Multinational corporations are taking advantage of worldwide expertise to adapt to the changing economic landscape. Corporations frequently have foreign nationals on their boards of directors. This item will assist U.S. companies and/or tax professionals dealing with the taxation of such directors.
Cross-Border Example
A resident of a foreign country at-tends a board meeting in the U.S. as a board member of a U.S. company. The fee received for such services is subject to U.S. tax, because the services were performed in this country.
Generally, under Sec. 871(a), every nonresident alien (NRA) who derives fixed or determinable annual or periodic (FDAP) income from sources within the U.S. (including remuneration for personal services) is subject to U.S. tax on such income. Further, under Sec. 1441(a) and (b), every U.S. person that makes FDAP payments to NRAs is required to withhold the proper tax and remit it to the IRS. The withholding rate on such income is generally 30%; however, it may be reduced under a treaty between the U.S. and the NRA’s resident country, per Regs. Sec. 1.871-12.
Modification by Treaty
When a tax treaty exists between the U.S. and the director’s home country, it may specify which country has the right to tax the income. For example, the U.S.-U.K treaty states that a corporation’s country of residence may tax nonresident directors only on compensation for services physically performed there; see Convention Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains, signed July 24, 2001, Art. 15, Director’s Fees.
In contrast, according to a treaty with Cyprus, directors’ fees received by Cyprus residents for service on the board of a U.S. corporation are exempt from U.S. income tax to the extent of a daily reasonable fixed amount; see Convention Between the Government of the United States of America and the Republic of Cyprus, signed March 19, 1984, Art. 20, Directors’ Fees. Thus, no withholding requirement applies in such cases, but certain other reporting requirements must be met.
NRA Withholding Requirements
Once the fees paid for services rendered in the director’s capacity as a board member are subject to U.S. tax (i.e., not exempt by treaty), the NRA withholding requirements apply. The company paying the compensation acts as a withholding agent and is liable for the tax. Such liability is independent of the director’s U.S. tax liability; thus, any failure to comply with the withholding requirements may lead to penalties (including those for late filing, late payment and failure to deposit tax when due) and interest. Penalties may also be imposed for negligence, substantial understatement of tax or fraud (these rates vary depending on the type of failure and the time overdue).
Formalities
U.S. withholding can be remitted to an authorized financial institution through electronic deposit or with Form 8109-B, Federal Tax Deposit Coupon. Electronic deposits are mandatory under certain circumstances.
Filing and remittance frequencies vary, depending on the amount of tax withheld. For example, if at the end of the tax year the total undeposited tax is less than $200, it may be paid with Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. If at the end of any month, the tax liability is $200–$2,000, the tax must be remitted within 15 days. If at the end of any quarter-monthly period the undeposited tax totals at least $2,000, the tax payment must be made within three banking days. The deposit requirement for the quarter-monthly period is met if at least 90% of tax due is paid during such period and the outstanding amount will be remitted with the next payment, which is due after the 15th of the following month. However, if the quarter-monthly period is in December, payment is due January 31 of the following year.
In addition to the actual withholding amount and its remission to the IRS, the company must meet certain reporting requirements. Any payment subject to withholding must be reported on Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, whether or not the appropriate tax was withheld. Additionally, Form 1042 must be filed to report annual payments of amounts subject to NRA withholding. Both returns must be submitted by March 15th of the succeeding year. If additional time is needed to file Form 1042-S, Form 8809, Application for Extension of Time to File Information Returns, may be filed no later than the original due date. To extend Form 1042, a taxpayer may file Form 7004, Application for Automatic 6-Month Extension of Time to File Certain Business Income Tax, Information, and Other Returns. However, the extension does not extend the payment due date.
Failure to Withhold
When the withholding agent does not comply with its requirements, it bears liability for the tax owed until the company remits the payment or the foreign director satisfies his or her U.S. tax liability. The withholding agent can still be subject to interest and penalties accrued until such payment is made, should the issue be brought up on audit. The company may be required to provide for such exposure under Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertain Tax Positions.
Solution
There are several options to repair a failure to comply with the withholding requirements.
- The company pays the required withholding to the Service, sets up a receivable and seeks cash repayment from the director.
- The company pays the withholding and seeks repayment by withholding from a future payment of director fees. Obviously, this alternative would work only if the director is due future payments. The company may want to ensure that its director’s contractual agreements provide for a right of setoff.
- The director may perform services for another company of the same group. In such case, the previous amount not withheld can be withheld by the second company. The first company creates a receivable; the second remits the amount via intercompany transfer. Depending on the group’s situation, this may become a complicated procedure.
- The company pays the withholding, but does not seek repayment. Obviously, this option depends on the company’s relationship with the director, as well as the amount of withholding involved. It would result in additional compensation expense to the company and additional income for the foreign director, which would be subject to a gross-up calculation.
