoidance and ensures some level of tax is paid on cross-border income. Double taxation agreements (DTAs) between countries often reduce or eliminate withholding tax to prevent income being taxed twice – once in the source country and again in the recipient’s country.

Withholding Tax Risks

For businesses and individuals, WHT can create both cash flow issues and administrative complications if not managed properly.

Common risks include:

  • Paying too much tax due to not applying treaty benefits

  • Non-compliance penalties if withholding obligations are not met

  • Delays in payment caused by misunderstanding tax responsibilities

  • Double taxation if relief is not properly claimed

  • Contract disputes if WHT responsibilities are not clearly defined

When entering into international contracts, it’s essential to check the tax treatment of payments, especially if your counterparty is overseas.

How Does the Withholding Tax Process Work?

  1. A UK company agrees to pay income (such as royalties or interest) to a foreign entity.

  2. The UK company checks whether withholding tax applies under UK law.

  3. The company determines the applicable rate – which may be reduced or eliminated by a tax treaty.

  4. If tax must be withheld, the company deducts it from the gross payment.

  5. The company pays the tax to HMRC and provides a certificate to the recipient.

  6. The recipient may then claim a credit or exemption in their home country using the relevant tax treaty.

The foreign recipient may also be asked to complete a double taxation relief form, such as the DT-Individual or DT-Company form, depending on the situation.

Withholding Tax Examples

Example 1: UK Company Paying Royalties to US Company

A UK business pays £10,000 in royalties to a US company. Under UK law, a 20% withholding tax applies, but the UK–US double tax treaty reduces this to 0%. The UK company applies for relief under the treaty using the relevant form, and no tax is withheld.

Example 2: UK Individual Receives Dividends from Overseas

A UK investor receives dividends from shares held in a German company. Germany deducts withholding tax at source. The individual can claim a foreign tax credit against their UK tax bill to avoid being taxed twice.

Can You Reclaim Withholding Tax?

Yes, in many cases, if too much tax is withheld, you can reclaim it by:

  • Claiming a tax credit through your Self Assessment tax return (if you’re a UK resident)

  • Submitting a claim for relief under the double tax treaty between the UK and the country that withheld the tax

  • Applying for a refund directly from the overseas tax authority using their forms

The process depends on the treaty terms and your tax residency status. In some cases, refunds may take months to process.

Final Thoughts

Withholding tax is a key part of international taxation. While it helps governments collect tax on cross-border payments, it can cause confusion and unnecessary tax bills if not handled properly.

Whether you’re a business making payments abroad or an individual receiving overseas income, it's important to understand when withholding tax applies and how to avoid double taxation. Make sure you use the right relief forms, understand the treaties in place, and seek advice when needed to stay compliant and tax-efficient.