The United States has income tax treaties with over 60 countries for the purpose of avoiding double taxation. The Residency Article of an applicable income tax treaty sets forth rules for determining which entities and individuals (collectively, persons) are residents of a country for purposes of the treaty. As the IRS expands its compliance enforcement with the 30 percent nonresident alien (NRA) withholding requirement for U.S.-source income payments to foreign persons, claims for exemption from tax under an income tax treaty will become increasingly important for foreign vendors with income subject to NRA withholding.
Treaty Country Residency Status
The determination of residence for treaty purposes is based on the person’s liability to tax as a resident under the internal tax laws of the treaty country. The treaty-country rules regarding tax residency may vary depending on whether the entity itself is a resident for tax purposes, as is the case with corporations, or whether the owners of the entity are subject to tax as residents, as is generally the case with fiscally transparent entities such as partnerships. Under the treaties with some countries, both an entity and its owners may be residents for treaty purposes.
Per Se Corporations
Corporations that are not fiscally transparent entities in the treaty country are qualifying residents for treaty purposes if they satisfy the treaty country rules of residence, generally under a place of management rule, and they meet the requirements of the Limitations on Benefits (LOB) Article (discussed below).
The IRS provides a list of foreign business entities that are always classified as corporations in Treas. Reg. Section 301.7701-2(b)(8). This list, known as the per se corporation list, is amended periodically by IRS Notices and temporary regulations. The foreign business entities on this list are commonly referred to as per se corporations. Not all countries that have a tax treaty with the United States are represented on the list, however.
If a foreign corporation making a treaty claim on Form W-8BEN is a per se corporation, the entity may designate that it is a corporation in box 3 of Form W-8BEN. If the country indicated in the permanent residence address or in the company’s records is a different country, the Form W-8BEN is invalid because residence in the treaty country is required for a treaty claim.
The entity must also provide its U.S. EIN on line 6 for the treaty claim to be valid (except for treaty claims on investment income from publicly traded investments and related loans).
A domestic corporation is a corporation organized under the laws of one of the 50 states or the District of Columbia. A domestic corporation might be a resident of the treaty country under the treaty-country’s place of management rule (called a dual-resident company).
Even though a domestic corporation may be a tax resident in a treaty country, domestic corporations and their shareholders may not claim a reduction of U.S. tax under a tax treaty because of the saving clause in U.S. treaties, which saves the right of the United States to tax its citizens and residents as if the treaty were not in effect. The instructions for Form W-8BEN make this clear with the following caution:
“An income tax treaty may not apply to reduce the amount of any tax on an item of income received by an entity that is treated as a domestic corporation for U.S. tax purposes. Therefore, neither the domestic corporation nor its shareholders are entitled to the benefits of a reduction of U.S. income tax on an item of income received from U.S. sources by the corporation.”
Corporations as Agents
In order for a corporation to claim a treaty exemption from tax, the corporation must be the beneficial owner of the income. In some situations in which a corporation is being paid for the services of an individual, the individual (not the corporation) is the beneficial owner of the income. Because this occurs most frequently with entertainers and athletes, treaties include provisions preventing a treaty exemption from tax by a corporation when the income accrues to another person unless:
“that other person establishes that neither the entertainer or sportsman nor persons related thereto participate directly or indirectly in the profits of that other person in any manner, including the receipt of deferred remuneration, bonuses, fee, dividends, partnership distributions, or other distributions.” See Article 16(2) of the treaty with the U.K.
The Treasury explanation for Article 16, Paragraph 2 of the 2006 U.S. Model Treaty points out that this occurs in situations in which the recipient of the services of the performer would contract with a person other than the performer (e.g., a company employing a performer) only if the recipient of the services was certain that the named performer would provide the services. However, if the employing corporation determines who will provide the services, then the corporation is likely a service company not formed to circumvent the maximum gross receipts amount specified by the Article. This explanation is incorporated into the text of newer treaties. See, for example, Article 16(2) of the treaty with Belgium.
A treaty claim by the corporation on Form W-8BEN which is acting as the agent for a named performer is invalid, in which case the income and taxes withheld are reported in the name of the performer.
Claims for Treaty Exemption
Claims for treaty exemption from withholding U.S.-source income paid to a business entity are requested on a Form W-8BEN with the tax treaty claim in Section II. In addition to a claim that the entity is a resident of the named treaty country (line 9a) and that the income is derived for treaty purposes by the entity submitting the form (line 9b), the entity must also meet the requirements of the Limitation on Benefits (LOB) Article of the treaty, if any (line 9c). The LOB Article is intended to prevent treaty-shopping by residents of third countries by ensuring, through objective criteria, that residents of the treaty country have a sufficient nexus to the treaty country to allow the entity an exemption from tax under that treaty. (The line 9c certification may simply be checked if there is no LOB Article in the treaty.)
The type of income and treaty article under which the claim for exemption is made must be recorded on line 10 along with the reduced rate of tax (particularly important since entities may submit Forms W-8BEN for other types of income). Claims of exemption from tax under the Business Profits Article on income that is effectively connected to the conduct of a U.S. trade or business (ECI) that is not attributable to a permanent establishment must state enough facts to support the claim. That may be merely a statement that the entity has no U.S. permanent establishment as defined by the treaty; or, if it has one, facts indicating why the income is not attributable to the permanent establishment.