Withholding taxes in the United States have become more complex since the introduction of the Foreign Account Tax Compliance Act (“FATCA”). FATCA withholding is referred to as “Chapter 4” withholding. The traditional withholding tax rules for FDAP and ECI are referred to as “Chapter 3” withholding. Companies can generally avoid assessing Chapter 4 withholding provided that they obtain and report specific information about the foreign recipients. If a withholding agent makes a payment to a foreign person and did not apply the proper withholding tax, the payer may be liable for the unpaid (or under-paid) tax.
Payments to foreign persons are generally subject to withholding tax at the time of payment. FDAP income is subject to withholding on the gross amount of the income. ECI that is earned by a U.S. fiscallytransparent entity (e.g., partnership or LLC) with foreign owners is subject to withholding at the maximum graduated tax rate. These rates can be reduced under a treaty, due to a statutory exemption, or, in the case of ECI of a foreign partner in a U.S. partnership, if the recipient provides the withholding agent support for a lower rate of tax to be applied under the graduated rates.
FDAP income – dividends, interest, royalties, wages, etc.
FDAP income, as described above in
Corporate Tax and Personal Income Tax, includes dividends, interest, rents, royalties, wages, salaries, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income. Such amounts are subject to 30% withholding tax on the gross amount of the payment to both individuals and corporations. Portfolio interest and bank interest earned by non-resident alien individuals are exempt from U.S. withholding due to a statutory exemption.
Effectively-connected income (“ECI”) is income that is attributed to a U.S. trade or business. A U.S. partnership (or other regarded fiscally-transparent entity) that has a foreign partner must withhold tax on the partner’s distributive share of the ECI of the partnership. The withholding tax rate is the maximum rate applicable to ordinary income of the recipient – 39.6% for non-resident alien individuals and 35% for foreign corporations. A foreign partner in a partnership (or other U.S. fiscallytransparent entity) can provide a certificate to the partnership to request reduced withholding if it can establish that a lower rate should apply.
Chapter 4 withholding (or “FATCA” withholding) applies to all U.S.-source withhold-able payments, which generally include payments of FDAP income. The withholding rate under FATCA is 30% on the gross amount of the payment. Statutory exemptions that may apply for purposes of Chapter 3 (e.g., portfolio interest) do not apply for purposes of FATCA. Generally, if the beneficial owner of the income provides a complete withholding tax certificate to the payer, the withholding agent should not need to apply Chapter 4 withholding. In that case, the payment may be subject to Chapter 3 withholding instead.
The United States has a suite of withholding tax certificates (Forms W-8) that must be provided by a foreign recipient of a U.S.-source payment of income. Below is a brief list of the forms available and their general purpose. There may be specific circumstances that warrant providing a different Form W-8 than the one listed below. A foreign person may need to complete different Forms W-8 for different payments of income.
|Form W-8BEN||Non-resident alien individuals, for payments of FDAP or for payments of ECI from a U.S. partnership.|
|Form W-8BEN-E||Foreign corporations, for payments of FDAP or for payments of ECI from a U.S. partnership.|
|Form W-8IMY||Foreign flow-through entities, for payments of FDAP or for payments of ECI from a U.S. partnership – typically must be accompanied by a withholding statement and the withholding certificates of its beneficiaries.|
|Form W-8ECI||Non-resident alien individuals or foreign corporations, for payments of ECI.|
|Form W-8EXP||Foreign governments, international organizations, foreign central banks, foreign tax-exempt organizations, and foreign private foundations, for payments of FDAP.|