Application of Double Taxation Treaties and the Withholding Tax
The Republic of Bulgaria has concluded sixty-nine treaties for the avoidance of double taxation (double taxation treaties or DTTs), the latest one having been ratified is the Convention between the Republic of Bulgaria and the Kingdom of Saudi Arabia for the avoidance of double taxation with respect to taxes on income and the prevention of tax evasion, which was promulgated in The State Gazette, No 77 of 18 September 2018.
Generally, the term “double taxation” means taxation of the same person (individual or legal entity) with a similar tax on the same income in two different countries. DTTs are intended to distribute taxation between the contracting states. A DTT is applicable in cases in which the person invoking the application of the treaty is a local person (resident) of either contracting state and there is a link between the two countries in the sense that one is the country of residence and the other is the country of the source of income. Furthermore, DTTs are applicable only to direct taxes (corporate income tax, personal income tax, etc.) rather than indirect taxes (VAT and excise duties) or local taxes.
It should be noted that DTTs never create new taxes or an additional tax burden. They just limit taxation rights by applying the following double taxation avoidance methods: (i) exemption with progression method, and (ii) tax credit method (ordinary or full tax credit). The income within the scope of a DTT could include business profits, royalties, profits from property conveyance, dividends, interest payments, and others.
In accordance with the Bulgarian Corporate Income Tax Act (CITA), local legal entities are liable to tax in Bulgaria with respect to the profit and income from all sources within the country and abroad. Where the source of income is another state, the latter has the right on these grounds, in most cases, to tax this income of the person. It is this type of double taxation that is to be eliminated or restricted through the application of DTTs.
Pursuant to Article 195(1) CITA, the income of non-resident legal entities from a local source as set out in Article 12(2),(3),(5) and (8) CITA, which has not been generated through a permanent establishment in the country, is taxable with a final withholding tax. The tax rate is 10 percent and it is levied on the gross value of the following income: rental income from letting immovable property in the country; income from the disposal with immovable property; technical service fees; interest payments; income from letting or lending movable property; royalties; income from financial assets; fees paid under franchise or factoring agreements; management fees paid for the management or control of a Bulgarian legal entity.
All these types of income received by non-resident legal entities in Bulgaria in a way other than by means of a permanent establishment (i.e. not through a branch, trade representation, shop, office, factory, construction site, etc.) are taxable with a final ten-percent tax under the Bulgarian laws in Bulgaria as the country of the source of income. If the country of residence taxes the same income, the risk of double taxation occurs and then the DTT should be applied upon presentation of the relevant documents, while observing the specific legal requirements to the applicability of the treaty.
In most cases, the withholding tax is levied on the local legal entities which declare and pay the tax due on a quarterly basis before the end of the month following the relevant quarter. The tax return is lodged with the territorial directorate of the National Revenue Agency at which the taxpayer is registered.
The income from dividends and liquidation quotas in local legal entities is also considered to have its source in the country. The withholding tax is levied also on the income from dividends and liquidation quotas which are distributed by local legal entities to the benefit of the following persons: (i) non-resident legal entities, except for the cases in which dividends are payable to a non-resident legal entity through a permanent establishment in the country; and (ii) local legal entities which are not traders, including municipalities.
The withholding tax is not levied where dividends and liquidation quotas are distributed to the benefit of a non-resident legal entity which is resident, for tax purposes, in a Member State of the European Union or another Contracting Party to the Agreement on the European Economic Area. Hidden profit distribution cases are the exception to this rule.
The tax on the income from dividends and liquidation quotas is deducted by the local legal entities which distribute the dividends. The tax rate is 5 percent. The payers of the income have to pay the taxes due before the end of the month following the quarter during which the decision on the distribution of dividends or liquidation quotas was made.