The IRS issued 2016 versions of Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, and Form W-8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities), and instructions for each form in April. The revised Form 1042-S requests important new information that was not required on the form for the 2015 reporting year.
In general, a withholding agent1 must file an information return on Form 1042-S to report amounts paid to foreign persons that are reportable under Chapters 3 and 4 of Subtitle A of the Internal Revenue Code.2Background of Form 1042-S
Form 1042-S is used to report amounts paid to foreign persons (including persons presumed to be foreign) that are subject to income tax withholding, even if no amount is deducted and withheld from the payment because of a treaty or exception to taxation, or if any amount withheld was repaid to the payee. It is also used to report amounts withheld under Chapter 3 of the Internal Revenue Code. The form also applies to foreign exempt organizations, withholding on "effectively connected income" of partnerships, and to Foreign Investment in Real Property Tax Act (FIRPTA)3 withholding.
The Foreign Account Tax Compliance Act (FATCA)4 established a new reporting and withholding tax regime under Chapter 4 of the Internal Revenue Code. The FATCA regime represents a significant development in the landscape of international tax compliance that aims to prevent efforts by U.S. persons to hide unreported income and assets offshore. Pursuant to Secs. 1471 through 1474,5 it requires withholding agents to withhold tax on certain payments to a foreign financial institution (FFI) unless the FFI has entered into an agreement with the United States to, among other things, report certain information with respect to U.S. accounts. In addition, it imposes withholding, documentation, and reporting requirements on withholding agents with respect to certain payments made to certain nonfinancial foreign entities.Changes to Form 1042-S
For the 2015 reporting year, boxes 13a through 13i, 16, and 17 provided the recipient's identifying information; for the 2016 reporting year,6 those are now boxes 13a through 13l.
A payer that makes a payment for which a beneficial owner (generally, the payee) that is an entity that has claimed a reduced rate of withholding under an applicable income tax treaty and has provided documentation establishing that it qualifies for the reduced rate under the treaty's limitation-of-benefits (LOB) article7 should enter the applicable LOB code in a new-for-2016 box 13j. The instructions to Form W-8BEN-E describe each LOB code. Although Form 1042-S has undergone these changes, withholding agents should be aware that they are not required to obtain new documentation unless they are otherwise required to do so.8
LOB codes are provided for:
- Government—contracting state/political subdivision/local authority;
- Tax-exempt pension trust/pension fund;
- Tax-exempt/charitable organization;
- Publicly traded corporation;
- Subsidiary of a publicly traded corporation;
- Company that meets the ownership and base erosion test;
- Company that meets the derivative benefits test;
- Company with an item of income that meets the active trade or business test;
- Discretionary determination; and
For the 2016 reporting year, withholding agents may choose to provide a unique identifying number in box 13k for recipients that do not have an assigned account number. In addition, starting with the 2016 reporting year, payers must indicate their Chapter 3 and Chapter 4 status codes on Form 1042-S. Also, new status codes have been added under Chapter 3 (code 34) and Chapter 4 (code 50) for payments made by a foreign branch of a U.S. financial institution.
Beginning for the 2016 reporting year, if the recipient is unknown, box 13b, the recipient's country code, is left blank, and "unknown recipient" should be entered in box 13a, the recipient's name.
For amounts paid on or after Jan. 1, 2016, a U.S. financial institution or a U.S. branch of an FFI maintaining an account within the United States must report payments of the same type of income (as determined by the income code in box 1) made to multiple financial accounts held by the same beneficial owner on separate Forms 1042-S for each account.
Finally, the instructions for the 2016 reporting year now provide further guidance on how to report payments that are made to hybrid and reverse hybrid entities9 in cases in which treaty claims are being made. The instructions also clarify which recipient code to use (if any) in certain cases, including when a withholding agent reports a pooled reporting code or makes a payment to a U.S. branch or to a limited branch treated as a nonparticipating FFI.Background of Form W-8 Series
International vendors must submit a U.S. withholding certificate (Form W-8 series) with an employer identification number (EIN), individual taxpayer identification number (ITIN), or Social Security number (SSN) to claim an exemption (validate the payer's position) from, or reduction in, withholding under an income tax treaty.10 With regard to business payments, the EIN, ITIN, or SSN can be used by the vendor only for U.S. business tax obligations and not for U.S. personal tax obligations.
The specific W-8 form used by the international vendor depends on the type of payment and the status of the business. A valid W-8 series form must be provided to the withholding agent prior to receiving a payment.Form W-8BEN-E
The old Form W-8BEN is available online at www.irs.gov, and the new Form W-8BEN-E, which was introduced as a result of FATCA, is available at www.irs.gov. While the general purposes of the forms are similar—they both document information on a foreign individual or entity and requested treaty benefits—the Form W-8BEN-E is much longer due to information required by FATCA for foreign entities. Any U.S. taxpayer that generally has nonproduct-related transactions with a foreign entity (FE) must receive a completed Form W-8BEN-E from that FE to determine whether the FE is subject to the default 30% withholding on payments to FEs or is eligible for any reduced withholdings related to an applicable income tax treaty.11 FEs use Form W-8BEN-E to document their status for purposes of Chapters 3 and 4, as well as for certain other provisions under the Internal Revenue Code.Changes to W-8BEN-E
New boxes have been added to Form W-8BEN-E, Part III, "Claim of Tax Treaty Benefits," for tests that can be met to satisfy an LOB provision.12 A taxpayer is required to check the appropriate box associated with the LOB test it meets with respect to the treaty benefits or to check a box indicating that it has obtained a discretionary determination from the U.S. competent authority that it qualifies for the claimed treaty benefits.
A new box has also been added to the Chapter 4 statuses in line 5 for payments made to payees for accounts they hold that are not financial accounts.13
The revised instructions for how nonreporting intergovernmental agreement (IGA) FFIs should properly document themselves on the form and certify their status are intended to coordinate qualification for that status under the IGA with the Chapter 4 regulations. An FFI that satisfies the requirements of both a nonreporting IGA FFI under the IGA and a deemed-compliant FFI status under the regulations should certify as a nonreporting IGA FFI, unless the entity meets the requirements for owner-documented FFI status for payments associated with the form, in which case it should certify that status under the regulations only, by completing Part X of Form W-8BEN-E.Summary
One of the changes above that will affect taxpayers claiming reduced or no withholding due to an income tax treaty is the requirement to indicate which LOB provision is satisfied. While in some cases the LOB provision may be simple to ascertain, in other, more complex organizational structures it may be difficult. Taxpayers and practitioners should not wait until March 15, 2017, (the due date of Form 1042-S) to ascertain which LOB provision is satisfied.
1The withholding agent is liable under Sec. 1461 for the tax.
2Temp. Regs. Sec. 1.1461-1T(c)(1).
3Subtitle C of Title XI of the Omnibus Reconciliation Act of 1980, P.L. 96-499, as amended.
4Title V, Subtitle A, of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147.
5A further discussion of FATCA is beyond the scope of this article.
6Form 1042-S (revised 2016), available at www.irs.gov, with instructions available at www.irs.gov.
7The LOB clauses of income tax treaties are intended to prevent treaty shopping. LOB provisions apply a series of objective tests, and a resident of a treaty country that satisfies one of the tests will receive the treaty's benefits.
8A further discussion of such requirements is beyond the scope of this article.
9A discussion of such entities is beyond the scope of this article.
10A payee may certify under penalties of perjury that because of the payee's foreign status, payments to the payee are exempt from information reporting and thus backup withholding. See Rev. Proc. 83-89.
11Secs. 1441 and 1442.
12See 2016 W-8BEN-E Instructions, available at www.irs.gov.
13Pursuant to Regs. Sec. 1.1471-5(b)(2).
Philip Pasmanik is a senior tax manager with Hertz Herson LLP in New York City with over 25 years of domestic and international tax compliance and planning experience for both public and closely held businesses. He is vice chair of the AICPA International Taxation Technical Resource Panel, a member of the International Tax Committee of the New York State Society of CPAs, and a member of the New Jersey Society of CPAs. For more information about this column, contact firstname.lastname@example.org.