by Bill Leary, CPA, International Tax Director, Doeren Mayhew

Beginning July 1, 2014, under the Foreign Account Tax Compliance Act (FATCA), U.S. taxpayers who make payments to foreign persons will be required to analyze and report information regarding payments to both foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs).

The rules also may require a 30 percent withhold on U.S.-source payments to foreign entities, including interest, dividends, and royalties and from the proceeds of sales of items producing U.S. source interest or dividends. The withholding applies whether the foreign entity receives the payments as beneficial owner or as an agent. The FATCA withholding applies to many items not otherwise subject to U.S. tax (e.g., portfolio interest and capital gains of foreign investors), and the withholding cannot be reduced or eliminated by treaty.

Below, the international tax accountants at Doeren Mayhew focus on the rules applicable to NFFEs.


FATCA Rules for Payments to Non-Financial Foreign Entities

The FATCA definition of a withholding agent is drafted broadly, and it requires any person, acting in any capacity, having the control, receipt, custody, disposal or payment of an item of income that is subject to FATCA withholding, to have appropriate IRS documentation. Withholding agents that fail to obtain the required documentation are required to withhold 30 percent on the gross payment to foreign entities. FATCA makes the withholding agent liable to deduct and withhold the tax and liable for unpaid withholding.

The new 30 percent withholding is different from the longstanding Chapter 3 withholding tax under §§ 1441 – 1446. First, the FATCA withholding applies to payments of U.S. source payments as well as the gross proceeds from the sales of securities that could pay U.S. source interest and dividends. Second, the new FATCA withholding is a backstop to the Chapter 3 withholding tax rules.

If the withholding of tax under the FATCA rules results in an overpayment by the beneficial owner of tax, the beneficial owner can obtain a refund or credit from the IRS. Generally, the availability of a refund or credit is determined, as though the tax had been withheld under §§ 1441 and 1442. The FATCA withholding is treated as a tax because of its integration with the Chapter 3 withholding regime.

Chapter 4 withholding requires U.S. payers to withhold the 30 percent on payments to noncompliant FFIs and NFFE for payments made after June 30, 2014, when the following conditions are all present:

  • The payee is foreign entity
  • The payment is not exempt
  • The payer did not receive a Form W-8BEN-E, “Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)” or similar form in the W-8 series.

Amounts exempt from Chapter 4 withholding include:

  • Amounts paid by a U.S. Real Property Holding Corporation or a qualified investment entity subject to FIRPTA withholding
  • A foreign partner’s distributable share of a partnership income subject to withholding under § 1446
  • Payments of income treated as effectively connected with a U.S. trade or business (income will not be treated as taken into account under this exception if it is or is deemed to be effectively connected with the conduct of a trade or business in the United States and the beneficial owner claims an exception from tax under an income tax treaty because the income is not attributable to a permanent establishment in the United States)

In the case of a withholdable payment that is both subject to withholding under Chapter 4 and is an amount subject to FDAP withholding, a withholding agent may credit the withholding applied under Chapter 4 against its liability for tax due under sections 1441, 1442 or 1443.

Additionally, no withholding is required if the payment is beneficially owned by an “exempt NFFE”:

  • A corporation, if its stock is regularly traded on an established securities market or if it is a member of an expanded affiliated group that includes a corporation with stock regularly traded on an established securities market
  • Any entity that is organized under the laws of a U.S. possession and wholly owned by bona fide residents of the possession
  • A foreign government, a political subdivision of a foreign government, an international organization or a wholly owned agency or instrumentality
  • A foreign central bank of issue

Certain types of income are specifically not withholdable amounts:

  • Services (including wages and other employee compensation, such as stock option income)
  • Use of property payments
  • Office and equipment leases
  • Software licenses
  • Transportation and freight payments
  • Gambling winnings, awards, prizes and scholarship amounts
  • Interest arising from the acquisition of goods or services

In general, FATCA targets payments that are more financial in nature, as opposed to those routinely made by nonfinancial entities. The FATCA regulations specifically identify payments considered withholdable:

  • Interest (including original issue discount as defined in § 871(g)(1))
  • Dividends
  • Lending transaction payments, including loans of securities
  • Forward, futures, options or notional principal contracts
  • Investment advisory fees
  • Custodial fees
  • Bank or brokerage fees
  • Premiums for insurance or annuity contracts
  • Cash-value insurance or annuity payments

Certain NFFEs, receiving otherwise withholdable payments, are not subject to Chapter 4 withholding: Publicly traded corporations and affiliated entities.

  • Active NFFEs
  • Territorial entities (wholly owned by one or more bona fide residents of a U.S. territory under the laws of which the entity is organized)

When a foreign payee who is not an excepted NFFE has substantial U.S. owners, U.S. payers will not only be required to obtain a completed Form W-8BEN-E, but also will need to complete Form 8966, “FATCA Report.” Form 8966 will provide the IRS the name, address and tax identification number of each substantial U.S. owner of the NFFE, and the total payments made to the NFFE.

A substantial U.S. owner is defined for these purposes as a U.S. person who owns, directly or indirectly, more than 10 percent of:

  • The stock of a payee corporation, by vote or value
  • The profits interests or capital interests of a payee partnership
  • The beneficial interest in a foreign trust (or is treated as the owner of a foreign grantor trust)

In addition to the challenges presented by the new Form W-8BEN-E, U.S. payers will need to institute new procedures in their accounts payable departments to properly identify potentially withholdable payments and foreign payees from whom Form W-8BEN-E must be obtained. Implementing these new procedures will take time.

For assistance navigating these new Foreign Account Tax Compliance Act (FATCA) requirements, contact our international tax accountants in Michigan, Houston or Florida.