U.S. sourcing rules vary with the type of income being paid, as do U.S. rules for a lower rate of or exemption from withholding. In addition, a payer must correctly record the income code on Form 1042-S so that the foreign vendor may submit a correct U.S. tax return, assuming one is required. Therefore, a payer must know the nature of the income in order to withhold and correctly report on income paid to foreign vendors.
IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, includes discussions about many common types of payments. It also includes on page 15 of the 2013 edition, the table Summary of Source Rules for FDAP Income including:
• Pay for personal services
• Royalties from natural resources
• Pension distributions and investment earnings
• Scholarships and fellowship grants
• Guarantees of indebtedness
The task of identifying income being paid is easy if the type of income named on an invoice is discussed in Publication 515 and the name used is the same as that used in Publication 515, but for some types of income the task is more difficult. For example, royalty income is discussed in Publication 515, but a royalty (which is a payment for the use of, or right to use, intangible personal property) might be called something else, such as a license fee, endorsement, or sponsorship.
Not all types of income are discussed in IRS Publication 515, however. For example, income from electronic commerce is not mentioned. Even though Treas. reg. section 1.861-18 is available to assist with identifying the type of income represented by software agreements, the task is particularly difficult for electronic commerce which has been evolving much faster than IRS guidance with the result that this regulation lacks examples for many forms of electronic commerce.
Visit Paula’s blog archive page to read her posts on payments to foreign individuals and entities, as well as the other posts in this series.
Thomson Reuters ONESOURCE Nonresident Alien Taxation has a number of webcasts to help organizations understand payments to foreign students, workers, and vendors. Visit our webcast page to view a complete schedule and register for a webcast.