The IRS Presumption Rules and the Withholding Certificate (Form W-8) Dilemma: A Solution for Foreign Partnerships Providing Services to U.S. Clients
Compensation paid to a nonresident alien or foreign entity for services performed outside the United States is not U.S. source income and is therefore not subject to nonresident alien/foreign entity withholding or FATCA withholding. Nonetheless, a U.S. payer may still be required to backup withhold at the rate of 28% on non-U.S. source payments if it does not receive a Form W-8 from each beneficial owner of the payment certifying his or her foreign status. This means that a foreign partnership (e.g., a foreign law firm) providing services to U.S. clients through a foreign office could be asked to provide a withholding certificate (Form W-8) from each individual partner in order to avoid backup withholding on the payment. For large partnerships with multiple offices this can present a daunting, if not wholly unrealistic, task. Fortunately, the U.S. Treasury Department has provided a solution to this problem by issuing regulations containing presumption rules that a U.S. payer must apply when it does not receive withholding certificate(s) from the beneficial owner(s) of a payment. By following the presumption rules, a U.S. payer may wholly avoid liability for tax, interest, and penalties when it does not obtain withholding certificate(s) from certain beneficial owner(s) of a payment.
The U.S. Accounts Payable Department Quagmire
Why is it so difficult dealing with U.S. accounts payable? A U.S. payer is required to apply the 28% backup withholding rate to a reportable payment made to a U.S. person (such as a payment for services made to a non-employee) if the U.S. payer has not received a valid U.S. taxpayer identification number from the payee. U.S. payers (and certain individual officers) are themselves held liable for the backup withholding tax that they incorrectly fail to collect if they do not precisely follow the IRS regulations. One way that liability for backup withholding may be avoided is by obtaining a valid Form W-8 from each beneficial owner of the payment certifying his or her foreign status. Thus, when making a payment for services to a foreign partnership, the legal department of a U.S. payor will typically instruct its accounts payable department to obtain a withholding certificate from each partner of the foreign partnership certifying his or her foreign status.
The Presumption Rules Pertaining to Partners of Foreign Partnerships
The IRS regulations provide that if a U.S. payer cannot reliably associate a payment with valid documentation, the U.S. payer must apply certain presumption rules in order to avoid liability for tax, interest, and penalties. If the U.S. payer complies with the presumption rules, it is not liable for tax, interest, and penalties even if the rate of withholding that should have been applied based on the payee's actual status is different from that presumed. The presumption rules apply to determine the status of the recipient of a payment as a U.S. or foreign person and other relevant characteristics, such as whether the payee is a beneficial owner or intermediary, and whether the payee is an individual, corporation, partnership, or trust.
Temporary regulations that became effective for payments made on or after June 30, 2014 provide presumption rules for the determination of a partner’s status as U.S. or foreign in the absence of documentation. These rules provide that so long as a foreign partnership provides a certificate certifying its foreign status, the individual partners of the partnership will be presumed to be foreign payees (assuming the U.S. payer does not have actual knowledge that any of the partners are U.S. persons). This means that a U.S. payor will not be held liable for backup withholding on payments for services made to a nonwithholding foreign partnership so long as the partnership furnishes a valid Form W-8 certifying its foreign status. Accordingly, by relying on the presumption rules, a U.S. payor can obviate the necessity of obtaining withholding certificates from each partner of a foreign partnership.
The real challenge for a foreign partnership, of course, is making this clear to U.S. accounts payable. The IRS regulations describing the documentation required from various foreign payees are exceedingly complex, which is why the accounts payable departments of U.S. businesses are instructed to obtain withholding certificates rather than determine when a withholding certificate may not be necessary. A foreign payee must therefore be in a position to pinpoint to the applicable regulatory authority if it believes it should not be required to provide a Form W-8.
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This summary is intended to provide general information only on the matters presented. It is not a comprehensive analysis of these matters and should not be relied upon as legal advice. If you have any questions about the matters covered in this publication, please contact:
Maureen R. Monaghan: maureen.monaghan@wg-law.com | (212) 509 6312
Charles E. Chromow: charles.chromow@wg-law.com | (212) 509 4712