A retention tax is a type of taxation that is applied to any income that is generated on investments based in a nation other than the country where the investor has a permanent residence. A tax of this type is not uncommon in many areas of the world, with the countries that are part of the European Union all imposing this type of tax. The imposition of this form of taxation makes it possible to tax capital gains that are not subject to the taxation laws that apply to returns on investments that are based in the same country as the investor.
The idea behind a retention tax is to minimize the incentive to focus investment activity on foreign investments as a means of avoiding paying taxes on income that is accrued from those investments. In times past, a tax of this type was not in place. This created a situation where investors had great incentive to concentrate on investments outside their own nations, even if the initial return on domestic investments was higher. Depending on the tax structure that was in place, an investor could conceivably earn a higher net return with international investments, simply because of the amount of taxes imposed on the return from those domestic investments.
Another important characteristic of a retention tax is that it tends to make tax evasion a little more difficult to accomplish. In nations where this type of tax is imposed, there are usually mechanisms in place that make it possible to obtain information regarding foreign investments, including the amount of taxable return that is generated. For this reason, nations in which a retention tax is imposed are much less likely to become tax havens, since agencies within those countries can and often do provide financial data to the investor’s home country.
In the case of the European Union, the imposition of a retention tax among the member countries went into effect in 2005. The exact structure of the tax code allows for a sliding scale that is used to determine the amount of taxes due on any capital gains generated. Over the years, the rate of tax has increased incrementally, a phenomenon that serves to motivate investors to focus more on investment opportunities within their own countries and less on foreign investments. The anticipated result of the use of a retention tax is that more money remains in the country, strengthens the business community, ensures that consumers have more choices available, and ultimately aids in keeping the national economy stable and strong.