Boosting Transparency can Recoup Millions in Withholding Taxes for Multinationals

Many U.S.-based multinational corporations could be leaving millions on the table due to opaque business processes that make it difficult to account for taxes withheld by foreign jurisdictions on the payment of income including royalties, interest or dividends.  It is a situation that can be easily remedied by introducing greater transparency and consistency into key business processes, according to one international tax expert.

“Most international companies that have to move money across borders to make interest, royalty or dividend payments have to deal with this.  A good percentage of these companies could be leaving money on the table and not realize it,” said Jeff Barr, a Kforce Finance & Accounting consultant specializing in corporate finance and international taxation.  “The problem relates to different IT systems making access to the data a challenge and a lack of processes to drive transparency.”

One problem area Barr commonly encounters is how corporations as a whole manage withholding taxes on inter-company payments.

In many instances, the subsidiary that incurs the withholding tax is able to recover most or all of those monies in the form of a foreign tax credit, which is allowed by most countries to eliminate double taxation.  However, when withholding taxes lack visibility, the company is unable to track them at its foreign divisions or in the U.S., where withholding taxes are expensed as incurred. 

“Withholding tax doesn’t get any visibility because of the different systems and processes in place at the various divisions.  Corporate just can’t see the information beyond what is actually coming into the U.S., which is often painful to extract.  Withholding taxes, whether direct or indirect, get lost,” said Barr.  “When that happens, you lose your opportunity to recapture that money.”

In this situation, Barr recommends first establishing separate accounts to capture withholding tax payments on the balance sheet and income statement.  This enables a company to identify those taxes that could be recovered from its subsidiaries and those that need to be added to the subsidiaries’ tax pool.  Also recommended is accumulating historical withholding tax information and required backup, so that the withheld amounts can be properly reflected  for recovery via a credit on IRS Form 1118 (Foreign Tax Credits-Corporations). 

Taking these actions on behalf of one company enabled Barr to identify more than $2 million related to indirect credits that the corporation will be able to recapture.  It also created an audit trail and supporting documentation that allowed the company to reduce its effective tax rate by up to 0.75 percent by acquiring back up documentation to support a $1.2 million withholding tax payment incurred by the U.S. parent.

Barr notes that, when taken individually, the numbers may seem insignificant.  For example, if a division is paying monthly intercompany interest of $15,000, a 10 percent withholding would be just $1,500.  That alone may be too small to focus resources on for recapture.  However, if that same company is receiving similar interest payments on 10 outstanding loans 12 times a year, “these little monthly charges add up,” he said.  “Now you’re talking some significant dollars.”

Barr also recommends establishing communication policies and other processes to further refine how a company is recognizing foreign withholding.  Doing so will help ensure a company is recapturing every dollar to which it is entitled. 

“If you put policies and processes in place, then what you’re talking about is needing to review them only once a quarter or even once a year to get a handle on the situation; to be sure no money is being left on the table and to know with certainty that you’re capturing the information you need to provide the best return for the company,” said Barr.

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