HW, an entity resident in Country X, owns 40% of the equity shares in SV, an entity resident in a foreign country, Country Y. For the year to 31 March 2010 SV had taxable profits of $12,500,000 and paid corporate income tax of $1,875,000. On 31 October 2010 HW received a dividend of $3,375,000 from SV, the amount received is net of tax of 10%.
Country X has a double taxation treaty with Country Y. The treaty provides for a group of entities to only be taxed once on each entity's profits. Credit is given for withholding tax and underlying tax paid in other countries, but no refunds are available if a higher rate of tax has been paid.
Required:
(i) Explain the meaning of "withholding tax" and provide an explanation as to why countries levy "withholding" taxes.
(ii) Calculate the amount due to be paid by HW on receipt of this dividend in Country X. Show all workings.