Withholding tax on royalties: can you get the amount right?

Do you pay royalties abroad? And are you sure who is the actual recipient? Find out when you pay the full amount of withholding tax on royalties and when you can reduce it on the basis of double taxation.

What are royalties?

In the Czech environment, royalties are defined by the Income Tax Act (§19 of the Income Tax Act). Such royalties can take the form of income for the rental or other use of industrial, commercial or scientific equipment, as well as payments for the use of copyright or similar rights in a work.

Taxation of royalties

To better understand and assess the level of taxation, royalties can be divided into three categories:

  • Cultural royalty income - typically royalties on literary or artistic works, including film and motion pictures;
  • income from industrial royalties - most often for the use of a computer program (software), as well as rights to a patent, trademark or industrial design, but also specific know-how in the form of a secret formula or perhaps a manufacturing process;
  • other royalty income - this includes income from the use of movable property leased from abroad.

The categories described above will help us to better understand how to correctly determine the amount of withholding tax or reduce it to zero - thanks to the international double taxation treaties (DTT) that the Czech Republic has concluded with selected countries (typically EU member states and the USA).

Some double taxation treaties assign different tax treatment to these categories. Cultural royalties, for example, may be tax-advantaged in the source country or even not subject to taxation at all.

International double taxation

International double taxation arises when the same income would be taxed in both the source state (= source state) and the tax resident state (= recipient state).

Example: you pay royalties within your company to an Austrian company that is not registered in the Czech Republic. This income was earned by the Austrian company in the Czech Republic and is therefore subject to tax in the Czech Republic = state of source. The Czech Republic transfers this obligation to your domestic company, which is obliged to pay tax to the local tax office on behalf of the Austrian company (because the Austrian company does not file a tax return in the Czech Republic without registration, it has its tax domicile in Austria).

The double taxation treaty (in our case between the Czech Republic and Austria) sets a limit for the withholding tax rate. Most treaties limit the rate to 15%, but in some cases the treaty does not allow the royalty to be taxed in the source state at all (then no withholding tax obligation arises).

Amount of withholding tax

  • The 35% rate applies if the foreign company entitled to the royalty is based in a state that does not have a double taxation treaty with the Czech Republic. This is currently the highest rate of withholding tax on royalties.
  • On the other hand, a rate of 15% is usual for royalty payments to countries that have an interstate double taxation agreement with the Czech Republic. In addition to the Czech Republic's neighbouring countries, this includes other EU member states. Many others have joined this agreement voluntarily, e.g. the USA or the UK after Brexit.
  • Zero taxation can be applied if we would pay royalties to another domestic company or to a foreign company that holds at least a 10% equity interest in our company (typically a combination of parent and subsidiary companies). Also, in the case of cultural royalties, some states may agree to exempt them from tax.

TIP: For an up-to-date overview of the Czech Republic's applicable double taxation treaties, please visit the Czech Ministry of Finance website directly.

Who is obliged to pay withholding tax and how?

The obligation to calculate and pay the withholding tax on royalties rests with the paying entity - i.e. the Czech company. If we want to pay a reduced tax rate, we need to obtain the following two certificates:

  • a declaration of beneficial ownership of the income (this is issued by the receiving entity);
  • a certificate of tax domicile (issued by the local tax authority).

However, there have been several recent case law cases where the ultimate recipient of the royalty (the so-called beneficial owner) has not been sufficiently proven and therefore the benefits of the double taxation treaty have not been available to the payer.

The assessment is simple: the beneficial owner must not be a mere "flow-through" person in the role of intermediary. It is the entity (person or company) that receives the royalties, does not have to pass them on to anyone else (whether by law or by virtue of a specific contract) and is free to dispose of them and determine their use.

If we are not sure where our funds flow or where they ultimately end up, we risk withholding tax surcharges of up to 35% and possibly unwanted audits and penalties.

We understand business at home and abroad

You can contact us both when you are dealing with your business in the Czech Republic and if you plan to set up your own business abroad. And if you are unsure about paying taxes in the Czech Republic or abroad, we are happy to take over your tax agenda. Contact us using the form below and we will propose a tailor-made solution.

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