Chapter
8 - U.S. TAX RULES.
¶801: Overview.
The prior Chapters dealt with characterizing types of income as
U.S. or foreign source. Once
the income has been sourced, the next determination which must be made
is whether there is a U.S. trade or business to which such income is
effectively connected. Where
there is a U.S. trade or business to which such income is effectively
connected, then the NRA or foreign corporation will be subject to tax in
the U.S. at a graduated rate of tax on net income.
There is no gross basis withholding tax related to effectively
connected income. Where
such income is not effectively connected to a U.S. trade or business,
then all such U.S. source income will generally be subject to a 30
percent (or lower treaty) gross basis withholding tax.
In
addition to the net basis tax on effectively connected income and gross
basis withholding tax on FADPI income, there is also a third system of
withholding tax known as backup withholding.
A withholding agent is required to backup withhold at a rate of
31 percent on specified payment where the payee fails to properly
identify themselves. A
completed Form W-8 or Form W-9 identifying the payee, providing their
EIN number or TIN number in the case of foreign payees or other
statement providing the similar type of information will be considered
sufficient to avoid the backup withholding provisions.
Where a taxpayer does not properly identify itself, it becomes
more difficult for the U.S. Government to apply their tax regimes to the
recipient. In order to
remedy this the U.S. requires backup withholding in such circumstances,
under the theory that they will withhold the tax and wait for the
taxpayer to properly identify itself when it files an annual tax return
or when it files a refund claim.
In addition to the various exemptions provided in sourcing U.S.
income, there also exists exemptions from the application of the net
basis tax and gross basis withholding tax.
One of the most notable exemptions from U.S. Withholding Tax is
interest on qualified portfolio indebtedness.
This exemption allows U.S. businesses to access foreign capital
and foreign financing by exempting interest on qualified portfolio
indebtedness from U.S. taxation and allowing the U.S. businesses an
interest deduction for such interest payments.
This section briefly discusses income which is classified as
effectively connected with a U.S. trade or business and subject to U.S.
net basis taxation. However, since this volume’s principal focus is to discuss
Non Resident U.S. Portfolio Investments, we have briefly discussed these
rules. For a more detailed
discussion of net basis taxation of income effectively connected with a
U.S. trade or business see in this topical library, “Taxation of
Foreign Corporations” and for a more detailed discussion of gross
basis withholding tax see “Withholding Obligations for U.S. Payors on
Payments Made to Foreign Persons”.
Deciding
whether a foreign person is engaged in a U.S. trade or business will be
determinative as to whether the foreign person will be taxed in the U.S.
on a gross or net basis.
NRAs have their U.S. income tax liability determined pursuant to
Code Secs. 871-877. The type of income subject to tax, allowable deductions and
the rate of tax depends on whether the taxpayer is engaged in a trade or
business in the U.S. An NRA
who is not engaged in a U.S. trade or business is subject to 30 percent
gross basis tax on FADPI income, which is collected through withholding. Code Secs. 871 and 1441(a).
A nonresident alien individual engaged in a U.S. trade or
business is subject to tax on a net income basis for effectively
connected income which is subject to regular U.S. graduated tax rates.
Code Sec. 871(b).
Foreign corporations are subject to U.S. tax pursuant to Code
Secs. 882-884. A foreign
corporation not engaged in a U.S. trade or business is subject to a 30
percent gross basis withholding tax on U.S. source FADPI income.
Code Secs. 881(a) and 1442.
A foreign corporation engaged in a U.S. trade or business is
subject to tax on a net income basis for effectively connected income at
regular graduated U.S. tax rates and is also subject to a branch profit
tax on an amount essentially equivalent to a dividend.
Code Secs. 882 and 884.
Besides actually being engaged in a trade or business, U.S. law
imputes a trade or business activity to certain taxpayers.
Where an NRA or foreign corporation has a gain from the sale of
U.S. real estate, U.S. tax law imputes a trade or business to such
activity. Code Sec. 897(a).
Example 1: Mr. NRA
owns vacant land in America which he sells at a gain. Mr. NRA will be deemed to be engaged in a U.S. trade or
business, from this isolated sale, and the gain will be subject to tax
net of offsetting deductions at normal graduated tax rates for U.S.
individuals.
There
are also special rules which impute a U.S. trade to business to partners
of partnerships, which include LLCs and LLPs which elect to be taxed as
partnerships and beneficiaries of Estates and Trusts.
Code Sec. 875. An
NRA or foreign corporation shall be considered as being engaged in a
U.S. trade or business where it is a partner in a partnership which is
engaged in a U.S. trade or business.
Code Sec. 875(1). Additionally, any NRA or foreign corporation which is a
beneficiary of an estate or trust, which is engaged in a U.S. trade or
business, shall also be treated as engaged in such trade or business. Code Sec. 875(2).
The interesting issue with such imputed U.S. trade or business is
whether the foreign partner or foreign beneficiary’s other U.S. source
income is treated as effectively connected with this imputed U.S. trade
or business. Code Sec.
864(c)(3). The intention of
imputing a U.S. trade or business to a foreign partner or beneficiary is
to define how the particular partner or beneficiary should be taxed on
its share of the income which is effectively connected with the
partnership’s U.S. trade or business or on its share of the trust or
estate’s effectively connected income.
The imputation of a U.S. trade or business is necessary because
partnerships are generally not taxable as an entity.
Partnerships determine solely the character of the income, which
is attributed and taxed to each separate partner.
For trusts and estates, income which is distributed to foreign
beneficiaries, is characterized at the trust or estate level and is
taxed to the beneficiaries. Rev.
Rul. 91-32, 1991-1 C.B. 107.
¶805:
Income Effectively Connected with U.S. Trade or Business.
(A) U.S. Trade or Business.
The definition of a trade or business is not specifically
provided in the Internal Revenue Code.
The term trade or business within the United States includes the
performance of personal services within the United States at any time
during the tax year. Code
Sec. 864(b). The rules for
determining whether other activities constitute a U.S. trade or business
have developed over the years through rulings and court decisions. As a result, the determination of whether a taxpayer’s
income is effectively connected with a U.S. trade or business is not an
exact science but rather a matter of particular facts and circumstances.
Engaging
in considerable, continuous and regular activity is the keystone for
classifying a taxpayers activities as a U.S. trade or business.
The passive collecting of income does not constitute a U.S. trade
or business. Pinchot v.
Comr., 113 F. 2d 718 (2d Cir. 1940).
A single transaction generally does not amount to engaging in a
U.S. trade or business. An isolated and relatively unplanned sale will
not, in and of itself, constitute a U.S. trade or business.
Linen Thread Co. v. Comr., 14 T.C. 725.
Significant transactions consummated on a sporadic basis will not
give rise to a U.S. trade or business.
Continental Trading, Inc. v. Comr., 265 F. 2d. 40 (9th
Cir.). Sporadic sales may
reach a significant volume, without being classified as a U.S. trade or
business. George Pasquel,
12 TCM (CCH) 1431 (1953).
While an isolated sale may not constitute a U.S. trade or
business, a single taxable event which is tailored to produce an
isolated contact with the U.S. may constitute a U.S. trade or business.
For example, a rock concert or a prize fight, a horse race or a
recording session will not be continuous but they are designed to be a
single taxable event and have been held to constitute a U.S. trade or
business. Therefore, a
single rock concert in the U.S., racing a horse in the United States on
one occasion, or cutting a record in the United States will be a U.S.
trade or business.
An NRA or a foreign corporation is engaged in a U.S. trade or
business, if they are so engaged at any time during the tax year.
Therefore, an annual determination as to whether the taxpayer is
engaged in a U.S. trade or business needs to be made.
It is possible to be in a U.S. trade or business in one year and
not in the next. Income
which is effectively connected during a particular tax year but which is
received in another tax year, when the taxpayer does not have a U.S.
trade or business, will be treated as effectively connected in the year
received if it would have been effectively connected in the year to
which it is attributable. Code
Sec. 864(c)(6).
Example 1: F Co.
was engaged in a U.S. trade or business in Y1.
F Co. sold an item requiring installment payments over 5 years.
F Co. discontinued its U.S. trade or business in Y3.
The income which F Co. collects in Y4 and Y5 from its sale in Y1
are treated as U.S. source effectively connected income in Y4 and Y5.
F Co. will have to continue to file a Form 1120F showing its U.S.
source effectively connected income from this installment sale in Y4 and
Y5.
Furthermore, gain from the disposition of any property that is
being used or held for use in a U.S. trade or business, within ten years
of the cessation of such U.S. trade or business, will be treated as
effectively connected upon its disposal.
Code Sec. 864(c)(7).
Example 2: NRA had
a printing business in the United States and owned a printing machine
which cost $100,000 upon which it took $40,000 of U.S. depreciation
deductions in Y1 and Y2. NRA
closed his business at the end of Y2, moved the machine to Argentina and
used the machine there for 3 more years.
In Y5, NRA sold the machine for $70,000.
The depreciation which would have been allowable in years Y3-Y5
is $60,000. Therefore, for
U.S. purposes, the taxpayer has a gain of $70,000 ($70,000 minus a zero
basis) of which $40,000 is recharacterized as U.S. source effectively
connected income. Code Secs.
865(c)(3) and 864(c)(7).
An
NRA or foreign corporation can also have a U.S. trade or business
imputed to it without any specifically identifiable events, where U.S.
tax law so provides. A good
example of such imputation of a U.S. trade or business are the U.S. tax
rules regarding gain from the sale of U.S. real estate by NRAs and
foreign corporations. Any
gain which a foreigner recognizes from the sale or disposition of U.S.
Real Estate is treated as income which is effectively connected to a
U.S. trade or business. Code Sec. 897(a).
There are two statutory exemptions from being categorized as a
U.S. trade or business. One is for personal services where the NRA is in the U.S. for
less than 90 days and their compensation does not exceed $3,000.00.
Code Sec. 864(b)(1). The
second exception is for trading in stocks or securities or commodities
through a resident broker, commission agent, custodian or other
independent agent. Code
Sec. 864(b)(2). The volume
of securities transactions are irrelevant in determining whether a U.S.
trade or business exists. Reg.
§ 1.864-2(c)(1).
Examples
of activities which have been held not to constitute a U.S. trade or
business based upon the specific facts include:
(1)
Management of one’s investments.
Continental Trading, Inc. v. Comr., 265 F2d 40(9th
Cir.)
(2)
Investigating a Business Opportunity in the U.S. Abbeg. v. Comr.,
50 T.C. 145(1968).
(3)
Mere Ownership of U.S. Rental Real Estate, Herbert v. Comr., 30 T.C. 26
(1958); and
(4)
Occasional sales of securities. Continental
Trading Inc. v. Comr. 16 T.C.M. 724 (1957).
(B) Effectively Connected Income.
(1) In General.
All
U.S. source income, other than certain FDAPI income, is automatically
treated as effectively connected income whether or not it is related to
a U.S. trade or business. Code
Secs. 864(c)(2) and 864(c)(3). FADPI
income is treated as effectively connected to a U.S. trade or business
only where it is deemed to be related to the U.S. business activity.
Code Sec. 864(c)(2).
(2) Effectively Connected FADPI Income – Special Rules.
Two
classes of FADPI income are subject to U.S. tax as effectively connected
income:
(a)
Gain or loss from the sale or exchange of capital assets, and
(b)
Income of the type described in Code Sec. 871(a)(1), 871(h),
881(a), or 881(c). Code
Sec. 864(c)(2).
The first category refers to capital gains arising from disposition of
capital assets as defined in Code Sec. 1221 and generally includes
nondepreciable tangible personal property.
The second class is FADPI income.
Furthermore, there are two rules set out to determine whether capital
assets and FADPI income are effectively connected with a U.S. trade or
business:
(a)
Whether the income or loss was derived from assets used in the
conduct of the U.S. trade or business (asset use test) or
(b)
Whether the activities of the U.S. trade or business were
material factors in the realization of the income, gain, or loss
(business activities test). Code
Sec. 864(c)(2).
Examples
of assets used in a U.S. trade or business would include cash, operating
capital, interest on accounts receivable, and other assets held in
direct relationship to the ordinary course of the U.S. trade or
business. Reg. § 1.864-4(c)(2)(ii).
However, assets held for future diversification, expansion,
future replacement or contingent events do not give rise to effectively
connected income, as these are not assets held in the ordinary course of
operating the existing U.S. trade or business. Reg. § 1.864-4(c)(2)(i).
Capital
Gains and FADPI income will also be effectively connected where the U.S.
trade or business was a material factor in obtaining the income. Reg. §
1.864-4(c)(2)(ii). This
business activity test is primarily significant where the operation is
financial, banking, or a similar business or is a licensing business and
the income derives from these activities. Reg. § 1.864-4(c)(3). Dividends or interest derived by a dealer of stock and
securities is effectively connected income.
Gains from sale of capital assets by an active investment company
are also effectively connected. Interest
on accounts receivable would generally meet the business activities test
for all types of taxpayers, as the business is a material factor in the
realization of income from these accounts receivable.
Example 3: F Co.
engages in a U.S. trade or business through a U.S. branch.
Interest on overdue receivables is paid directly to the parent
corporation abroad. Such
interest is effectively connected with F Co.’s U.S. trade or business,
since the activities of the U.S. branch were a material factor in the
realization of this interest income.
(3)
Effectively Connected Income – All other income.
All
other U.S. source income, other than FADPI type income discussed above,
is effectively connected with a U.S. trade or business. No additional
analysis needs to be made as far as connecting the income to the U.S.
trade or business.
Caution: Therefore,
it is very crucial to determine whether a taxpayer’s activity is
regular and continuous thus giving rise to a U.S. trade or business,
since the minute the taxpayer is deemed to be engaged in a U.S. trade or
business, all U.S. source income which is not FADPI income will
immediately be treated as effectively connected income and subject to
U.S. net income tax.
(4) Foreign source effectively connected income.
Three
classes of foreign source income can be treated as effectively connected
with a U.S. trade or business, but only where the taxpayer has an office
or other fixed place of business in the U.S. to which the income is
attributable. Code Sec.
864(c)(4)(B). The following
types of foreign source income will be treated as effectively connected
with a U.S. trade or business where the income is attributable to such
U.S. trade or business:
(a)
Rents, royalties, and gains from the sale of intangible personal
property.
(b)
Dividends, Interest and Gains from stocks and securities.
(c)
Sale of personal property (including inventory).
The
above mentioned three types of income can only be sourced in the U.S.
where this foreign source income is attributable to a U.S. office.
Example 4:
Where F Co. sells inventory and where title to inventory
passes outside the U.S., and the U.S. office materially participates in
the sale of such property, then such income will be foreign source
income effectively connected with a F Co.’s U.S. trade or business.
Code Sec. 864(c)(4)(B)(iii).
However,
it is essential to point out that this foreign source income will only
be effectively connected to a U.S. trade or business where the U.S.
office materially participates in generating the income and where no
foreign office materially participates in generating such income.
Comment:
This foreign source effectively connected income is really a trap
for the unwary, as it is relatively simple to have this foreign income
attributed to a foreign office which materially participates in
generating such income.
(D) Net Basis Graduated Tax on U.S. Source Effectively Connected
Income.
NRAs and foreign corporations who have U.S. or foreign source
income, which is effectively connected with a U.S. trade or business,
shall be taxed on a net basis using graduated income tax rates.
Code Secs. 871(b) and 882. In
determining the taxable income which is effectively connected to a U.S.
trade or business, a foreign taxpayer must allocate and apportion
deductions attributable to such income.
Code Secs. 873 and 882(c).
Once
effectively connected income is reduced by attributable deductions in
arriving at taxable income, this taxable income is subject to graduated
rates of tax. This income
may also be subject to additional state and local taxes.
The
imposition of tax on effectively connected income is administratively
significantly more burdensome on the foreign taxpayer as a result of
requiring the taxpayer to file U.S. tax returns and requiring the
foreign taxpayer to allocate and apportion deductions attributable to
its U.S. trade or business income.
Furthermore, once a foreign taxpayer is engaged in a U.S. trade
or business, it is also required to keep certain records relating to
foreign activities in order to determine whether its apportionment of
income and expenses to the U.S. is in fact correct.
Code Secs. 482 and 6038(C).
The benefit of having U.S. source income treated as effectively
connected with a U.S. trade or business, is that it is taxed on a net
basis, subject to graduated net income rates and is not subject to
withholding tax when it is earned.
Planning Note: There
may arise situations where a net income tax from a transaction results
in less tax than a 30% gross basis withholding tax.
In these situations, a taxpayer may plan to have more than an
isolated transaction and attempt to have its income classified as
effectively connected with a U.S. trade or business.
Upon qualifying as a U.S. trade or business all non FADPI U.S.
income will automatically be effectively connected and subject to a
graduated rate of tax on net income.
¶815: Fixed and Determinable Periodic Income (FADPI).
(A)
In General.
All
U.S. source income, which is not effectively connected to a U.S. trade
or business, is subject to U.S. gross basis withholding tax.
The rate of withholding is generally 30 percent (or lower treaty)
rate, which is required to be withheld at the time of payment.
Code Secs. 1441 and 1442. The
obligation to withhold is imposed upon all persons, acting in whatever
capacity, having the control, receipt, custody, disposal or payment of
any kind of FADPI income derived from sources within the United States
by an NRA or foreign corporation. The place of payment is irrelevant as it relates to the
obligation to withhold. Foreign
source income, is not subject to withholding.
U.S.
tax rules make the withholding agent personally and primarily liable for
the amounts required to be withheld.
Code Sec. 1461. Where
the withholding agent does not withhold such tax, it will be liable for
such amount. In addition,
there are multiple penalties imposed for failure to file, negligence and
fraud, failure to make deposits and failure to collect and pay overtax.
Code Secs. 6651, 6653, 6656 and 6672.
However, where the withholding agent does not withhold and the
taxpayer pays such amount with the filing of its tax return or
otherwise, then the withholding agent is only responsible for interest
from the date payment of income was made to the taxpayer (date of
required withholding) until the date the taxpayer actually pays such
tax.
(B) Withholding Tax On Payments of FADPI income to NRA’s.
All persons acting, in whatever capacity (including lessees or
mortgagors of real or personal property, fiduciaries, employers, and all
officers and employees of the U.S.) having control, receipt, custody,
disposal, or payment of any items of FADPI income are subject to these
gross basis withholding requirements.
Code Sec. 1441(a). The U.S. puts the withholding obligation on the U.S. payor in
order to ensure the collection of this withholding tax.
The term FADPI income includes Fixed And Determinable Periodic
Income. FADPI income is
subject to gross basis withholding tax; regardless of whether it is
received in a series of payments or in one lump sum. Reg. §
1.441-2(a)(1). An item of
the income is fixed when the amount to be paid is definitely
predetermined. Income is
also determinable when there is a basis of calculation by which the
amount to be paid can be ascertained. Reg. § 1441-2(a)(2).
Example 1: USCO
entered into agreement to pay a royalty for the use of F Co.’s name in
the United States. The
royalty provides that USCO shall pay at the end of Y3 3% of its gross
revenue from years Y1-Y3 from selling F Co.’s products.
In Y3, when USCO makes the payment of such royalty, this royalty
is FADPI income regardless of the fact that it is not paid every year.
(C) Foreigners are Subject
to Gross Basis Withholding Tax on FADPI income.
Gross basis withholding tax is imposed solely upon foreign
persons who receive payments of FADPI type income.
The following are foreign persons upon which withholding on
payments of FADPI type income must be made:
(1)
A Nonresident alien. Code
Sec. 1441(a);
(2)
A Foreign Corporation. Code
Sec. 1442(a);
(3)
A Foreign Partnership. Code
Sec. 1441(a); and
(4)
A Foreign Trust or Estate. Reg.
§ 1.1441-2(a).
¶825: Exemption from Withholding.
(A) In General.
After the withholding agent has determined that the payment which
they are about to make is FADPI income, that the recipient is a foreign
person, they must then analyze the payment to see whether it is an
exempt payment pursuant to the exemptions provided within the Internal
Revenue Code or whether it is a treaty reduced or exempt payment.
The exemptions include but are not limited to the following:
(1) Certain types of interest;
(2) Non U.S. source income;
(3) Certain dividends from domestic corporations;
(4)
Income that is otherwise effectively connected with a U.S. trade
or business;
(5)
Compensation for personal services which was already subject to
tax as wage withholding;
(6) Annuities from certain qualified plans;
(7)
Payments to foreign governments and foreign central banks of
issue;
(8) Scholarship and Grants;
(9) Payments by the U.S. Government to nonresident trainees; and
(10) Certain Gambling Winnings.
(B) Exempt Interest.
(1)
Bank Interest. Bank Interest and Similar Types of Deposits
(including original issue discount) that are U.S. source are exempt from
withholding;
(2)
Foreign Banking Branch. Interest on Deposits with a foreign
branch of a domestic corporation or domestic partnership engaged in
commercial banking. Code Sec. 861(a)(1)(B).
(3)
80 percent Foreign Income. Interest from a resident alien
or domestic corporation where the payor receives 80 percent or more of
its income from the active conduct of a foreign trade or business.
Code Sec. 861(a)(1)(A).
(4)
Interest on Short Term OID Instruments. Interest on all
obligations, which are payable in 183 days or less from the date of
original issuance, are exempt from U.S. gross basis withholding tax.
Code Secs. 871(g)(1)(B) and 881(a)(3).
(5)
Interest from State and Local Bonds. Bonds issued by state
and local government organizations, in the United States, are exempt
from U.S. gross basis withholding tax regardless of the term of such
obligation. Code Secs.
871(g)(1)(B)(ii) and 881(a).
(6)
Foreign Central Bank. Interest Payments to a Foreign
Central Bank of issue or Bank for International Settlements, which are
exempt by Code Sec. 895, are exempt from gross basis withholding tax.
Code Secs. 871(i)(2)(C) and 881(d).
(7)
Portfolio Indebtedness. Interest on Qualified Portfolio
Indebtedness is Exempt from Gross Basis Withholding Tax.
Code Secs. 871(h)(1) and 881(c) (see detailed discussion at ¶
835 below).
(C) Income Effectively Connected With a U.S. Trade or Business.
Income
effectively connected with a U.S. Trade or Business is not subject to
gross basis withholding tax. Code
Secs. 1441(c)(1) and 1442(b). Income
which is effectively connected with a U.S. trade or business does not
escape U.S. taxation, it is taxed on the net basis and therefore is
exempt from U.S. gross basis withholding tax.
The withholding agent must be notified on Form W-8ECI (Form 4224
prior to January 1, 2000) or similar Form, prior to payment of the FADPI
income.
(D) Exempt Dividends.
(1)
Dividends Paid by U.S. Corporations With 80% or more Foreign
Income.
Dividends
paid by a domestic corporation which derived at least 80% of its gross
income, during the test period, from the conduct of an active foreign
trade or business; shall have that same portion of its dividends exempt
from U.S. gross basis withholding tax.
Code Sec. 871(i)(2)(B) and 881(d).
(2)
Foreign Dividends with Greater than 25 Percent ECI.
Dividends
of a Foreign Corporation should be treated as U.S. source dividends
where 25% or more of the corporation’s worldwide gross income consists
of U.S. source effectively connected income, unless the foreign
corporation had the same earnings subject to U.S. branch profit tax for
the year. Code Secs.
861(a)(2)(B) and 884(c)(3)(A). Where
the foreign corporation has U.S. source effectively connected income of
25% or more of its worldwide gross income, during the testing period
then the same portion of dividends paid by the foreign corporation shall
be treated as U.S. sourced dividends.
Code Sec. 861(a)(2)(B).
Example 1: FCO had
30% of its worldwide earning from U.S. source effectively connected
income, during the testing period.
When FCO makes a $100,000 dividend, $30,000 of the dividend will
be treated as U.S. sourced dividends.
The
testing period is the three year period ending with the close of the tax
year preceding the declaration of such dividend. Code Sec. 861(a)(2)(B).
(E) Compensation
for Personal Services.
Compensation
for Personal Services is exempt from gross basis withholding tax, where
such income has already been subject to normal U.S. wage withholding
pursuant to Code Sec. 3402. Code
Sec. 1441(c)(4).
(F) Annuities
from certain qualified plans.
Annuities
from certain qualified plans are exempt from withholding where the
amount received qualifies as an annuity.
(G) Payments to Foreign Governments.
Payments
to Foreign Governments (including a foreign central bank of issue, that
are excludable from gross income pursuant to Code Sec. 892 exclusion for
income of foreign governments and international organizations).
Reg. § 1.1441-8(a).
(H) Scholarships and Grants.
Scholarships
and Grants are subject to a reduced 14% gross basis withholding tax.
Code Sec. 1441(b).
(I) Per Diem of Certain Alien Trainees.
Gross
basis withholding is not required on per diem amounts for subsistence
paid by the U.S. government to NRA trainees.
Code Sec. 1441(c)(6).
(J) Foreign Tax Exempt Organizations.
Amounts
paid to foreign tax exempt organizations are exempt from withholding to
the extent that the income which they receive is not income from a trade
or business unrelated to their charitable purpose.
Reg. § 1.1441-1(b)(4)(xvii).
(K) Gambling Winnings.
No
gross basis tax is required to be withheld from the foreigners on their
recipient of gambling winnings from blackjack, roulette, baccarat, craps
and big six wheel. Code
Sec. 1441(c)(11).
(L) Treaty Exemptions.
Amounts
that would otherwise be subject to U.S. gross basis tax may be reduced
or eliminated pursuant to an income tax treaty, which the United States
has with certain foreign countries. Code
Sec. 894.
¶835: Portfolio Interest Exemption.
(A) In General.
NRAs and foreign corporations are exempt from U.S. tax on certain
“portfolio interest” income that is not effectively connected with
the foreign recipient’s U.S. trade or business.
Portfolio Interest includes noncontingent interest and OID, which
is paid on certain obligations that meet specific requirements.
Two
types of obligations may qualify for the portfolio interest exemption:
(1) obligations which are in registered form and (2) certain bearer
obligations. Portfolio
interest is defined as interest otherwise subject to gross basis
withholding tax on any obligation that is either:
(1)
In registered form and the withholding agent receives an
appropriate statement that the beneficial owner of the obligation is not
a U.S. person or
(2)
Not in registered form and it meets the foreign targeted
obligation requirements of Code Sec. l63 (f)(2)(B).
Code Secs. 871(h)(2) and 881(c).
(B)
Obligations in Registered Form.
(1) In General.
Portfolio
interest includes interest paid on an obligation that is in registered
form and for which the United States person who would otherwise be the
withholding agent on such interest has received a statement that the
beneficial owner of the obligation is not a United States person.
The statement can be made either by the beneficial owner or the
securities clearing organization, bank, or other financial institution
that holds customer’s securities in the ordinary course of their trade
or business. The purpose of
the registration requirement is to insure that the issuer knows the
identity of the holder of the instrument.
This enables the issuer to furnish the appropriate reports to the
IRS regarding interest payments made to foreign persons. An
obligation does not have to be registered with the U.S. Securities and
Exchange Commission in order to be qualified as a registered obligation
for the portfolio interest exemption.
(2)
Registered Form.
The
term “registered form” has the same meaning giving such term by Code
Sec. 163(f). Code Secs.
871(h)(7) and 881(c)(7).
An
obligation will be in registered form if:
a.
The obligation is registered as to principal and interest with
the issuer or its agent, and transfer of the obligation can be effected
only by surrender of the old instrument and either re-issuance of the
old instrument or issuance of a new instrument to the holder;
b.
The right to principal of and stated interest on, the obligation
can be transferred only by a book entry system maintained by the issuer
(or its agent); or
c.
The obligation is registered both as to principal and interest
with the issuer or its agent and can be transferred only through both
surrender and issuance (or re-issuance) of the obligation and the
issuance is recorded on the book entry system of the issuer (or its
agent). Temp. Regs. § 5f.
163-1 and 5f. 103-1(c)(1).
Although
the temporary regulations do not further explain what constitutes
registration, in practice this means that the issuer must maintain a
written record of the ownership of the obligation and the holder is
identified in the certificate, promissory note, or other document issued
to him in evidence of the obligation.
The
temporary regulations explain that a book entry is a record of ownership
that identifies the owner of an interest in an obligation. In effect a book entry system requires maintenance of records
in the same manner of the stock registered.
The temporary Regs. impose additional requirements on post
January 20, 1987 instruments, designed to disqualify instruments that
are convertible into bearer interest instruments at any time before
maturity. Temp. Reg. § 5f.
103-1(e). In short, a
registered obligation is disqualified where it is convertible into
bearer form.
(3)
Certificate of Foreign Status.
For
the portfolio withholding exemption to apply to interest received by a
foreign holder of an obligation in registered form, a further
requirement is that the withholding agent (U.S. payor) must receive a
statement meeting prescribed requirements that the beneficial owner of
the obligation is not a U.S. person.
The statement must be prepared, renewed, and retained under the
procedures applicable under Reg. § 1.6049-5(b)(7).
That regulation requires that the statement on form W-8 (or a
substitute) to be received in the calendar year the interest payment is
made or collected or in either of the proceeding two calendar years (W-8
is good for 3 years). The
payor must retain this statement for 4 years following the end of the
last calendar year the statement is relied on (7 years in total). The payee must notify the payor of any change in residence or
citizenship within 30 days following the change of status.
The
form W-8 or substitute form generally most contain the following
information:
1.
Certification that the owner of the portfolio note is not a
United States person,
2.
The name and address of the beneficial owner of the portfolio
note, and
3.
A signature by the beneficial owner under penalties of perjury.
Even
though the portfolio interest is exempt from tax, the withholding agent
generally is required to file form 1042 (Annual Withholding Tax Return
For U.S. Source Income Of Foreign Persons) and 1042S (Foreign Persons
U.S. Source Income Subject to Withholding) for all payments on portfolio
interest on a registered obligation.
Form 1042 is a summary of all payments made to foreign persons
that are subject to (or exempt by treaty from) withholding and
identifies the payees and the amounts withheld.
The form must be accompanied by copies of each 1042S issued by
the withholding agent and each form W-8 received by the withholding
agent. Form 1042S is a form
that must be given separately by the withholding agent to each payee.
The holder of a portfolio interest obligation is not required to
file from 1001 with the withholding agent.
Form 1001 is a form used to establish entitlement to tax treaty
exemptions or rate reductions.
(C) Bearer Obligations.
(1)
In General.
There
are three requirements which the bearer instrument must meet to qualify
for portfolio interest exemption. The
obligation must be foreign targeted, the interest must be payable
outside the United States and the obligation must bear a legend on the
face of it that U.S. people who hold such instrument will be subject to
U.S. income tax laws. Code
Secs. 871(h)(2)(A) and 881(c)(2)(A).
(2)
Foreign Targeting Pre-9/7/90.
The
rules which define what qualifies as foreign targeting are encompassed
in Reg. § 1.163-5(c). This
regulation has two different standards: one standard for what qualifies
as foreign targeting for obligations issued before September 7, 1990 and
a different set of requirements for what qualifies as foreign targeting
after September 7, 1990.
(a)
Foreign Distribution.
The
foreign targeting requirement is met if the obligation is offered for
sale outside the U.S. and is not registered under the Securities Act of
1933 because it is intended for distribution to persons who are not U.S.
persons. The issuer must
obtain an opinion of counsel that such security is exempt from SEC
Registration as it is foreign targeted. Reg. § 1.163-5(c)(2)(i)(A).
(b)
SEC Registered or Exempt.
The
foreign targeting requirement will also be met if the securities
obligation is registered under the Securities Act of 1933 or is exempt
from registration under Section 3 or Section 4 of such act or if it
doesn’t qualify as a security under the Securities Act of 1933; where
such obligation also meets the following requirements:
(i)
The obligation is offered for sale outside the U.S. and only
delivered outside the U.S.
(ii)
The issuer and the underwriters covenant that they will offer the
obligation only to foreign persons or qualified financial institutions;
(iii)
The issuer or underwriter send the confirmation to each purchaser
stating the purchaser represents itself either as a foreign person or
qualified financial institution;
(iv)
Before the obligation is released, the issuer or underwriter must
receive the signed certificate from the person entitled to physical
delivery that the obligation has been acquired by the foreign person,
and
(v)
The issuer and its underwriters do not have actual knowledge that
the certificate is false. Reg. § 1.163-5(c)(2)(i)(B).
(c)
Issued outside U.S.
In
addition to the above mentioned alternative rules for meeting the
foreign targeting requirement, Pre-September 7, 1990, there is a further
obligation that the issuer does not engage in Interstate Commerce in
issuing the obligations directly or through an agent.
If the issuer is a U.S. person, the issuer may satisfy this
requirement where:
(i)
It is engaged in the active conduct of a banking business through
a branch outside the U.S.;
(ii)
The obligation is issued by the branch;
(iii)
The obligation is sold directly to the public; and
(iv)
The issuer maintains documentary evidence that the purchaser is
not a U.S. person. Reg. § 1.163-5(c)(2)(i)(C).
(3)
Foreign targeted Post-9/7/90.
For
obligations issued after September 7, 1990, to qualify as foreign
targeted, the instrument must be offered and sold to a non U.S. person,
the obligation must be delivered outside the U.S. and the issuer must
receive a certificate stating that the recipient is not a U.S. taxpayer.
Reg. § 1.163-5(c)(2)(i)(D).
(4)
Interest payable outside the U.S.
The
requirement that interest be payable outside the U.S. is satisfied if
payment can only be made upon the presentation of a coupon or making the
demand for payment outside the U.S. to the issuer of the obligation or
its agent. There is an
exemption for interest paid to a qualified institution as a step in
clearing funds where the interest is promptly credited to an account
maintained outside the U.S. Reg. § 1.163-5(c)(2)(v).
(5)
Legend Requirement.
The
legend which may be on the face of the obligation must state “any
United States person who holds this obligation will be subject to
limitations under the United State Income tax Laws, including the
limitations provided in Sections 165(j) and 1287(a) of the Internal
Revenue Code”. Reg. § 1.163-5(c)(1)(ii)(B).
(D) Exclusion from Portfolio Interest.
The
portfolio interest exemption does not apply in the following cases:
(1)
Interest received by a 10% shareholder.
In
the case of a corporate issuer, this means the holder of 10% or more of
the combined voting power of the issuer. Modified attribution rules
apply, under Section 318(a), in determining ownership of stock.
Therefore, it is a direct or indirect 10% ownership interest in the
borrower, or in the case of an obligation issued by a partnership, any
person who owns 10% or more of the capital or profits interest in such
partnership, or
(2)
Interest paid to a U.S. controlled foreign corporation by a
related person,
or
(3)
Interest received by a banking corporation on the extension of
credit made under a loan agreement entered into under ordinary course of
its trade or business,
or
(4)
Interest which is contingent.
Code Secs. 871(h) and 881(c).
Contingent
interest received by a foreign person after December 31, 1993, will not
qualify for tax-free treatment as portfolio interest.
In the case of an instrument on which a foreign person earns both
contingent and noncontingent interest, the portfolio interest exemption
is denied only to that portion of the interest that qualifies as
contingent interest. H.R. Conf. Rep. No. 213, 103rd Cong., 1st Sess. at
653(1993).
Contingent
interest is defined as any interest the amount of which is determined by
reference to:
1.
the sales, receipts, or other cash flow of the debtor or any
related person;
2.
any income or profits of the debtor or any related person;
3.
any change in the value of the property of the debtor or any
related person;
and
4.
any dividend, partnership distribution, or similar payment made
by the debtor or a related person (e.g., interest contingent on the
payment of a dividend to the shareholders by the borrower).
Code Sec. 871(h)(4)(A)(i).
For
these purposes, a "related person" is any person who is
related to the debtor within the meaning of Code Secs. 267(b) or
707(b)(l), or who is a party to any arrangement designed to circumvent
the application of the contingent interest provisions.
Code Sec. 871(h)(4). Interest
is not contingent interest solely because the timing of the interest (or
any related principal) payment is subject to a contingency. Code Sec. 871(h)(4)(C)(i).
For example, if the debt instrument allows the borrower to defer
the payment of interest in any period prior to maturity where the
borrower has insufficient cash, such interest is not contingent
interest, provided that the debt obligation accrues interest at a
competitive market rate. H.R.
Rep. No. 111, l03rd Cong., lst. Sess. at 725(1993).
The
contingent interest provisions are not intended to override any existing
U.S. treaties. See Notice
94-39; 1994-1 C.B. 350. Thus,
any interest received by a foreign person that is exempt (or subject to
a reduced rate of tax) under a current U.S. tax treaty will not be
subject to U.S. tax as contingent interest.
¶845: Withholding Agents.
(A) In General.
A withholding agent is responsible for deducting and withholding
gross basis withholding tax from payments of FADPI.
A withholding agent includes all persons, in whatever capacity
acting (including lessees or mortgagers or personal property,
fiduciaries, employers, and all officers and employees in the United
States) having the control, receipt, custody, disposal, or payment of
any FADPI type income. Code
Secs. 1441 and 1442. Practically,
this definition is so broad as to include every type of entity and every
type of person who had any nexus with the payment of the U.S. source
FADPI income. Therefore,
any time a taxpayer has control or receives or has custody or disposes
of or makes a payment of any U.S. source FADPI income, to be
conservative, they should either withhold U.S. gross basis withholding
tax or receive an exemption statement as to why the recipient is exempt
from such tax. If several
persons qualify as withholding agents with respect to a single payment,
only one tax is required to be withheld and generally, only one return
is required for such taxes withheld.
Reg. § 1.1441-7(a). Furthermore,
a withholding obligation does not arise until there is actual payment of
the FADPI income. There is
no withholding obligation on accrual of income which is legally payable
to a foreign party.
(B) Agents and intermediaries.
Any agents or intermediaries who receive payment on behalf of
foreign persons are also withholding agents with respect to FADPI income
where the income they received has not already been subject to U.S.
gross basis withholding tax.
Example 1: U.S.
Bank receives dividends on behalf of its foreign clients. U.S. Bank supplies USCO its EIN number, thereby exempting
USCO from gross basis withholding tax on dividend payments to U.S. Bank.
U.S. Bank, as an intermediary, then becomes a withholding agent
on its subsequent payment of this dividend to its foreign clients.
Example 2: Foreign
broker is organized in a country which has a tax treaty with the U.S.
which provides for a 5% gross basis withholding tax on interest
payments. Foreign broker
receives interest from U.S. payor net of the 5% U.S. gross basis
withholding tax. When foreign broker pays out this interest to its foreign
clients, it becomes a withholding agent to the extent of the remaining
25% gross basis withholding tax. There
are new withholding regulations that have been proposed in 1996 which
are now scheduled to be effective for payments made starting January 1,
2001, which will impact the withholding tax obligation on withholding
agents and intermediaries. See
¶ 845(E) below.
(C) Partnerships.
(1) U.S. Partnerships.
U.S. Partnerships must withhold tax on:
(a) Actual Distributions of FADPI income to the foreign partner,
(b)
A foreign partner’s distributive share of the U.S.
partnership’s FADPI income whether distributed or not.
Reg. § 1.1441-3(f). and
(c)
A foreign partners share of the U.S. partnership’s effectively
connected income. Code Sec. 1446(a).
Example 3: U.S.
Partnership (P Ship) paid interest on shareholder loans, received
dividends from U.S. companies which were not effectively connected with
its trade or business and operated a restaurant in the United States.
P Ship is required to withhold on interest payments to the
shareholders when the interest is actually paid on the shareholder
loans. P Ship is also
required to withhold on the U.S. sourced dividends it receives which are
not effectively connected with its trade or business to the extent USCO
did not withhold on such payments to P Ship.
Finally, P Ship must calculate its U.S. source net income and to
the extent such net income is attributable to foreign partners, it must
deduct and withhold tax at the applicable percentage provided in Code
Sec. 1446(b)(2).
(2)
Foreign Partnerships.
A
Foreign Partnership is only required to withhold on a foreign
partner’s allocable share of the foreign partner’s U.S. source
effectively connected income. Code
Sec. 1446(a). Where a
foreign partnership does not have U.S. source effectively connected
income, it has no withholding requirement for distributions to foreign
partners or for foreign partners distributive share of U.S. source
noneffectively connected FADPI type income.
Reg. § 1.441-3(f).
(D) Determination of amount to be withheld.
(1) In General.
Generally,
all FADPI type income is subject to a 30% gross basis withholding tax.
Code Secs. 1441 and 1442. The
amount is imposed on the gross amount paid or distributed to a foreign
person without reduction for any type of deduction.
Gross basis withholding tax is collected by deducting the 30%
withholding amount from total amount of the FADPI payment and remitting
it to the IRS. This
withholding tax must always be deducted and paid in with the following
exceptions:
1.
The withholding agent receives an EIN number or social security
number showing that the recipient is not a foreign person.
2.
The withholding agent receives a Form 4224 showing that the
foreign recipient is receiving this income and that this income is
effectively connected with its U.S. trade or business (Form W8-ECI after
January 1st, 2001).
3.
Recipient receives a Form 1001 which sets forth the foreign
recipient’s right to a reduced rate of or elimination of withholding
tax pursuant to a U.S. foreign country tax treaty (Form W8-BEN after
January 1st, 2001).
4.
The withholding tax is in connection with a domestic or foreign
partnership’s effectively connected income.
Here the withholding rate for the allocable portion to a foreign
partner is the highest rate for individuals specified by Code Sec. 1 or
the highest tax rate for corporations specified in Code Sec. 11.
Code Sec. 1446(b).
5.
The withholding obligation is imposed on amount realized by a
foreign person’s disposition of U.S. real property interest and the
withholding tax rate is 10% on the amount realized.
Code Sec. 1445(a).
(2) Corporate Distributions.
There
must be a gross basis withholding tax on the full amount of any
corporate distribution. The
fact that the corporation’s earnings and profits are less than the
amount distributed, will not be determined until the end of the year. Therefore, withholding is required on all distributions
during the year. The fact
that the distribution is in
excess of that U.S. corporation’s earnings and profits and therefore
does not qualify as a dividend, does not impact the withholding
requirement on the total distribution.
The remedy for the foreign recipient is to file a claim for
refund for the excess amount of taxes withheld on the portion of the
distribution that did qualify as the dividend.
(3) Failure to Withhold.
Every
withholding agent is liable for the full amount of the tax required to
be withheld. Code Sec.
1461. Where the withholding
agent does not withhold such tax but the recipient of income pays the
tax in thereafter, the withholding agent is absolved from its liability
for the taxes which should have been withheld.
Code Sec. 1463. However,
the withholding agent still remains liable for interest between the time
which it made the payment and was required to withhold tax and the time
when the recipient actually paid such tax.
(4) Penalties.
In
addition to the liability for the tax and interest from the time the tax
is imposed until it is actually paid, a withholding agent may also be
subject to the following penalties:
(a)
A penalty of 20 percent of the amount of underpayment of withheld
tax in the case of negligence. Code
Sec. 6662.
(b)
A penalty of 75 percent of the amount of underpayment of withheld
tax in the case of fraud. Code
Sec. 6663.
(c)
An addition to tax of 5-25 percent for negligent failure to file
a return. Code Sec. 6651(a).
(d)
An addition to tax of 15-75 percent for fraudulent failure to
file a return. Code Sec. 6651(f). and
(e)
A percentage of the amount required to be deposited but not
timely deposited. Code Sec. 6656.
In
addition to the civil penalties, the withholding agent may be liable for
criminal penalties of up to $10,000 and/or 5 years in prison for willful
failure to collect and pay over tax.
Code Sec. 7202.
(5) Over Withholding of Tax.
(a)
In General.
Where
the withholding agent withholds tax in excess of the required amount to
be withheld, the foreign taxpayer is entitled to a refund of such over
withholding. If the
withholding agent pays in an amount of tax in excess of the amount that
was actually withheld from foreign taxpayers, the withholding agent is
able to claim a refund. Code
Sec. 1464.
Example 1: A
withholding agent who is required to withhold $300 of tax from rents
paid to an NRA mistakenly withholds $320 from the NRA’s payment and
mistakenly pays $350 to the IRS. The
NRA is entitled to a refund for the $20 of overwithholding from his
rental payment. The
withholding agent is also entitled to a $30 refund for the amount in
excess which it withheld from the NRA and paid over to the IRS.
(b)
Remedies for Over Withholding.
(i)
Foreign Taxpayer receives refund from broker.
The
broker may pay the over withheld amount to the foreign taxpayer
directly. In the example
above, the broker could pay $20 of overwithholding directly to the NRA.
The broker would then have $50 of refund as a result of the $20
refund which it paid the NRA and the $30 which it paid the IRS in excess
of what was withheld from the NRA. The broker can then amend the original tax filing showing the
correct amount of tax which should have been paid or it can adjust the
subsequent tax filing for other clients and pay $50 less with the
subsequent filing. Reg. §
1.1461-2(a).
(ii)
Application directly to IRS.
Alternatively,
the withholding agent and the taxpayer could amend their respective
returns to correct the mistakes in the above mentioned example.
The withholding agent could amend its Form 1042 to show the
correct amount of tax withheld as $320.
This would result in the taxpayer having to file a Form 1040 or
1120 to claim a refund for the $20 over withholding.
The disadvantage of this method is that the taxpayer will not be
able to obtain a refund until after January 1, of the calendar year
following the withholding agent's mistake.
(E) Revised Duty of Withholding Agents and Intermediaries under the
1996 Proposed Regulations.
(1) In General.
The
Department of Treasury and the IRS issued a comprehensive set of new
regulations affecting withholding requirements pursuant to Code Secs.
1441-1464. The original
effective date of such proposed regulations was for all payments after
December 31, 1999. However,
due to various comments received by financial institutions describing
the difficulty of implementing such regulations and adjusting their
computer systems to become Year 2000 compliant; the Treasury and the IRS
have amended the effective date to apply to all payments made after
December 31, 2000. Notice
99-25, 1999-20 I.R.B. Therefore,
the above-mentioned rules for withholding and the above mentioned forms
to be received by foreigners claiming exemption from withholding remain
in effect until January 1, 2001.
(2) Withholding Obligations After December 31, 2000.
A
key component to these proposed regulations deals with qualified
intermediaries. A qualified
intermediary is a foreign entity or a foreign branch of the U.S. entity,
that obtains the benefit of establishing the foreign status of its
account holders and their entitlement to reduced rates of withholding,
by using a single withholding certificate rather than having to provide
documentation for each customer to a U.S. withholding agent.
These new Proposed Regs. set out the new requirements for
withholding agents.
The
new Proposed Regs. combine several existing forms used in connection
with withholding, including Forms 1001 and 4224, into four Form W-8s.
The four new Form W-8s have been released and are available for
use and must be used for all payments made after December 31, 2000.
While the new Form W-8s are effective immediately, a withholding
agent may wish to review the existing withholding certificates currently
in its position to determine when new Form W-8s will be required.
Any
of the older Forms, e.g. Form 1001 for treaty reduced income, Form 4224
for effectively connected income, etc. will expire on December 31, 2000
and will need to be replaced with the new Form W-8s. Most of the new Form W-8s are effective for a period
beginning on the date that the Form is signed and ending on the last day
of the third calendar year following the year in which the Form is
executed.
Example 2: NRA
signs Form W-8 on February 3, 2000, it will be effective for the period
February 3, 2000, ending on December 31, 2003.
The
new Form W-8s consist of the following:
1.
Form W-8BEN – Certificate of foreign status of beneficial owner
for United States tax withholding to be used to identify owner as a
foreigner and used to claim tax treaty benefits (replaces Form 1001).
2.
Form W-8ECI – Certificate of foreign person’s claim for
exemption from withholding on income effectively connected with the
conduct of a trade or business in the United States (replaces Form
4224).
3.
Form W-8EXP – Certificate of foreign government or other
foreign organization for United States tax withholding (replaces Form
8709).
4.
Form W-8IMY – Certificate of foreign intermediary, foreign
partnership, or certain U.S. branches for United States tax withholding
to report individuals or entities which are either qualified or
non-qualified intermediaries.
(3)
Withholding Agent Responsibility After December 31, 2001.
First,
a withholding agent needs to establish whether the payee is U.S. or
foreign. Where the payee is
U.S., the withholding agent must either receive a completed Form W-9
providing all the information regarding the U.S. payee, including their
identification number or must subject the U.S. payee, to backup
withholding. See ¶ 855
below. If the withholding agent has no actual knowledge or reason to
know that the U.S. payee is acting as an agent of a foreign person, the
agent may rely on a Form W-9 given by the U.S. payee.
Prop. Reg. § 1.1441-1(d)(1).
Absent
actual knowledge or reason to know otherwise, a withholding agent may
treat a payee as foreign if the agent receives a Form W-8 from the
payee, complies with any electronic confirmation procedure that may be
issued by the IRS, and has not been notified by the IRS that the
information on Form W-8 is incorrect or unreliable.
Prop. Reg. § 1.1441-1(e)(1).
Where a withholding agent cannot validate the Form W-8, it must
conform to the following:
1.
When payment of a reportable amount is made to a nonexempt payee
and the withholding agent has not timely received a reliable Form W-8 or
W-9, unless a specific grace period applies, the payee is presumed to be
a U.S. individual subject to both information reporting and backup
withholding provision. Prop.
Reg. § 1.1441-1(f)(2)(i) and (ii).
2.
A payment to an exempt payee may be presumed to be made to a
foreign person if the payor knows the payee’s employer identification
number and that number begins with “98”, communications with the
payee are mailed to a foreign address or the payment is made outside the
U.S. Prop. Reg. §
1.1441-1(f)(2)(iv). In all
the other cases, the withholding agent must presume the recipient is a
nonexempt U.S. payee.
Where
the withholding agent does not conform to the foregoing, it will be
liable for any underpayment of tax pursuant to Code Sec. 1461.
Prop. Reg. § 1.1441-1(f)(5).
(4) Payments to Qualified Intermediaries.
The
Proposed Regs. permit one singular Form W-8IMY on behalf of beneficial
owners, if that intermediary has entered into a withholding agreement
with the IRS and the IRS appoints it as a qualified intermediary.
Persons that may be qualified intermediaries include entities
that are financial institutions or securities clearing houses,
partnerships, and any other person acceptable to the IRS.
Prop. Reg. § 1.1441-1(e)(5).
A qualified intermediary would have the choice of whether to
assume primary withholding liabilities for payments made to it for the
benefit of others. Where
the qualified intermediary accepts such responsibility, it could file
one Form W-8IMY for itself and would not need to attach various Form
W-8BENs for its beneficial owners.
Prop. Reg. § 1.1441-1(e)(5)(iv)(C).
(5) Payments to Nonqualified intermediaries.
A
payment made to a nonqualified intermediary would require the
withholding agent to obtain a Form W-8IMY from the nonqualified
intermediary as well as a Form W-8BEN for each of the beneficial owners
for whose benefit the payment is being made.
Prop. Reg. § 1.1441-1(e)(3)(iv).
This results in the nonqualified intermediary (as opposed to
currently the withholding agent) becoming responsible for obtaining the
requisite certifications from the beneficial owners of U.S. sourced
FADPI income.
¶855: Backup Withholding.
In addition to the net basis tax regime and gross basis tax
regime mentioned above, there also exists a third tax regime entitled
backup withholding. This
third tax system applies where a payee has failed to furnish his
taxpayer identification number to the payor or where the IRS informs the
payor that such number is incorrect.
The payor is required, under the backup withholding provisions,
to withhold and remit to the IRS 31 percent of all payments to such
taxpayer. Code Sec.
3406(a)(1). Backup
withholding applies to:
(1) Reportable interest and dividend payments and
(2) Certain other reportable payments.
Code Sec. 3406(b)(1).
Reportable interest and dividend payments are those with respect
to which information returns are required, such as payments of interest
pursuant to Code Sec. 6049(a), payments of dividends pursuant to Code
Sec. 6042(a) and payments of patronage dividends pursuant to Code Sec.
6044. Other reportable
payments are those with respect to which information returns are
required such as payments made in the course of a trade or business
pursuant to Code Sec. 6041, payments relating to remuneration for
services pursuant to Code Sec. 6041A(a), payments relating to returns of
brokers pursuant to Code Sec. 6045, payments relating to certain fishing
boat operators pursuant to Code Sec. 6050A or certain royalty payments
pursuant to Code Sec. 6050N.
Where the withholding agent is making a reportable payment and it
has not received a Form W-8 or Form W-9 identifying the payee, then it
must subject the payment to 31 percent backup withholding tax.
There
is multiple overlapping between the regular and backup withholding tax
rules. For example,
generally backup withholding will apply where the payee fails to
identify themselves, even where the regular system of tax exempts such
payee from U.S. tax. The
purpose of backup withholding is to allow the U.S. government to take a
certain portion of each payment from a payee who has not identified
themselves and thereby force the payee to either identify themselves and
obtain the refund or a credit of such tax or to allow the IRS to keep
such tax as a result of non identification of the recipient.
Chapter
1. Introduction
- Source of Income Rules.
Chapter
2. Interest Income, excluding OID and OID Income.
Chapter
3.
Dividend Income.
Chapter
4. Rents and Royalties.
Chapter
5. Sale of Personal Property Income.
Chapter
6. Services Income.
Chapter
7. U.S. Real
Estate and Other Unique Income.
