Preamble to Prop Reg REG-132881-17; Prop Reg §1.1441-1, Prop Reg §1.1441-6, Prop Reg §1.1461-1, Prop Reg §1.1461-2, Prop Reg §1.1471-1, Prop Reg §1.1471-2, Prop Reg 1.1471-3, Prop Reg §1.1471-4, Prop Reg §1.1471-5, Prop Reg §1.1473-1, Prop Reg §1.1474-1, Prop Reg 1.1474-2
IRS has issued proposed regs that would reduce or defer certain withholding, etc. requirements under the Foreign Account tax Compliance Act (FATCA) and Chapter 3 of the Code. The proposed regs would eliminate withholding on payments of certain gross proceeds, defer withholding on foreign passthru payments, eliminate withholding on certain insurance premiums, and clarify the definition of investment entity. The proposed regs also include guidance concerning certain due diligence requirements of withholding agents and guidance on refunds and credits of amounts withheld.
Background—FATCA and chapter 3. In general, nonresident aliens and foreign corporations are subject to a U.S. withholding tax on certain items of income that they receive from U.S. sources that are not effectively connected with a U.S. trade or business. The U.S. withholding tax is generally collected at the source by the withholding agent—generally, the last person in the U.S. who handles the item before it is remitted to the foreign taxpayer or the taxpayer’s foreign agent.
Under chapter 3 of Subtitle A to the Code, “Withholding of Tax on Nonresident Aliens and Foreign Corporations,” a withholding agent must withhold 30% of any payment that is subject to withholding and made to a foreign payee, unless it can reliably associate the payment with valid tax documentation. (See Code Sec. 1441 to Code Sec. 1446.)
Chapter 4 of the Code (Code Sec. 1471 through Code Sec. 1474, commonly referred to as FATCA) requires withholding agents to withhold 30% of certain payments to a foreign financial institution (FFI) unless the FFI has entered into a “FFI agreement” with IRS to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes withholding, documentation, and reporting requirements on withholding agents with respect to certain payments made to certain non-financial foreign entities (NFFEs).
In cases in which foreign law would prevent an FFI from complying with the terms of an FFI agreement, IRS has collaborated with other governments to develop two alternative intergovernmental agreement (IGA) models that facilitate FATCA implementation.
Background—Executive Orders 13777 and 13789. In 2017, President Trump issued Executive Orders 13777 and 13789, which require reviews by federal government agencies of existing regs with the idea of modifying or eliminating them in order to reduce unnecessary burdens.
Elimination of withholding with respect to certain sale gross proceeds. Under Code Sec. 1471(a) and Code Sec. 1472, withholdable payments made to certain FFIs and certain NFFEs are subject to withholding under chapter 4. Code Sec. 1473(1) states that, except as otherwise provided by IRS, the term “withholdable payment” means: (i) any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the U.S.; and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the U.S.
IRS notes that 87 jurisdictions have an IGA in force or in effect and 26 jurisdictions are treated as having an IGA in effect because they have an IGA signed or agreed in substance, which allows for international cooperation to facilitate FATCA implementation. IRS has therefore concluded that the current withholding requirements under chapter 4 on U.S. investments already serve as a significant incentive for FFIs investing in U.S. securities to avoid status as nonparticipating FFIs, and that withholding on gross proceeds is no longer necessary in light of the current compliance with FATCA.
Therefore, the proposed regs would eliminate withholding on gross proceeds by removing gross proceeds from the definition of the term “withholdable payment” in Reg. §1.1473-1(a)(1) and by removing certain other provisions in the chapter 4 regs that relate to withholding on gross proceeds.
Deferral of withholding on “foreign passthru payments. “An FFI that has an agreement described in Code Sec. 1471(b) in effect with IRS is required to withhold on any passthru payments made to its recalcitrant account holders and to FFIs that are not compliant with chapter 4 (nonparticipating FFIs). Code Sec. 1471(d)(7) defines a “passthru payment” as any withholdable payment or other payment to the extent attributable to a withholdable payment.
In Notice 2011-34, 2011-19 IRB 765, IRS set forth a proposed framework for participating FFIs to withhold on withholdable payments. However, Reg. §1.1471-4(b)(4) provides that such withholding will not begin until the later of Jan. 1, 2019 or the date of publication in the Federal Register of final regs defining the term “foreign passthru payment.”
In recognition of the successful engagement of IRS and partner jurisdictions to conclude IGAs to implement FATCA, the proposed regs would further extend the time for withholding on foreign passthru payments. Accordingly, under Prop Reg §1.1471-4(b)(4), a participating FFI would not be required to withhold tax on a foreign passthru payment made to a recalcitrant account holder or nonparticipating FFI before the date that is two years after the date of publication in the Federal Register of final regs defining the term “foreign passthru payment.”
Nevertheless, IRS continues to have concerns regarding account holders of participating FFIs that remain recalcitrant account holders or nonparticipating FFIs and regarding payments made to nonparticipating FFIs. Accordingly, IRS continues to consider the feasibility of a system for implementing withholding on foreign passthru payments.
Elimination of withholding on non-cash value insurance premiums under Chapter 4. Under Reg. §1.1473-1(a)(1), a withholdable payment generally includes any payment of U.S. source fixed or determinable annual or periodical (FDAP) income, subject to certain exclusions, such as for “excluded nonfinancial payments.” Excluded nonfinancial payments do not include premiums for insurance contracts.
The Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017) amended Code Sec. 1297(b)(2)(B) to provide a more limited exception to passive foreign investment company (PFIC) status by replacing the exception for corporations predominantly engaged in an insurance business with a more stringent test based generally on a comparison of the corporation’s insurance liabilities and its total assets.
In light of this change in law and in furtherance of the burden-reducing policies in Executive Orders 13777 and 13789, the proposed regs provide that premiums for insurance contracts that do not have cash value (as defined in Reg. §1.1471-5(b)(3)(vii)(B)) would be excluded nonfinancial payments and, therefore, not withholdable payments. (Prop Reg §1.1473-1(a)(4)(iii))
Clarification of definition of “investment entity. ” Under Reg. §1.1471-5(e)(4)(i)(B), an entity is an investment entity (and therefore a financial institution) if the entity’s gross income is primarily attributable to investing, reinvesting, or trading in financial assets and the entity is “managed by” another entity that is a depository institution, custodial institution, insurance company, or an investment entity described in Reg. §1.1471-5(e)(4)(i)(A).
A “discretionary mandate” is an investment product or solution offered by a financial institution to certain clients where the financial institution manages and invests the client’s funds directly (rather than the client investing in a separate entity) in accordance with the client’s investment goals.
The proposed regs clarify that an entity would not be “managed by” another entity for purposes of Reg. §1.1471-5(e)(4)(i)(B) solely because the first-mentioned entity invests all or a portion of its assets in such other entity, and such other entity is a mutual fund, an exchange traded fund, or a collective investment entity that is widely held and is subject to investor-protection reg. (Prop Reg §1.1471-4(e)(5)(i)(B)) In contrast, an investor in a discretionary mandate described above would be considered “managed by” the financial institution under Reg. §1.1471-5(e)(4)(i)(B). (Preamble to Prop Reg REG-132881-17)
Treaty statements provided with documentary evidence for chapter 3. Under chapter 3, a withholding agent must generally obtain either a withholding certificate or documentary evidence and a treaty statement in order to apply a reduced rate of withholding based on a payee’s claim for benefits under a tax treaty. Existing regs add a requirement that when a treaty statement is provided with documentary evidence by an entity beneficial owner to claim treaty benefits, the statement must identify the specific limitation on benefits (LOB) provision relied upon in the treaty. In addition, those regs added a 3-year validity period applicable to treaty statements provided with documentary evidence and a transition period that expires Jan. 1, 2019, for withholding agents to obtain new treaty statements that comply with the new LOB requirement for accounts that were documented with documentary evidence before Jan. 6, 2017 (preexisting accounts).
The proposed regs would make the following changes to the rules on treaty statements provided with documentary evidence. First, the proposed regs would extend the time for withholding agents to obtain treaty statements with the specific LOB provision identified for preexisting accounts until Jan. 1, 2020 (rather than Jan. 1, 2019). Second, the proposed regs would add exceptions to the 3-year validity period for treaty statements provided by tax-exempt organizations (other than tax-exempt pension trusts or pension funds), governments, and publicly traded corporations—entities whose qualification under an applicable treaty is unlikely to change. (Prop Reg § 1.1441-1(e)(4)(ii)(A)(2))
And, a withholding agent could rely on the taxpayer’s claim on a treaty statement regarding its reliance on a specific LOB provision absent actual knowledge that such claim is unreliable or incorrect. (Prop Reg §1.1441-6(c)(5)(i))
Permanent resident address subject to hold mail instruction for chapters 3 and 4. Existing regs allow an address to be treated as a permanent residence address despite being subject to a hold mail instruction when a person provides documentary evidence establishing residence in the country in which the person claims to be a resident for tax purposes. (Reg. §1.1441-1(c)(38))
The proposed regs provide that the documentary evidence required in order to treat an address that is provided subject to a hold mail instruction as a permanent residence address is documentary evidence that supports the person’s claim of foreign status or, for a person claiming treaty benefits, documentary evidence that supports the person’s residence in the country where the person claims treaty benefits. Regardless of whether the person claims treaty benefits, the documentary evidence on which a withholding agent may rely would be the documentary evidence described in Reg. §1.1471-3(c)(5)(i), without regard to the requirement that the documentation contain a permanent residence address. (Prop Reg §1.1441-1(c)(38); Prop Reg § 1.1471-1(b)(99))
Prop Reg §1.1471-1(b)(62) adds a definition of a hold mail instruction to clarify that a hold mail instruction would not include a request to receive all correspondence (including account statements) electronically.
Partnership withholding and reporting in a subsequent year. Under Reg. §1.1441-5(b)(2)(i)(A), a U.S. partnership is required to withhold on an amount subject to chapter 3 withholding (as defined in Reg. §1.1441-2(a)) that is includible in the gross income of a partner that is a foreign person. A U.S. partnership satisfies this requirement by withholding on distributions to the foreign partner that include an amount subject to chapter 3 withholding. To the extent a foreign partner’s distributive share of income subject to chapter 3 withholding is not actually distributed to the partner, the U.S. partnership must withhold on the partner’s distributive share of the income on the earlier of the date that the partnership K-1 is provided to the partner or the due date for furnishing the K-1. Under Code Sec. 6031(b), a partnership that files its return for a calendar year (calendar-year partnership) must generally furnish to each partner a Schedule K-1 on or before March 15 following the close of the tax year, a due date that may be extended up to six months. (Reg. §1.6031(b)-1T(b) and Reg. § 1.6081-2T(a))
Similar requirements apply in the chapter 3 and chapter 4 contexts.
Under Reg. §1.1461-1(c)(1) and Reg. §1.1461-1(c)(2), a partnership is required to report on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, any amount subject to withholding that is allocable to a foreign partner for a calendar year. The partnership must file Form 1042-S (and furnish a copy to the partner) by March 15 of the calendar year following the year in which it receives the amount subject to withholding. The due date for filing a Form 1042-S may be automatically extended by 30 days (and an additional 30 days at the discretion of IRS). (Reg. §1.6081-8T(a)) Amounts that are reportable on Forms 1042-S are also required to be reported on a withholding agent’s income tax return, Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. The due date for Form 1042 is March 15, which may be automatically extended for six months. (Reg. §1.6081-10) Similar reporting rules apply to a partnership that receives a withholdable payment and withholds under chapter 4. (Reg. §1.1474-1(c) and Reg. §1.1474-1(d)(1))
Because the extended due date for filing a Form 1042-S generally occurs before the extended due date for furnishing a Schedule K-1 to a foreign partner, a partnership may be required to report an amount subject to withholding on a Form 1042-S before it performs all of the withholding required on such amount under Reg. §1.1441-5(b)(2)(i)(A) or Reg. §1.1473-1(a)(5)(ii) and Reg. §1.1473-1(a)(5)(vi). To address this case, the Instructions for Form 1042 require a domestic partnership to report any withholding that occurs with respect to an amount that a partnership received but did not distribute to a partner in a calendar year (preceding year) on the partnership’s Form 1042 for the following calendar year (subsequent year) (referred to as the “lag method” of reporting). In this case, the partnership would deposit the amount in the subsequent year and designate the deposit as made for that year for reporting on Form 1042. To correspond to the timing of the reporting on Form 1042, the partnership must also report this withholding on Forms 1042-S filed and issued for the subsequent year.
To avoid a mismatch between the years in which a partner reports partnership income and the year in which he or she is credited with withholding, the proposed regs would generally require a withholding agent (including a partnership or trust) that withholds in a subsequent year to designate the deposit as attributable to the preceding year and report the amount on Forms 1042 and 1042-S for the preceding year. An exception to this requirement for a partnership that is not a calendar-year partnership (a fiscal-year partnership) provides that such partnership could designate a deposit as made for the subsequent year and report the amount on Forms 1042 and 1042-S for the subsequent year. (Prop Reg §1.1461-1(a)(1))
The proposed regs also provide a revised due date for a partnership to file and furnish Form 1042-S when it withholds the tax after March 15 of the subsequent year that it designates as deposited for the preceding year. Under this new rule, the due date for a partnership to file and furnish a Form 1042-S in such a case would be September 15 of the subsequent year. (Prop Reg §1.1461-1(c)(1)(i)(B))
IRS intends to amend the Instructions for the 2019 Form 1042 to remove the requirement that a partnership or trust apply the lag method and to incorporate the proposed regs. IRS also intends to amend the Instructions to the 2019 Form 1042-S to require that in a case when a partnership is filing Form 1042-S after March 15 for a partner’s distributive share of an amount received by the partnership in the preceding year, the partnership must file and issue a separate Form 1042-S for such amount for the preceding year (in addition to any Forms 1042-S filed and issued to the partner for amounts that are withheld when distributed to the partner before March 15 and reported for the preceding year). (Preamble to Prop Reg REG-132881-17)
Overwithholding under the reimbursement and set of procedures. Under Reg. §1.1461-2(a), a withholding agent that has overwithheld and deposited the tax may adjust the overwithheld amount under either the reimbursement procedure or the set-off procedure. If a withholding agent cannot apply the reimbursement or set-off procedure, a beneficial owner or payee must file a claim for credit or refund with IRS in order to recover the overwithheld tax.
The proposed regs would modify the reimbursement procedure to allow a withholding agent to use the extended due date for filing Forms 1042 and 1042-S to make a repayment and claim a credit. The proposed regs also include revisions that would conform the requirements for the set-off procedures to those that apply to the reimbursement procedures. (Prop Reg §1.1461-2(a)(2); Prop Reg §1.1461-2(a)(3)) In addition, the proposed regs would remove the requirement that a withholding agent include with its Form 1042 a statement that the filing constitutes a claim for credit when it applies reimbursement in the year following the year of the overwithholding. (Prop Reg §1.1461-2(a)(2)(i)(B)) This statement is no longer necessary because Form 1042 was revised in 2016 to provide separate fields for adjustments to overwithholding and underwithholding. (Preamble)
Reporting of withholding by non-qualified intermediaries. The proposed regs would modify the rules for reporting by a nonqualified intermediary under Reg. §1.1461-1(c)(4)(iv) and Reg. §1.1474-1(d)(2)(ii) to address a case in which a nonqualified intermediary receives a payment for which a withholding agent has withheld at the 30% rate under chapter 4 and reported the payment on Form 1042-S as made to an unknown recipient. In such a case, the proposed regs would permit a nonqualified intermediary that is a participating FFI or registered deemed-compliant FFI to report the withholding applied to the nonqualified intermediary on a Form 1042-S as chapter 3 withholding to the extent that the nonqualified intermediary determines that the payment is not an amount for which withholding is required under chapter 4 based on the payee’s chapter 4 status.
Under this modified requirement, the nonqualified intermediary would be permitted to substantiate the credit even though the Form 1042-S furnished to it reports chapter 4 withholding and the corresponding Forms 1042-S that the nonqualified intermediary issues reports chapter 3 withholding. This change should assist account holders using Form 1042-S to claim foreign tax credits in their jurisdictions of residence in these cases. (Prop Reg §1.1461-1(c)(4)(iv); Prop Reg § 1.1474-1(d)(2)(ii))
IRS believes that this determination should be limited to a nonqualified intermediary that is a participating FFI or registered deemed-compliant FFI given the role of these FFIs in documenting their account holders for chapter 4 purposes and their compliance requirements under the chapter 4 regs or an applicable IGA jurisdiction. (Preamble)
Reliance on the proposed regs. Taxpayers may rely on the proposed regs until final regs are issued, except as provided below.
With respect to the elimination of withholding on non-cash value insurance premiums under Prop Reg § 1.1473-1(a)(3)(iii), the clarification of the definition of a “managed by” investment entity under Prop Reg § 1.1471-5(e)(4)(i)(B), and the revised allowance for a permanent residence address subject to a hold mail instruction under Prop Reg § 1.1441-1(c)(38) and Prop Reg § 1.1471-1(b)(99), taxpayers may apply the modifications in the proposed regs to all open tax years until final regs are issued.
For the revisions included in the proposed regs that relate to credits and refunds of withheld tax, taxpayers may not rely on the proposed regs until Form 1042 and Form 1042-S are updated for the 2019 calendar year. (Preamble)
References: For Chapter 3 withholding on nonresident aliens, foreign corporations, and foreign partnerships in general, see Federal Tax Coordinator 2d ¶ O-11900; United States Tax Reporter ¶ 14,414. For reporting under FATCA, see Federal Tax Coordinator 2d ¶ O-13070 et seq.; United States Tax Reporter ¶ 14,714 et seq.