Varying Approaches to Withholding Take Place Around the World

Several different systems represent the various models of income tax withholding used around the world, a global payroll practitioner said May 18.

The UK and Ireland use a “cumulative year-to-date” model, where thresholds separating the income tax brackets in effect are turned into monthly amounts and accumulate each month until the full annual figure is reached, said Tim Kelsey, managing director of Kelsey’s Payroll Services. Employees’ pay is compared against the thresholds for each month to determine the tax rates to apply.

For example, the threshold between the 20% and 40% tax brackets in the UK outside of Scotland is 37,700 pounds (US$46,790.98), he said at PayrollOrg’s 41st Payroll Congress. Dividing by 12 gives a rounded monthly figure of 3,142 pounds. In the first month, pay of up to 3,142 pounds is taxed at 20%. In the second month, total year-to-date pay of up to 6,283 pounds, or the monthly threshold multiplied by two, is taxed at 20%.

Fluctuations in monthly pay because of bonuses or other payments can result in more tax being owed for one month and less tax being owed for another month, or even a refund, because the employee’s income would move the employee into a different tax bracket. “The system is automatically self-correcting,” he said.

The idea behind the system is that it can almost exactly measure employees’ tax liability if their situation is straightforward and saves many people from having to file tax returns, Kelsey said. In the UK, only about 30% of taxpayers file returns.

However, this system makes many employees feel that income tax is their employer’s responsibility and not theirs when it ultimately is their responsibility, Kelsey said.

Pay Period Tax Tables

Most countries do require employees to file tax returns and do not need withholding to be as accurate because employees reconcile any differences through the tax return, Kelsey said. These jurisdictions use tables based on pay periods, often monthly, and some combine income tax and social taxes into one deduction.

Many of the tables use “steps” where one withholding amount applies to a range of income and the step to use is the one closest to but below the amount of actual income, he said.

This system does not cope as well with spikes or decreases in income through bonuses or periods of leave, Kelsey said. He cited an example of how Germany taxes bonuses and 13th-month payments using an annual table and a calculation that gives the employee’s likely annual income.

The Netherlands uses the previous year’s taxable income, or an approximation for part-year employees, to determine a withholding percentage for bonuses and other supplemental payments in the current year, he said.

In Japan, withholding per pay period for some employees is compared to the annual tax tables in December and any under- or overwithholding is then corrected to ensure that employees with simpler tax situations do not have to file returns. The system is “remarkably successful” at its goal, Kelsey said.

Documentation

Documents related to withholding include statements for employees beginning or leaving, tax cards or codes in some countries, and monthly submissions of payroll data to tax agencies where required, Kelsey said.

He cited the Netherlands as an example where employers are required to gather and retain new employees’ data, but compliant employers are trusted to keep the data while noncompliant employers must report it to the Tax and Customs Administration.

Jamaica’s Form P45, Particulars of Employee Leaving, is an example of a form given to employees and filed when the employee leaves a company. The employee must give the form to the new employer to ensure the continued correct calculation of withholding, he said.

Finland uses a system of tax cards, which are requested for new employees by the employer and show a flat rate to withhold, Kelsey said. They also include a wage threshold at which a higher rate begins to be used if an employee’s wages for a year exceed the threshold.

Flat Rates, Supplemental Taxes

The last major withholding model is the use of flat rates calculated by the employer or communicated by the tax agency, Kelsey said. France uses the latter method, while India uses the former and requires the employer to calculate each employee’s likely income for the tax year at the beginning of the tax year in April.

Indian employers must calculate the amount of tax using the tax rates in effect and then withhold 1/12 of that amount from the employee’s wages each month. Employers must adjust the withholding amount for employees who receive bonuses or raises, he said.

Some countries have supplementary income taxes, some of which are based on percentages of income tax liability instead of taxable wages, Kelsey said. India’s health and education cess and tax surcharges, as well as Germany’s church taxes and solidarity surcharge, are all assessed on income tax liability.

Denmark, Finland, Norway, and Sweden also have church taxes, but these are often combined with municipal and national income taxes into one rate and are not shown separately on payslips, Kelsey said.