International Tax Blog

FATCA, NFFEs, and Draft W-8BEN-E - Unnecessary Complexity

The U.S. Treasury Department recently finalized the FATCA regulations.(FN 1)

The bulk of the regulations deal with certain U.S. source payments to foreign financial institutions (“FFIs”).

However, the regulations also require a withholding agent to generally withhold 30% of certain U.S. source payments (made after December 31, 2013) to a payee that is a non-financial foreign entity (“NFFE”) unless three requirements are met. The three requirements are:

1. The beneficial owner of the payment is the NFFE or another NFFE;
2. The withholding agent can treat the beneficial owner of the payment as an NFFE that does not have any substantial U.S. owners, or as an NFFE that has identified its substantial U.S. owners; and
3. The withholding agent reports certain information relating to substantial U.S. owners of the NFFE.(FN 2) 

Simple Reporting in Many Circumstances

In many circumstances it will be quite easy to confirm that the NFFE has no substantial U.S. owners or to identify who the substantial U.S. owners are. For example, a Canadian non-financial company that is wholly owned by a Canadian citizen who lives in Canada should be able to easily certify that it is the beneficial owner of a payment and that it has no substantial U.S. owners.

Similarly, if that same Canadian company were 50% owned by the Canadian citizen and 50% owned by a U.S. citizen, the company should be able to easily certify that it is the beneficial owner of a payment and that it has a 50% substantial U.S. owner. The reporting of the substantial U.S. owner will be done on I.R.S. Form 8966 (or such other form as the I.R.S. may prescribe).(FN 3)

Excepted NFFEs

No withholding is required under the FATCA rules if the payment is beneficially owned by an “excepted NFFE.”(FN 4) Excepted NFFEs include:

1. Publicly traded companies;
2. Affiliates of publicly traded companies;
3. Certain entities organized in U.S. territories;
4. Active NFFEs;
5. Certain non-financial entities (such as holding companies, treasury centers, captive financial companies of a non-financial group, start-up companies, liquidating or bankrupt companies, and not-for-profit organizations).

An “active NFFE” is an entity that meets an income test and an asset test.(FN 5) Under the income test, the entity must have less than 50% of its gross income for the preceding calendar year as passive income. Under the asset test, the entity must have less than 50% of its assets for the preceding calendar year as passive assets (i.e., assets that produce or are held for the production of passive income).

Very generally, “passive income” can be thought of as investment income, such as dividends, interest, rents and royalties (other than certain active rents and royalties), annuities, the excess of gains over losses from the sale or exchange of the foregoing types of property, etc.(FN 6)

A “passive NFFE” is an NFFE other than an excepted NFFE.(FN 7)

Draft Form W-8BEN-E

The current draft version of the Form W-8BEN-E (found here) is eight pages long and has 25 parts.

Parts 1, 2, 3, and 24 represent the four parts included in the existing W-8BEN. Parts 4 through 22 include various categories, including multiple types of FFIs and excepted NFFEs.

Part 23 addresses passive NFFEs and requires that the foreign entity certify that (i) it is not a financial institution, (ii) it is not an excepted NFFE, and (iii) either (a) it has no substantial U.S. owners, or (b) it has provided certain information about each of its substantial U.S. owners in Part 25 of the form.

Unnecessary Complexity

Unfortunately, the way that the W-8BEN-E is currently drafted, a foreign non-financial entity must certify that it is either an active NFFE (in Part 22) or a passive NFFE (in Part 23). If it is an active NFFE, then there is no need to provide information about the substantial U.S. owners. If it is a passive NFFE, then it must provide information about the substantial U.S. owners in Part 25 of the form.

As currently drafted, there is no option to avoid the legwork required to determine whether the NFFE is active or passive, and to simply volunteer the information about the substantial U.S. owners (or lack thereof).

To determine whether a foreign entity is an active or passive NFFE, both its income statement and its balance sheet must be reviewed for the prior calendar year. What if the NFFE has a fiscal year rather than a calendar year? Must calendar year financial statements be created and reviewed? What if there are substantial book-tax differences? Are assets valued on a fair market value basis or using U.S. tax basis? If using fair market value, must a valuation be performed? If using U.S. tax basis, has the foreign entity been tracking the U.S. tax bases of its assets (even though it may be 100% foreign owned)?

Foreign non-financial entities should be able to avoid making the determination as to whether they are active or passive NFFEs.  The NFFE would voluntarily provide the information about the substantial U.S. owners (or lack thereof). The I.R.S. would get the information that it seeks without requiring an extensive analysis to be performed with respect to the foreign entity’s financial statements.

The Form W-8BEN-E should be modified to allow a NFFE to volunteer the substantial U.S. owner information in Part 25 and not have to certify that it is or is not an active NFFE (or any other type of excepted NFFE). One can only hope that the Treasury Department will add this simplification to the final Form W-8BEN-E.

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Footnotes:

1    Treasury Decision 9610.

2    Treas. Reg. §1.1472-1(b)(1).

3    Treas. Reg. §1.1474-1(i)(2).

4    Treas. Reg. §1.1472-1(c).

5    Treas. Reg. §1.1472-1(c)(1)(iv).

6    Id.

7    Treas. Reg. §1.1471-1(b)(88).

Form 1099 for Payments to Foreign Contractors for Services?

One question that often comes up is how a domestic U.S. business should treat payments to a foreign contractor for services performed outside the U.S.  Is a Form 1099 required?  Is withholding required?

As long as the foreign contractor is not a U.S. person and the services are wholly performed outside the U.S., then no Form 1099 is required and no withholding is required.

Not a U.S. Person

So, how do you “know” that the foreign contractor is not a U.S. person?  If the contractor is an individual, perhaps he or she is a U.S. citizen living outside the U.S.?  While you may be able to rely on certain presumptions regarding the foreign contractor’s status (Treas. Reg. §1.1441-1(b)(3)), it is generally easier to simply ask him or her to complete a Form W-8BEN.  By signing Form W-8BEN, the foreign contractor is certifying that he or she is not a U.S. person.

In this circumstance there is no need for the foreign contractor to get a U.S. taxpayer identification number or to complete Parts II or III of Form W-8BEN.  All that the foreign contractor needs to do is to complete the basic information in Part I and sign in Part IV, attesting that the information is true, correct, and complete.  No Form 1099 then needs to be filed for payments to foreign persons.  Treas. Reg. §1.6041-4(a).

The Form W-8BEN is not filed with the I.R.S.  It is kept on file with the U.S. payor in case the U.S. payor is audited.  If audited, the Form W-8BEN supports why no Form 1099 was issued and why no tax was withheld.

Where Were the Services Performed?

Now that you know that the foreign contractor is not a U.S. person, how do you know that he or she is not performing some or all of the services in the U.S.?  Perhaps he or she spends two or three months a year at his or her second home in the U.S. and he or she works on your project while in the U.S.?

You won’t know if the services are performed in the U.S., unless you ask.  There is no special form for this.  The easiest way is to get a signed statement from the foreign contractor that he or she will not perform any of the services in the U.S.  It is typically best to attach this statement to the W-8BEN.

Form 1042 must be filed with respect to certain payments to foreign persons.  Code §1461 and Treas. Reg. §1.1461-1.  However, Form 1042 is required only for payments of “U.S. source income.”  If the payments are for services and the services are performed outside the U.S., then the payments will be foreign source income (Code §861(a)(3) and Treas. Reg. §1.861-4), and no Form 1042 will be required.

When in Doubt, Withhold

Say that you have some reason to doubt the veracity of the foreign contractor’s statements.  Perhaps you know that he or she was born in the U.S. (which would make him or her a U.S. citizen, unless he or she renounced his/her U.S. citizenship)?  Perhaps you know that the foreign contractor spends a good amount of time in the U.S. and you believe some of the services may be performed in the U.S.?

If you do not withhold tax on the payments to the foreign contractor but you are required to withhold, then you, as the payor (i.e., the “withholding agent”), can be held liable for the tax that you did not withhold.  Treas. Reg. §1.1441-1(b)(7).  Thus, if you are uncertain as to whether you need to withhold, it is generally better to withhold.  If the foreign contractor does not owe U.S. tax, then he or she can file a U.S. tax return and claim a refund for the tax that was withheld.