Foreign Income & Taxpayers
In Chief Counsel Advice (CCA) 201428007, issued July 11, the IRS concluded that it has the authority to notify a withholding agent that a foreign person's claim of withholding tax exemption with respect to its income effectively connected with a U.S. trade or business is invalid. The withholding agent is required to withhold tax beginning 30 calendar days after it receives this notification.
In the CCA, a withholding agent relied on a Form W-8ECI, Certificate of Foreign Person's Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States, provided by a foreign person to support a withholding exemption for withholding on payments of effectively connected income. During an examination, the IRS determined that the foreign person did not file a U.S. income tax return for any of the years to which the form related or for any subsequent year. Based on the IRS's determination, the examiner intended to notify and instruct the withholding agent that it could not rely on the foreign person's claim of exemption for effectively connected income and requested the advice of the Office of the Chief Counsel (OCC) regarding authority to do so.
Under Secs. 871(b) and 882(a), a nonresident alien or a foreign corporation engaged in a trade or business within the United States during the tax year is taxed at a graduated rate on income that is effectively connected with the conduct of a trade or business within the United States.
Secs. 1441 and 1442 generally require a withholding agent to withhold tax equal to 30% of any U.S.-source fixed or determinable, annual or periodical income paid to a foreign person. However, Sec. 1441(c)(1) provides an exception: No deduction or withholding is required in the case of any item of income that is effectively connected with the conduct of a trade or business within the United States and that is included in the gross income of the recipient under Sec. 871(b)(2) for the tax year.
Regs. Sec. 1.1441-4(a)(2) provides that in the absence of actual knowledge or reason to know otherwise, a withholding agent may rely on a claim of exemption for effectively connected income if, prior to the payment to the foreign person, the withholding agent can reliably associate the payment with a Form W-8 provided by the foreign person. A Form W-8 is valid only if it includes the taxpayer identifying number of the person whose name is on the form and represents, under penalties of perjury, that the amounts for which the certificate is furnished are effectively connected with the conduct of a trade or business in the United States and are includible in the beneficial owner's gross income for the tax year. In the absence of a reliable claim that the income is effectively connected with the conduct of a trade or business in the United States, the income is presumed not to be effectively connected.
Temp. Regs. Sec. 1.1441-7T(b)(1) provides that a withholding agent that has been notified by the IRS that a claim of U.S. status or of a reduced rate is incorrect has actual knowledge beginning 30 calendar days after the date the notice is received. A withholding agent is liable for tax, interest, and penalties if it fails to withhold tax as required. Under Sec. 1461, a withholding agent is liable for any tax due on payments to a foreign person if it fails to properly withhold the tax.
In the CCA, the OCC advised that a withholding agent's ability to rely on a foreign person's claim of exemption from withholding tax was not limited to the information provided by the foreign person on a Form W-8ECI. If the withholding agent has actual knowledge or reason to know that the claim of exemption for effectively connected income is incorrect, it must still withhold. The OCC then noted that by filing the Form W-8ECI, the foreign person certified under penalties of perjury that the amounts for which the certification was provided were effectively connected with the conduct of a trade or business in the United States and were includible in its gross income for the tax year. Form W-8ECI also includes a note at the top of the form that states, "Persons submitting this form must file an annual U.S. income tax return to report income claimed to be effectively connected with a U.S. trade or business." The OCC determined that, by filing the Form W-8ECI, the foreign person was making a statement that it would timely file a U.S. income tax return to include the effectively connected income in its gross income for the years for which the withholding agent relied on the form and did not withhold.
If a foreign person fails to file tax returns to include in gross income the amounts claimed on the Form W-8ECI, the OCC concluded that the IRS can determine the claim to be incorrect and directly notify the withholding agent that under Temp. Regs. Sec. 1.1441-7T(b)(1), it cannot rely on the foreign person's claim of exemption. A withholding agent cannot rely on the foreign person's claim of exemption beginning 30 calendar days after receiving the notification. The withholding agent may also be liable under Sec. 1461 for any deficiency in the amount withheld.
The OCC also noted that the foreign person could file a U.S. income tax return for the year in which the withholding agent withheld pursuant to the notification received from the IRS and claim a credit or refund, if applicable, for the amounts withheld at the source.
In this CCA, the OCC concluded that the IRS may notify a withholding agent that a foreign person's claim of withholding tax exemption is invalid because it failed to file a U.S. income tax return and include the amounts that are effectively connected with the U.S. trade or business in its gross income. Based on this conclusion, when a foreign person provides withholding tax documentation (i.e., a form in the Form W-8 series), the withholding agent should make sure that all representations included on the form are factually correct. A withholding agent that receives IRS notification that it cannot continue to rely on a foreign person's claim of withholding tax exemption should begin to withhold any required tax on payments to the foreign person.
The final regulations are effective for tax years ending after July 20, 2014, and may be applied to any previous years for which the statute of limitation is still open.
Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.
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