Tax and VAT
Withholding tax (WHT)
Withholding tax is a government requirement where a payer deducts a set percentage of tax from a payment made to a supplier and remits it directly to the tax authority.
What is Withholding tax?
When you purchase services from certain suppliers, your local tax authority may require you to hold back a portion of the payment. Instead of paying the full invoice amount to the supplier, you pay the withheld amount directly to the government. This mechanism is known as withholding tax. It acts as an advance payment of income tax for the supplier and helps tax authorities prevent tax evasion, especially when dealing with foreign entities or freelance contractors. As a business owner, you act as a collection agent for the government. You must recognise the gross expense in your general ledger, deduct the correct tax percentage, and remit the funds by the official deadline. The supplier then claims this deducted amount as a tax credit when they file their annual corporate income tax return.
Withholding Tax = Gross Amount x Withholding Tax Rate
Subtract the resulting withholding tax from the gross invoice amount to find the net payable to your supplier.
How Withholding tax works
The withholding tax process begins when a supplier issues an invoice for their services. Before you settle the bill, you must determine if the specific service or the supplier's location triggers a withholding tax obligation under your local tax laws. If it does, you calculate the tax based on the gross invoice value using the rate specified by your tax authority. You then pay the supplier the net amount after the deduction. Next, you declare and transfer the withheld funds to your national tax department, usually on a monthly or quarterly schedule. Finally, you provide the supplier with a withholding tax certificate. This official document proves that you paid the tax on their behalf, allowing them to offset it against their final tax liability.
- The supplier sends a standard invoice for the total gross amount of their services.
- The payer identifies the applicable withholding tax rate set by the local tax authority.
- The payer deducts the tax and transfers only the net balance to the supplier.
- The payer remits the withheld funds directly to the government before the filing deadline.
- The payer issues a tax certificate so the supplier can claim a tax credit.
Worked example
Apex Consulting provides marketing services to Gulf Trading LLC for a gross fee of $10,000. Gulf Trading LLC operates in a jurisdiction that requires a 10 percent withholding tax on professional services. First, Gulf Trading calculates the tax by multiplying the $10,000 gross amount by 10 percent, which equals $1,000. Gulf Trading then subtracts this $1,000 from the gross invoice, leaving a net payable amount of $9,000. Gulf Trading pays $9,000 to Apex Consulting and remits the $1,000 withholding tax directly to the tax authority. Apex Consulting later uses the $1,000 tax certificate to reduce its annual income tax bill.
Why it matters for your business
Failing to deduct withholding tax when required leaves your business liable for the uncollected amount. Tax authorities will demand the missing funds from you directly, often adding severe financial penalties and late payment interest. This mistake drains your working capital and complicates your cash flow statement. Accurate tracking is essential to avoid these penalties and maintain good relationships with your vendors. You must keep clear records of gross expenses, tax liabilities, and net payments. Paper & Pen creates invoices, quotations and receipts while posting the necessary journal entries to keep your tax liabilities perfectly organised.
See also
Questions
Common questions
Do I apply withholding tax on the amount including or excluding VAT?
How does a supplier recover the withheld tax?
Does withholding tax apply to the purchase of physical goods?
Related terms
- Corporate income tax Corporate income tax is a direct levy imposed by a government on the net profits or taxable income earned by a registered company during a specific financial period.
- Value added tax Value added tax is an indirect consumption tax assessed on the incremental value created at each stage of the supply chain, from initial production to the final sale.
- Accounts payable Accounts payable is the total amount of short-term debt your business owes to suppliers and vendors for goods or services that you have received but have not yet paid for.
- Journal entry A journal entry is a formal accounting record that logs a business transaction by showing the date, the accounts affected, and equal debit and credit amounts.
- Customs duty Customs duty is an indirect tax imposed by a government on the import and export of goods, calculated based on the item's classification and its total assessed value at the border.
- E-invoicing E-invoicing is the automated creation, exchange and processing of invoices in a structured digital format between a supplier and a buyer, often directly integrated with government tax authorities.