The Foreign Account Tax Compliance Act (FATCA), signed into law on March 18, 2010, added a new chapter (Chapter 4) to the Internal Revenue Code. While FATCA’s primary purpose is to overcome perceived tax abuse by US persons utilizing offshore accounts, the new rules require (1) foreign financial institutions to provide information to the IRS regarding US account holders, and (2) other non-US entities to provide information about any US owners.
The implementation of FATCA resulted in a new emphasis on US entities making payments to non-US persons. US withholding agents are required to document, report, and, potentially, withhold US tax on certain payments. Therefore, FATCA impacts virtually all non-US entities who, directly or indirectly, receive most types of US-source income. US entities may now be required to withhold a 30% tax on US-source income that is paid to a non-US person under FATCA. US entities are also required to maintain documentation on non-US payees and tract how those payees are classified under FATCA.
The risk of non-compliance could be very costly. If documentation is not maintained, the IRS could subject ALL payments to non-US persons to the 30% withholding tax – paid by the payor.
A US Withholding Agent is any US person that has control, receipt, custody, disposal or payment of a withholdable payment. A US Withholding Agent is required to:
- Determine foreign payees
- Obtain a Form W-8 from foreign payees to certify foreign status, treaty benefits and FACTA categorization (Forms W-8 need to be re-certified every 3 years)
- Establish a process for tracking and retaining correspondence with foreign payees regarding status
- Maintain documents associated with each payee to support decisions regarding classification of entity, classification of income-type, and withholding requirements or exemption therefrom
- Establish a process for appropriate withholding from payments and reporting of all payments on Forms 1042/1042-S
Generally, vendor payments made to foreign payees in the ordinary course of business for purchases of goods or services supplied from outside of the US are exempt from withholding; however, payments for services provided inside the US as well as payments classified as royalties (including software license fees) may not be exempt from withholding.
There are a series of W-8 forms and it is important that the foreign payee provide the correct form to the US withholding agent.
- Form W-9 is used by US taxpayers (US citizens/permanent residents, US corporations, partnerships, LLC, etc). Non-US persons should not supply Form W-9 to a US Withholding Agent
- Form W-8BEN is used by foreign individuals to establish foreign status and to claim treaty benefits
- Form W-8BEN-E is used by non-US entities to establish foreign status, FATCA classification, claim treaty benefits and disclose ownership of the non-US entity by US persons
- Form W-8IMY is used by foreign intermediaries – where the direct payee is not the beneficial owner of the income. Form W-8IMY is frequently accompanied by Forms W-8BEN or W-8BEN-E of the beneficial owners
- Form W-8ECI is used by non-US entities with a US trade or business and those entities certify that they are filing a US income tax return
- Form W-8EXP is used by foreign governments or other foreign organizations certifying non-taxable/non-withholding and foreign status
Once an US withholding agent has identified all foreign payees and has determined the appropriate income type and withholding requirements, payments to the foreign payees are made and federal tax withholding should be deposited with the IRS using the Electronic Federal Tax Payment System (EFTPS). Deposits are required on an annual, quarterly, monthly, semi-monthly or second-day basis determined by the US Withholding Agents cumulative deposits (the higher the amount to be deposited, the shorter the window for making the deposit). On an annual basis, the US withholding agent will file Forms 1042/1042-S reporting the payments (and related tax withholdings) to foreign payees – these forms are similar to Forms 1099-MISC/1096, but require additional coding and information.
Any business entity making payments to non-US persons should undertake a detailed review of the payments, documentation requirements and withholding obligations in order to avoid a 30% tax – plus penalties and interest – if the appropriate forms are not obtained or if foreign payments are not property withheld upon and/or reported.
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
