Payments free of taxes: Overview, definition, and example
What are payments free of taxes?
Payments free of taxes refers to an arrangement where payments made under a contract or agreement are provided without any deductions for taxes, duties, or other levies. In other words, the payor (the party making the payment) is responsible for ensuring that the full amount agreed upon is received by the payee (the party receiving the payment), without any withholding or deductions related to taxes. If taxes are applicable, the payor typically agrees to cover these costs separately or adjust the payment accordingly to ensure the recipient receives the full payment.
This provision is commonly found in contracts where parties want to avoid the impact of taxes on the amounts being paid, and it is often used in international agreements where different tax jurisdictions may apply.
Why are payments free of taxes important?
Payments free of taxes are important because they ensure that the recipient receives the agreed-upon amount without reductions for taxes, which may be particularly crucial in business transactions, cross-border agreements, or situations where the tax obligations are complex or uncertain.
For the payee, this provision guarantees they are not burdened by unexpected tax deductions, providing clarity and certainty regarding the amount of money they will receive. For the payor, ensuring payments are free of taxes may be a way to simplify the contract and avoid any disputes related to tax withholding.
In international business, this clause is particularly important because it can address issues like withholding taxes, which may be imposed by one jurisdiction on payments made to non-resident entities or individuals. This clause can help avoid complications or delays in payments, as it clarifies the responsibility for paying taxes.
Understanding payments free of taxes through an example
Imagine a company in the U.S. entering into a contract with a supplier in another country. The contract specifies that all payments for goods or services will be made free of taxes, meaning that the U.S. company will ensure the full amount of the agreed price is paid to the supplier, without any deductions for withholding taxes that might otherwise be imposed by either country.
For example, if the supplier’s invoice is $100,000 and the applicable withholding tax in the supplier's country is 10%, the payments free of taxes clause would require the U.S. company to pay the full $100,000. The company would cover the $10,000 withholding tax, either by making the payment to the tax authority on behalf of the supplier or as part of a tax reimbursement arrangement.
An example of a payments free of taxes clause
Here’s how a payments free of taxes clause might look in a contract:
“All payments made under this Agreement shall be made free of taxes, duties, or other governmental charges, so that the full amount due is received by the payee. If any tax or duty is required to be withheld by law, the payor shall increase the payment by the amount necessary to ensure that the payee receives the full amount specified in this Agreement.”
Conclusion
Payments free of taxes clauses are essential in ensuring that the recipient receives the agreed-upon amount without deductions for taxes. This provision provides clarity and certainty in financial transactions, especially in international contracts where different tax jurisdictions may apply. By clearly addressing tax liabilities, the clause helps avoid confusion and ensures that both parties understand their responsibilities, particularly in terms of paying any taxes associated with the transaction.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.