What Is Withholding Tax? When It Applies in the EU

Withholding tax is tax deducted by the payer from a payment and remitted directly to the tax authority, rather than paid by the recipient afterwards. The recipient gets the net amount and a certificate saying the rest went to the state.

It exists for a practical reason: a country wants to tax income arising within it, but the recipient is abroad and beyond its enforcement reach. Making the local payer withhold solves the collection problem — the money never leaves the jurisdiction untaxed.

Where it applies

Withholding usually attaches to passive cross-border income rather than trading income:

• Dividends paid to foreign shareholders
• Interest on loans to non-resident lenders
• Royalties — licensing, patents, trademarks, sometimes software
• Certain service fees — management, technical and consultancy fees in some countries
• Payments to entities in blacklisted jurisdictions, often at penal rates

Normal trade rarely triggers it: buying goods from a foreign supplier does not. Selling software licences into some countries does. The distinction between a service and a royalty is where most disputes live, and it is genuinely difficult — a SaaS subscription may be a service in one country's view and a royalty in another's.

Domestic withholding exists too, and it is often overlooked because it is not called this: employer income-tax withholding on salaries is exactly the same mechanism, as is withholding on dividends paid to resident individuals.

Three layers of rules

The rate that actually applies is the outcome of a stack:

1. National law. Each state sets its own domestic rate — commonly 10–20% on dividends, interest and royalties, and higher for blacklisted jurisdictions.

2. Double tax treaties. Bilateral treaties reduce the domestic rate, often substantially, and sometimes to zero. Treaty benefits are not automatic: they normally require a certificate of tax residence from the recipient, dated appropriately, and often a formal claim. No certificate, domestic rate — which is why the certificate is the single most important piece of paperwork in this area.

3. EU directives. Within the EU, two directives can eliminate withholding entirely between associated companies:

• The Parent-Subsidiary Directive removes withholding on dividends from a subsidiary to a qualifying parent in another member state, subject to holding thresholds and minimum periods.
• The Interest and Royalties Directive removes withholding on interest and royalty payments between associated companies in different member states.

Both carry anti-abuse conditions and require the recipient to be the beneficial owner — routing a payment through a conduit company to reach a better rate is precisely what the general anti-abuse rule is designed to defeat.

Lithuania's own position is worth noting: it applies no withholding tax on dividends, interest or royalties paid to companies in EEA states or in treaty countries in most standard cases, which makes it a relatively simple jurisdiction on the paying side — but a Lithuanian company receiving foreign income still meets whatever the source country withholds.

The entries

A Lithuanian company pays a 10,000 € royalty to a licensor in a country where a treaty sets 5% withholding:

Account	Debit	Credit
6209 Royalty expense	10,000
4430 Trade payables (net to supplier)		9,500
4499 Withholding tax payable		500

The full 10,000 € is your expense — withholding does not reduce the cost of the service. You pay 9,500 € to the supplier and 500 € to the tax authority, and issue the supplier a withholding certificate.

On the receiving side, the credit is where value is recovered or lost:

Account	Debit	Credit
2710 Bank	9,500
2435 Withholding tax receivable / credit	500
5001 Revenue		10,000

Revenue is the gross 10,000 €. Whether the 500 € becomes a credit against your corporate income tax or an unrecoverable cost depends on your country's rules and the treaty — and excess withholding above the treaty rate is generally not creditable, only reclaimable from the source state through a refund procedure that is often slow enough that companies quietly write it off. That is the real cost of missing a residence certificate.

Gross-up clauses flip the burden: a contract stating the recipient must receive 10,000 € net means you pay the tax on top, and your cost becomes 10,526 € at a 5% rate. Read the contract before calculating.

The practical checklist

1. Determine the payment type. Service, royalty, interest or dividend — the classification decides everything.
2. Check the source country's domestic rate.
3. Check for a treaty, and whether an EU directive eliminates it.
4. Obtain the residence certificate before paying. Retrospective claims are refunds, and refunds take years.
5. Withhold, remit and report on the source country's schedule.
6. Issue the certificate to the recipient — without it they cannot claim their credit.

Status in Nordlet

Withholding tax is not implemented. There is no withholding calculation, no treaty-rate table, no residence-certificate tracking and no withholding-tax reporting. The one adjacent thing that does exist is Lithuanian payroll withholding — personal income tax and social contributions deducted from salaries, with the GPM313 and SAM declarations — which is the same mechanism in a domestic employment context, but it does not extend to cross-border payments to suppliers.

In practice that means a withheld payment is recorded manually: post the gross expense, split the payable between the supplier's net and the tax authority's share using journal entries, and track certificates outside the system. The supplier invoice is registered at its gross amount, and the payment settles less than the full balance — so the difference needs a deliberate entry rather than being left as an unexplained partial payment.

FAQ

What is withholding tax?

Tax deducted from a payment by the payer and remitted directly to the tax authority, so the recipient receives a net amount plus a certificate. It is a collection mechanism for taxing income where the recipient is outside the taxing country's reach.

Does withholding tax apply to normal supplier invoices?

Usually not. It targets passive income — dividends, interest, royalties — and in some countries specific service fees. Buying goods from a foreign supplier generally does not trigger it, but licensing software might.

How do tax treaties reduce withholding tax?

Bilateral treaties set maximum rates lower than domestic law, sometimes zero. The reduction is not automatic: the recipient normally must supply a certificate of tax residence, and without it the payer must apply the full domestic rate.

Is withholding tax the same as VAT?

No. VAT is a consumption tax charged on top of a price and generally recoverable by businesses. Withholding tax is an income tax deducted out of a payment, reducing what the recipient receives, and is credited against their income tax rather than reclaimed.

Can withholding tax be reclaimed?

The treaty-rate portion is normally credited against the recipient's corporate income tax at home. Anything withheld above the treaty rate is usually not creditable and must be reclaimed from the source country through a refund procedure — which is why getting the rate right before paying matters far more than fixing it afterwards.