Tax & Accounting Blog

Withholding on U.S. Business Income of Foreign Vendors – Part 5: U.S. Tax Return Requirement

ONESOURCE March 13, 2012

IRS provides the following alert at the top of Form W-8ECI:

Persons submitting this form must file an annual U.S. income tax return to report income claimed to be effectively connected with a U.S. trade or business (see instructions).

Under U.S. tax return rules, a tax return is required for Effectively Connected Income (ECI) even if the income is exempt from tax under an applicable income tax treaty provision. Foreign corporations use Form 1120-F (using the simplified procedure described in the instructions) and nonresident alien individuals use Form 1040NR with a Schedule C or C-EZ. Although U.S. tax law attributes a permanent establishment of a partnership to its owners, there is no guidance in either IRS Publication 901 U.S. Tax Treaties or the instructions for Form 1040NR on attributing a treaty claim of exemption from tax because a partner’s allocable partnership income (normally recorded on Schedule E) is not attributable to a PE under the Business Profits Article. This is especially the case when the Business Profits Article of the applicable treaty does not cover ECI of an individual.