- IRS New Withholding Rules for Payments to Foreign Entities and Individuals
- May 5, 2003 | Author: Duane E. Schroeder
- Law Firm: Fredrikson & Byron, P.A. - Minneapolis Office
On January 1, 2001, new regulations for withholding and information reporting under Sections 1441 and 1442 of the Internal Revenue Code became effective. These regulations state that every individual, partnership, corporation, nonprofit organization or other entity that makes, receives or processes a taxable U.S. payment to a non-U.S. individual or entity (including some U.S. branches of foreign banks and insurance companies) has reporting responsibilities, regardless of whether they are the beneficial owner of a payment. Failure to withhold can result in penalties and/or liability for the amount not withheld. This article summarizes the most important part of the more than 120 pages of new regulations as they relate to the payers' responsibilities under the Internal Revenue Code and applicable bilateral income Tax Treaties.
How Do the New Rules Work?
The new withholding system for payments to non-U.S. taxpayers is largely document driven and is designed to distinguish payees who beneficially own income from those who act only as intermediaries. Generally, the payer ("withholding agent") must withhold the 30% of gross due the non-U.S. payee on any amount subject to withholding, unless: (i) the payee files with the withholding agent the proper tax forms to establish whether the payee is a U.S. resident for U.S. tax purposes (or is entitled to reduced withholding requirements under a income tax treaty with the U.S.), or (ii) the foreign payee assumes responsibility for withholding as a "qualified intermediary." If the new rules are not followed, the payer must withhold at the highest rate (30% or 31%) on the gross amount.
Determining the Proper Tax Forms to Use
Although the new system is document intensive, it is designed to be integrated with the backup withholding requirements for U.S. citizens and residents and the domestic payment reporting system (i.e., Form 1099s). Effective January 1, 2001, forms W-8, 1001 and 4224 can no longer be used. The new form to use depends on both the type of payee and the type of income to be paid. Most must be filed every three years, and require a tax identification number (TIN). They include:
- Form W-8BEN: This can be used where the beneficial owner of the payment is claiming an exemption from withholding under: a tax treaty, the domestic "portfolio interest exemption" under Internal Revenue Code (IRC) Sections 871(h) or 881, bank deposit interest under IRC 871(i), certain U.S. source dividends paid by certain foreign corporations, and a number of other passive types of income.
- Form W-8ECI: This is used when a foreign person is claiming an exemption from withholding because the income is (or is deemed to be) effectively connected with a trade or business in the U.S. It does not need to be filed with the IRS if the beneficial owner of the U.S. source income claims an exemption from tax under an income tax treaty because the income is not attributable to a permanent establishment in the U.S.
- Form W-8IMY: This new form is for foreign intermediaries, brokers, agents, nominees, custodians, trustees or partnerships and U.S. branches of foreign banks or insurance companies, where a payment is made to the intermediary by the payer. Even though filing it will exempt the intermediary from having the 30% gross amount withheld, there still may be a withholding requirement on its subsequent payment to a non-U.S. taxpayer. Unless the intermediary is "qualified" (see below), the non-U.S. taxpayer should fill out one of the other forms listed; otherwise, the intermediary must withhold 30% (or 31% in appropriate cases) of the gross amount due the payee.
- W-8EXP: This replaces Form 8709 for foreign governments and international organizations.
- W-9: The new version of this form to obtain a TIN will contain a block to indicate the status of the payee (U.S. or foreign) and will allow a payer receiving a W-9 from a non-U.S. taxpayer to rely on it as the basis for not withholding 30% of the gross amount. This form has replaced 1078, which was used by aliens claiming residence in the United States, requesting TINs, certifications, and claims for exemption.
- Form 8233: Form 8233 is currently used by nonresident aliens to claim treaty benefits on fees paid for independent personal services. The new version will also serve nonresident aliens claiming treaty benefits for dependent personal services (e.g., a non-U.S. taxpayer who has been employed by a U.S. company as an employee, is in the U.S. for less than 183 days in a tax year or is exempt from withholding requirements under a tax treaty). Before this form is used, an employer should determine whether the person it is paying is an independent contractor or employee for tax purposes under the IRC, case law, and income tax treaty.
A payer also can avoid withholding when the foreign payee is a "qualified intermediary." This is either a foreign entity, foreign branch of a U.S. financial institution or clearing organization, a foreign financial institution, foreign clearing organization, foreign corporation asserting an exemption on behalf of its shareholders, or other person acceptable to the IRS. An agreement with the IRS must specify the certifications and documentation (Forms such as W-9, W-8ECI, etc.) on which it can rely on to determine the classification (individual, corporation, partnership) and status (U.S. or foreign) of the beneficial owners and payees who will receive the payments collected by the qualified intermediary. The required documentation may include the names and addresses of foreign customers, especially if those customers are claiming a benefit under a tax treaty. In addition, the qualified intermediary must file a Form W-8IMY, unless it meets certain procedural terms required in the agreement.
The new withholding rules affect any U.S. entity that pays foreign persons or entities or any foreign intermediary that invests foreign client funds in the U.S. If one of the new forms are not obtained from the recipient, the payee itself may be liable for the tax not withheld.