When an income payment is one amount that covers more than one type of income, the payment must be reasonably allocated among all types of income covered by the payment. For example, a single payment to a foreign vendor for the purchase of equipment, which is not subject to 30 percent withholding, might include shipping and services for installation and training. Whether or not the shipping or services income is subject to withholding depends on relevant facts associated with the type of income. For example, where services are physically provided determines the source of compensation, U.S. or foreign. If a purchase of equipment is paid on an installment basis, the related interest is subject to 30 percent withholding.
When a reasonable allocation by type of income is not provided either on the invoice or by parties familiar with the terms of the contract, the full amount is subject to 30 percent withholding. The foreign vendor might have the opportunity to allocate the income on its U.S. tax return and obtain a refund of some of the withheld tax. However, the IRS has recently tightened the process for tax return refund claims (currently treaty related) not supported by a Form 1042-S by requesting that the taxpayer obtain supporting information from their payer before a refund will be issued. IRS could extend this process to other types of refund claims, especially in cases where the refund will be sent outside the United States.
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.