NAVIGATING THE TAX MAZE FOR PAYING FOREIGN VENDORS

Transcription

1 NAVIGATING THE TAX MAZE FOR PAYING FOREIGN VENDORS By Jerri LS Langer, JD, LLM Founding member of COKALA Tax Information Reporting Solutions, LLC A decade ago, many U.S. businesses might have said they rarely paid foreign vendors so the details of IRS Form W-8 and 1042-S tax requirements were not an important part of their Accounts Payable process. Today there would be significant risk for a U.S. business that did not build thorough W- 8 and 1042-S compliance into its processes for AP, Tax and Treasury operations. Even small companies today frequently contract with foreign businesses, borrow from foreign banks, pay royalties for foreignheld patents and copyrights, pay for electronic access to material or services furnished by a foreign company, and generally operate in a global marketplace. As a consumer, think about what you see when you are shopping in the local grocery store. How many of the products are from other countries? Fruit and vegetables come from Mexico, beef comes from Chile or Argentina, and paper towels are imported from China. Although grocery purchases are not withholdable, their diverse sourcing gives us perspective. In business, the vendor master file of your company probably mirrors a similar diversity. And just because the vendor has a U.S. address, or instructs you to pay a U.S. address or a U.S. bank, or even has a U.S. tax identification number, does not mean that 30% withholding is not required or that 1042-S reporting is not needed if you are paying income subject to these requirements. Because business today is global, AP needs to be well acquainted with the new tax regulations that start with how to use one of the new W-8 and W-9 forms to determine whether your payee holds U.S. or foreign status. These forms have been recently redesigned to add the requirements under new Chapter 4 of the Internal Revenue Code (the FATCA provisions under the Foreign Account Tax Compliance Act) and to address universal rules now found in the harmonization regulations written to conform the older Chapter 3 requirements to the new FATCA ones. The new forms are designed to sort payees into the proper withholding regimes and where a valid form is not provided, new presumption standards will apply to determine U.S. or foreign status and the withholding required. ALERT: Take care when you read the new tax regulations and IRS form instructions. The IRS has confused us a bit in the instructions to the new forms and in new IRS Publication 515, by using a new terminology and changing the meanings of old terminology, making it a challenge for even the most experienced tax reporting specialists to glean accountabilities. For example, generalizing in favor of FATCA, when the IRS now speaks of a withholdable payment without modifiers, they mean only a FATCA withholdable payment. When giving instructions for Chapter 3 withholding, the type of withholding mostly addressed by AP, the instructions will say payment subject to chapter 3 withholding. To learn the new terminology, a good place to start is to read the section on definitions found at the beginning of each set of IRS instructions to the forms discussed in this paper. 1

2 The steps you need to take under the new rules include: First, distinguish the types of withholdable income you might be paying. Second, make a clear determination as to the beneficial owner of the income you are paying. Third, make sure you are soliciting the proper form from your vendor. Fourth, keep up with required due diligence for the duration of the vendor relationship and timely cure any conflicts. Fifth, apply the presumption standards for status if no W-8 or W-9 is on file before payment. Each of these steps is discussed below and the final segment of this paper covers important tips in handling W-8s in an AP environment. First, distinguish the types of withholdable income you might be paying In order to understand the uses and applications of the new forms, it is necessary to learn to identify the payments that are affected by them. The right withholding treatment first depends on the type of payment you are making and then depends upon which, if any, form you might have received from your vendor. There are now three sets of payments under three very different withholding regimes to be cognizant of when paying a foreign vendor. 1. Chapter 3 withholdable income under the traditional withholding rules, generally known as NRA withholding or 1042 withholding, but that we will address as Chapter 3 withholdable income, following new IRS terminology; 2. Income that is withholdable under the Foreign Account Tax Compliance Act (FATCA) found in Chapter 4 of the Internal Revenue code, which is a new subset of the Chapter 3 payment categories. We will address Chapter 4 income as FATCA withholdable income ; and 3. Income subject to the backup withholding and 1099 reporting requirements. Do not lose sight of these, because backup withholding and 1099 reporting could attach to some payments if an uncertified payee is presumed to be a U.S. person. Even payments for services performed or use of property located outside the United States could be subject to backup withholding and 1099 reporting under the right circumstances. In this paper, when we speak of withholding without any modifiers, the rules can be considered to apply across the board. Where we are specific as to the type of withholdable payment, the rules we are discussing are focused on just that type of payment. Chapter 3 Withholdable Income For the most part, AP makes withholdable payments under the older Chapter 3 requirements generally known as the NRA withholding or 1042 withholding rules. This is a much broader category of income than the limited subset of FATCA withholdable payments. A simple starting place for AP is to build upon the knowledge of income subject to 1099-MISC reporting when paid to a U.S. person. Chapter 3 withholdable income is similar to payments reportable on the 1099-MISC form, but MISC reportable income does not cover every type of Chapter 3 withholdable payments. For example, interest and dividend income are withholdable under Chapter 3, but if paid to a U.S. reportable person, are reported on other 1099s. Payments for telecommunication, transportation and shipping services are expressly exempt from 1099 reporting, but could be subject to Chapter 3 withholding and reporting requirements if considered U.S. source income. Insurance premiums are generally not subject to 1099 reporting, but are considered FATCA withholdable income and if an excise tax has not been paid on the premium, even if the foreign insurer is exempt from FATCA, the premiums would be subject to Chapter 3 withholding and reporting. Like payments reportable on the 1099-MISC, to be withholdable under Chapter 3 the payment needs to be fixed or determinable annual or periodic income and it must be 2

3 taxable to the recipient. Also, like the rules for 1099-MISC reporting, Chapter 3 rules provide that amounts paid for purchases are not subject to Chapter 3 withholding or reporting. U.S. Sourcing Unlike 1099 reportable payments, Chapter 3 withholdable payments must be derived from U.S. sources. U.S. persons (both individuals and entities) are subject to U.S. tax on worldwide income. This rule means that you may have worldwide Form 1099 reporting obligations on payments. For example, payments for services performed outside the U.S. by a U.S. person are still subject to the Form 1099 reporting and withholding rules. Income sourcing is not necessary for payments to U.S. persons because of U.S. worldwide income taxation, but income sourcing is crucial for payments made to foreign persons (individuals or entities) because for them only U.S. source income is subject to U.S. taxation including withholding of tax, and Form 1042-S reporting. Under U.S. tax regulations, all income paid by a withholding agent is considered to be from U.S. sources unless proven otherwise. While the W-8 forms are used, in large part, to document WHO your payee is (non-u.s. status), there is no IRS form for documenting the source of income. Withholding agents carry the responsibility of sourcing the income they pay and should use the evidence underlying the transaction, such as an invoice, purchase order, contract, etc., to document the source of income as non-u.s. or U.S. An express statement in the contract or purchase order, and in invoices later received, that the income is not derived from any U.S. services or from property located or used in the U.S. will be critical in meeting this burden of proof of non-u.s. source. The sourcing rules can be a challenge since they vary by type of income being paid. Service income is sourced based on where the services are performed. For individuals, look to where the individuals are located when they perform the services to source compensation. If that is in the U.S., the service fees will be U.S. sourced and subject to withholding. Where services are both within and without the U.S., apportionment based on hard evidence is required. But for entities, sourcing is harder. Concepts of where business profits are derived may start with where the services are performed by the entity s employees, but where an entity s agents and subcontractors are performing services can also affect the outcome. If you have a contract for services from a foreign vendor and that vendor hires a U.S. agent or subcontractor to perform those services, the related payments will be U.S. sourced payments to the foreign vendor or at least a portion will be, even if the foreign vendor asks you to directly pay the U.S. service provider or another U. S. entity. In contracts, billing and invoices, careful segregation of services performed inside the U.S. is needed to support foreign sourcing of other services. If there will be a U.S. service company, it is wise to contract directly with the intended U.S. service company rather than through its foreign parent, foreign affiliate or other foreign vendor. If the foreign vendor says it is merely an agent of the actual service provider, your contract needs to say that and a W-8IMY will be needed along with all of its accompanying documentation, allocation statements and complex 1042-S filing needs. (See below.) Even the variant amounts of compensation paid in different regions for contacted services can affect the balance of sourcing the fees. Rental income is sourced based on where the item is located. Royalties from patents and copyrights are sourced based upon where the property is used, but natural resource royalties are sourced based on where the property is located. Interest is sourced based on the residence of the payer and dividends are sourced in the U.S. if paid by a U.S. corporation (but, on rare occasion a foreign corporation can pay U.S. source dividends and interest if paid from U.S. profits or operations). These are just a few of the many sourcing rules that could come into play. If you cannot determine the source of income, regulations require that you treat all of the payment as U.S. sourced 3

4 and withholdable. Step one in this process is to learn what you are paying, whether it is considered U.S. sourced and distinguish FATCA withholdable income from other withholdable income. No exceptions for de minimis dollar amounts or for corporations or for intercompany payments For purposes of Chapter 3 and FATCA withholding, there is no exemption for corporations and there is no de minimis dollar threshold. (Also, unlike with the 1099s, there are extremely limited government and not-for-profit exemptions that will require a properly completed Form W-8-EXP to be on file.) Withholding attaches to the first dollar paid unless you have an exemption certified on the right W-8 form. Intercompany payments are not be exempted just because they are made in an intercompany context. We sometimes hear from those responsible for the company s tax returns that Forms 1042-S are not important filings on intercompany payments. However, in the eyes of the U.S. Treasury and the IRS, the withholding and 1042-S reporting rules must be complied with because they serve different purposes than the reporting regimes under I.R.C and 6038A which underlie IRS Forms 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, and 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, the forms filed in the context of corporate returns. Even under Chapter 3, 30% withholding will apply to intercompany payments unless a treaty would exempt the payment, and benefit of the treaty is available only if a W-8BEN with a U.S. EIN or foreign tax identification number has been provided by the affiliate. A lot of caution is warranted when making payments to affiliates since many times the U.S. entity gives payments a different tax classification than the billing reflects. Often, the only FATCA withholdable payments AP makes are those to their affiliates since FATCA withholdable payments are for the most part financial or financial service payments. ALERT: Your tax department should have a say in this process. Healthy tax positions in a company s tax return require parity between how the expense in treated for deduction purposes and how it is classified for withholding purposes. The required 1042-S report needs to be aligned with the deduction in the company s return. Classifying income should be a team effort in your company. FATCA Withholdable Income Though many ordinary course of business payments are not FATCA income, on occasion AP does make FATCA withholdable payments, usually upon instruction from the company s treasurer. An important task for AP is to learn when you are making FATCA withholdable payments so that you know when the FATCA sections of the W-8 forms are required to be completed and whether FATCA 1042-S reporting and possibly 30% withholding is required. FATCA withholdable income, like income withholdable under Chapter 3, is fixed or determinable annual or periodic income that is both taxable and from U.S. sources. So you start with Chapter 3 withholdable income in defining FATCA withholdable income, but there are many exceptions, making FATCA withholdable income a small subset of the Chapter 3 withholdable income. Income that is considered effectively connected income (see the discussion on Form W-8ECI below) and nonfinancial ordinary course of business payments are exempt from FATCA withholding. The ordinary course of business exclusion covers payments for: services (including wages and other forms of employee compensation such as stock options), the use of property, office and equipment leases, software licenses, transportation, freight, gambling winnings, awards, prizes, scholarships, and interest on outstanding accounts payable arising from the acquisition of goods or services. For purposes of the interest exemption, note that the term goods is extremely limiting as it 4

5 may not include manufacturing inventory, commodities, intangibles (such as patents, software, copyrights and intellectual knowledge property) and many other items where interest is paid on purchases in a business context. Such interest outside the goods or services limitation may now be subject to FATCA compliance. For AP, some FATCA withholdable income to look out for includes: insurance premiums paid to offshore insurers to insure any form of U.S risk; interest from U.S. companies paid to foreign lenders as well as other fees associated with lending arrangements like guarantees on loans and service fees; all financial service payments to foreign entities; payments on certain notional principal contracts, swaps, derivatives and other structured financial products; dividends on stock; just to name a few. Unlike Chapter 3 withholdable income, FATCA withholdable income will be expanded in 2017 to include gross proceeds from the sale or other disposition of any property if of a type which can produce U.S. source interest or dividends. Gross proceeds from the sale or other disposition of any property that can produce excluded income is also excluded. So if you pay proceeds to dispose of a loan used to finance the acquisition of goods or services where related interest is exempt from FATCA, the proceeds from disposition of the loan will be exempt from FATCA withholding and reporting. But, starting in 2017, gross proceeds from the disposition of debt from the purchase of property other than goods or services where interest payments would be subject to FATCA withholding, such as in a general loan from a foreign bank, even if in a business context, may remain subject to FATCA compliance where the related interest is subject to FATCA. It is important to know when you are making FATCA withholdable payments for W-9 purposes as well. The rules for requiring a Form W-9 have changed and a W-9 is now necessary from all new relationships with U.S. corporations or U.S. financial institutions (even those with U.S. addresses) if you are paying FATCA withholdable income, to avoid foreign characterization of the vendor and 30% FATCA withholding on the payments. Initially, the regulations would have required a W-9 on all reportable payments to U.S. corporations and financial institutions in order to maintain U.S. status, but the amended version of the regulations carved the application back to just FATCA withholdable payments and limited its application to new relationships on and after July 1, Chapter 3 statutory withholding exemptions and treaty benefit claims do not apply for FATCA purposes. An exclusion from an amount subject to withholding for Chapter 3 purposes, such as the exemptions for bank deposit interest or the portfolio interest exemption under Reg (a) or other exclusion from taxation under IRC 871 or 881, does not apply for purposes of determining whether such income constitutes a FATCA withholdable payment. If no FATCA withholding, Chapter 3 withholding may still apply. Under the stacking rules found in the FATCA provisions, you start with determining if FATCA applies to the payments you are making. If the payment is exempt from FATCA withholdable income, or if the payment is FATCA withholdable but the payee is exempt based on the FATCA status declared on the correct W-8 form, you move to the Chapter 3 requirements to determine if withholding is required. Form 1042-S reporting under FATCA may be required even if exemption is warranted. So be sure to check the IRS instructions for the 1042-S form for the year of payment. It is important to remember that even if there is a documented payee exemption from FATCA withholding, withholding may still be required under the more general Chapter 3 regulations. FATCA withholdable income is a mere subset of the larger pool of income subject to Chapter 3 withholding. So, where there is an exception from FATCA, you still need to consider 30% withholding on the payment under the Chapter 3 rules. 5

6 Second, make a clear determination as to your beneficial owner One of your primary tasks as a withholding agent is to know your vendor. For U.S. tax law purposes, the beneficial owner is defined as the owner of income; that is, the person actually required to include the payment in gross income reported in the U.S. tax return if a return were due. This is the individual or entity from whom you are to obtain documentation and upon whom you are to 1042-S or 1099 report and withhold tax when required. By obtaining a W-8BEN-E or W-8BEN (Individual) from your vendor, you are obtaining their representation that they are the beneficial owner of the income. Note the first bullet in the certification section of both forms includes a representation on beneficial owner status. It is important that the contract and invoices do not contain any different indication of the beneficial owner. This is where your legal counsel comes in. If you have mixed signals in the documentation you have received, seek help from your counsel to resolve the conflicts. AP representatives can have difficulties in determining who their beneficial owners are. Contracts are with one party, invoices come from other parties, instructions are received to pay a different party, and when wire instructions come, sometimes another party is introduced. And, when vendor information in your business files conflicts with the submitted tax form, AP loses the anchor that ties the benefits in that form to that vendor. The vendor is then treated as undocumented until the conflict is cured. In tax lingo, these tasks are referred to as due diligence or knowing your payee and the requirements are covered in the next section of this paper. The IRS sometimes refers to these requirements as the KYC rules for know your customer, taken from the financial institution regulatory terminology used in the anti-money laundering (AML) requirements. An example of this would be when a person you know is acting as an agent for a beneficial owner, submits the W-8BEN-E under its own name. You know the withholding and reporting relates to the beneficial owner and not the agent. IRS auditors are trained to perform this type of evaluation in their field audits and for each payee selected for review, that payee s certification is looked at and sometimes compared to your contract and other business records. When agents pursue this course, they can build cases that documents on file are not valid, or second guess your determination as to the type of income being paid to whom, and as to its sourcing. Tax rules attach to the beneficial owner of the income, not their agent or representative, or their designated payee. Third, make sure you are making the proper form solicitation from your vendor A central focus of the new rules is the making of a timely solicitation of the right certifications on Form W-9, if a U.S. vendor, or on one of the W-8 forms, if a foreign vendor, prior to payment. Partial checklists for reviewing certifications are included in the IRS Instructions for the Requester of Forms W 8BEN, W 8BEN E, W 8ECI, W 8EXP, and W 8IMY (Rev. July 2014) found on the IRS website, and some are covered in the discussion below. Five of the six IRS forms in the W-8 series are important to AP (Form W-8BEN, -BEN-E, -ECI, -IMY, and -EXP; the Form W-8CE, for covered expatriate, is beyond the scope of this paper). If you include the W-9 and 8233 forms, AP has seven payee forms to become acquainted with in order to cope with the multifaceted new compliance requirements spelled out in the complex new regulations now in effect. Determining the right form depends on: The nature of the payment; 6

7 Whether an exception to withholding is claimed, such as a tax treaty or effectively connected income claim (both requiring special W-8 documentation); The status of the person as a: Non-U.S. resident alien (NRA) (Use W-8BEN for individuals unless a treaty claim is being made for compensation for their personal services in the U.S. where Form 8233 is mandated.) ALERT: Form 8233 requires special processing. Unlike with the Forms W-8 or the Form W-9, the withholding agent is required to review the information and sign the Form 8233 under penalties of perjury to certify that the withholding agent believes the information to be correct. This form must then be sent to the IRS for verification within five days of the withholding agent s acceptance of it. The IRS has ten days within which to respond. If no response is received within the ten-day period, the withholding agent can presume the treaty claim made on the form is valid and release the payment without withholding tax from it. Foreign entity (W-8BEN-E) Foreign fiscally transparent entity (W-8IMY) Foreign intermediary (agent) (W-8IMY) Foreign government, foreign tax-exempt organization (Form W-8EXP) (Exemptions claimed on this form are very limited when compared to the broad 1099 exceptions for tax-exempt organizations.) U.S. person no matter where the address is located (Form W-9). Resident aliens also use Form W-9 and may provide an ITIN on the W-9 and still have the form considered valid for tax purposes although this may raise other compliance flags in your organization that should be explored; for example, are they authorized to work in the U.S. The sixth form in the W-8 series is Form W-8CE, Notice of Expatriation and Waiver of Treaty Benefits. Although in the W-8 series, it has little use in an AP relationship and is only used by covered expatriate individuals to notify a payer or trustee of a non-grantor trust that they are subject to special tax rules on deferred compensation and other matters. If the payment is Chapter 3 withholdable income, a treaty or other exemption may be claimed but must be supported by provision of the right tax form correctly filled out and provided prior to payment to avoid 30% withholding. Actual knowledge absent the right certification form will not suffice to eliminate the withholding burden. For the present, there is no grace period or deferral of withholding allowed for the kind of payments AP makes once it is time to make the payment. Withholding is required unless the form is obtained and it makes a valid claim for reducing or eliminating the withholding. For those who later discover that they have failed to acquire the right form and failed to withhold correctly, regulations support retroactive application to cover the payment if the right form is obtained within 30 days of the first payment. After 30 days, a complex curing process is permitted by regulations which entails obtaining an affidavit of retroactive application and, if a year has passed, also some form of documentary evidence. FORMS in the W-8 series Each of these forms and related instructions can be found on the IRS website at For individual nonresident aliens (NRAs) on-boarded after September 3, 2014, Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals) must be provided to claim foreign status for exemption from worldwide 1099 reporting and backup withholding, and where applicable to claim tax treaty benefits on U.S. source income, 7

8 except for compensation paid for an individual s personal services where Form 8233 is required for treaty claims. On the new W-8BEN form, the NRA agrees to update the form if there are any changes to his or her status. There is also a new line that requires the NRA to print their name. If the printed name is missing, the IRS considers that to be an inconsequential error only if you have government-issued documentary evidence of the NRA s foreign status such as a foreign passport or foreign driver s license. To be valid, the form also requires an unabbreviated country of citizenship. If abbreviated, you will need documentary evidence to support the country. If the NRA is not the signer of the form, the signer will need to enter the capacity in which he or she is acting and possibly provide a copy of IRS Form 2848 (tax power of attorney) to support their status. For payments on and after March 6, 2014, a foreign TIN may be used on W-8BEN instead of a U.S. TIN to support a treaty claim. [Reg T(c)(1)] For most income paid by AP, either a U.S. or foreign TIN is required for an effective treaty claim. Remember, if personal services are involved, the Form 8233 must be used to claim treaty benefits and not the Form W-8BEN. Beginning in 2015, entities that are not fiscally transparent, which usually means that the entity (not its owners) is directly taxed by its country of tax residence, must provide the new Form W-8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities), which has been expanded to eight pages to accommodate the FATCA certification requirements. Fiscally transparent entities, such as partnerships, certain private limited liability companies, and simple or grantor trusts generally provide Form W-8IMY instead of Form W-8BEN-E. Critical points in reviewing a submitted W-8BEN-E: Line 2: requires submission of the country where the entity was incorporated or organized. It must be fully written out and not abbreviated. If omitted, the form is considered invalid. If abbreviated, then as for the W-8BEN for individuals, you will need government-issued documentary evidence on file supporting the place of formation of the entity. Line 3: is used only if paying FATCA withholdable income. The IRS has provided some limited instructions for designing a substitute form for use when payments are not FATCA withholdable. Eliminating the FATCA parts from the W-8BEN-E will greatly simplify the form for foreign vendors to whom you are not making FATCA withholdable payments. Line 4: requires an indication of the vendor s type of Chapter 3 status (check one box only). The W-8BEN-E is considered invalid if a box is not checked. Caution is warranted if the box for partnership or disregarded entity is checked and there is no treaty claim included in Part III, because a W-8BEN-E may not be the correct form for a foreign partnership unless it is a hybrid entity taxed at the entity level in its resident country. Hybrids may claim treaty benefits at the entity level. But for the most part, small private partnerships or limited liability companies will be fiscally transparent and may not claim treaty benefits at the entity level so they must submit the W-8IMY instead of a W-8BEN-E. (See below.) Usually the owner of a disregarded entity, and not the entity itself, is required to submit a W-8 if foreign or possibly a W-9 if a U.S. person. AP should know to set up the disregarded entity s owner as the tax payee for withholding and reporting purposes. ALERT: Although the IRS has not pointed this out as part of compliance surveillance, it is important to note that indicators of per se foreign corporate status (PLC, Ag, SA, etc.) are listed by country in Reg Where the entity s name on the form indicates one of the types listed in the regulation, it will be treated as a corporation for U.S. tax purposes unless the entity is acting as an intermediary or agent for another. As a corporation, the entity would not be considered fiscally transparent and submission of the W-8BEN-E would be proper. Examples 8

9 of organizations listed include: Societas Europaea (SE), British Public Limited Company (PLC), French Societes Anonyme (SA), German Aktiengesellschaft (AG), and Spanish Sociedad Anonima (SA). There are clarifications in this regulation for certain companies formed in Canada (a Nova Scotia ULC is not treated as a corporation for U.S. tax purposes), Cyprus, Hong Kong, India, Jamaica, Malaysia (a Sendirian Berhad is not respected as a corporation) and Mexico, and for companies with multiple charters. Under the tax rules, as a payer AP is considered to have public knowledge of the required tax treatment of different entity types and to know, to a certain degree, what type of entity the payee is. All of the Forms W-8, except the W-8IMY, require the form to be completed only by beneficial owners of the income. The form actually requires the payee (even an individual) to tell you their entity type. Under the form revisions covering FATCA requirements, entities will also need to tell you their FATCA payee type if you are paying FATCA withholdable income and in this regard, there are more than 20 different new categories. When you receive the form from the payee, you are expected to make sure the statuses are indicated on the form when required and are reasonable based on what you know about the payee. You really have to look at each form and make a clear call on whether you can honor the form or have reason to doubt the validity of the form. Whether you are considered to have reason to know that a company may be fiscally transparent, rendering a submitted W-8BEN-E invalid when provided by a company of a type not listed in the regulation, is still perplexing to many payers. Note that the IRS list is not a complete listing of all entities that could be considered beneficial owners for these purposes. It is hoped that the IRS will at some point provide better instructions on a payer s responsibilities. Payers are expected to understand the terms of tax treaties and definitions of covered residents within the treaties. However, accomplishing a refined understanding on a particular entity can be arduous. You can respect the form unless you have reason to know the claims on it might not be valid. Make sure the capacity to sign box is checked. Form W-8ECI, Certificate of Foreign Person s Claim That Income Is Effectively Connected with the Conduct of a Trade or Business in the United States, is used by foreign persons to claim no withholding on income that is effectively connected with the conduct of a trade or business in the United States ( ECI ). Form W-8ECI cannot be used to claim the ECI exemption on compensation for personal services (instead, use Form 8233) or on income subject to withholding under I.R.C (dispositions of U.S. real property interests). The W-8ECI must list in specifics all the income that you pay covered by the ECI claim and include the vendor s U.S. EIN to be valid. For the most part, ECI is non-passive income from the conduct of a trade or business in the U.S., but ECI can include passive income like royalties if trade or business related. Examples of ECI include income from such activities as construction, transportation, engineering, consulting, and retail store ownership. Factors to be considered in determining whether income is effectively connected with a U.S. trade or business include whether: the income is from assets used in, or held for use in, the conduct of that trade or business, or the activities of that trade or business were a material factor in the realization of the income. Real property rentals are usually considered passive income. However, a foreign person who receives real property rentals can elect ECI treatment by two means: through a tax treaty by providing a Form W-8BEN (individuals) or W-8BEN-E (entities), and through the Internal Revenue Code provisions by submitting a Form W-8ECI. 9

10 Form W-8EXP, Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding, is used by payees to claim a reduced rate of, or exemption from, 30% Chapter 3 withholding as a foreign government, international organization, foreign central bank of issue, foreign tax-exempt organization, foreign private foundation, or government of a U.S. possession. This form is one of the most complex of the W-8 series, must have additional documentation attached (see the form instructions) and should always be reviewed by counsel before honoring any claim of exemption. Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding, is used to establish that the payee is not the beneficial owner of the income, but instead is a partnership or trust that is fiscally transparent or a nonqualified intermediary or agent (NQI) that is not acting for its own account. Form W-8IMY from these entities is used to transmit withholding certificates (W-8 series orw-9) from the beneficial owners and a withholding statement that shows the applicable apportioned amounts of the payments and other information for each beneficial owner that will allow the withholding agent to correctly withhold and information report the payments to the beneficial owners. In the last few years, this form is more frequently being provided to AP in support of service contracts with foreign entities. It is critical that AP be cognizant of responsibilities in receipt of this form as it may require withholding and 1042-S reporting of beneficial owners other than the party paid. You withhold based on the owner s position represented in the attached W-8 or W-9 and you information report to that owner and the IRS on the 1099 or 1042-S form as required. As pointed out above, payees need to be beneficial owners of the income you pay in order to be able to endorse the W-8 BEN, W-8BEN-E, ECI, EXP, and the The beneficial owner who endorses the W-8 can be a person other than the person you actually pay. But if you pay an agent, nonqualified intermediary, partnership, simple or grantor trust, or a disregarded entity, such payees are usually not considered beneficial owners and will need to submit a W-8IMY instead of one of the other forms in the W-8 series. For payments to individuals, determining who the beneficial owner is can be a much easier task than in the case of entities, since an AP professional usually knows who is actually performing services or who created a copyright. You also usually know if you are paying an agent or intermediary and not the actual individual who has the right to the income. There are actually two definitions of beneficial owner. When addressing U.S. tax issues such as who should sign the W-8 to avoid backup withholding and 1099 reporting, you look to U.S. tax law to make the determination and the beneficial owner is the person required to report on and pay taxes on the income in their U.S. tax return. In the context of certifications of tax treaty benefits, the tax laws of the foreign country of residence control the determination and resolution usually turns on whether the entity or its owners pay the taxes on the income the entity earns. If you collect money for someone else, you are never a beneficial owner, but instead an intermediary or agent. A W-8IMY is also used by Qualified Intermediaries (QIs), qualified withholding partnerships (WPs), and qualified withholding trusts (QTs) that have entered into agreements with the IRS to withhold and report on the beneficial owners. These payee types are rare in AP. Fourth, keep up with required due diligence for the duration of the vendor relationship and timely cure the conflicts The 2014 harmonization regulations established a new order of accountability for AP when setting up, processing and paying vendors -- not just foreign vendors, but all vendors that receive taxable, reportable payments. Once certifications are on file, AP will need to continuously monitor the business relationship for certain elements that are red flags alerting to the possibility 10

11 that certifications on the form may not still be valid. Surveillance is required on all account documentation and other business records for the red flags that give reason to void a provided certification. Under the new regulations, you generally ignore a U.S. intermediary (an agent) if you know the payee is acting for a foreign person. Instead, you treat the payment as being made directly to the foreign beneficial owner, soliciting the proper W-8 form from the owner, withholding under Chapter 3 or possibly under FATCA if required and reporting the payment on Form 1042-S. There is an exception to this look- through rule if the agent is a U.S. financial institution (or U.S. insurance broker if paying a premium) and you have no reason to know that the institution will not comply with its withholding responsibilities. This exception will not apply if you are merely asked to make a payment to the payee s account in a U.S. bank. IRS corrections to the final harmonization regulations on July 1, 2014, added new instructions on due diligence and use of red flag reasons to doubt certification validity, including for accounts on-boarded after A withholding agent will have reason to know that a chapter 3 claim is unreliable or incorrect if any information contained in its account opening files or other files pertaining to the account information conflicts with the account holder's claim. Red Flags that Challenge U.S. or Foreign Status Regulations require looking for the following red flags on an ongoing basis from the beginning of the payee relationship forward to the very last payment you make, and sometimes beyond that point if filings are still to be made. You are to catch any changes whenever they occur in account information that would raise any of the listed red flags. The following red flags must be identified on any submitted W-8 form or whenever conflicts arise between information on the submitted form and information in your business files. Red flags in this listing require curing with additional documentation and often also require certified written statements before you may continue to honor the claim on the W-8 form (see the discussion of curing below). Although the regulations make reacquiring certifications on a new W-8 form optional, getting new W-8 forms as part of the curing process is the best strategy to apply. A form becomes invalid from the date that a change in circumstances affecting the correctness of the certificate or documentation is discovered. A change of address is not a change in circumstances with respect to a claim of foreign status if the change is to another address outside the U.S., but is a change in circumstances if the change is to an address in the U.S. Red flags that will give reason to consider a W-8 claim of foreign status unreliable include: A current U.S. permanent or mailing address exists on the W-8 certification or in your records even if the U.S. address becomes known after the account is opened and the W-8 has been received. In-care-of or hold mail addresses are not permanent addresses. Missing a permanent address in a foreign country is a fatal flaw to relying on any W-8 form. The payee is classified as a U.S. person in any of your business files. You have a U.S. telephone number on file anywhere if it is the only phone number you have and you have no other phone number outside of the U.S. There is a known U.S. place of birth of an individual payee that is an unambiguous indication of the U.S. as place of birth, such as seen on a reviewed passport. 11

12 Incomplete forms that are missing signatures, dates, permanent foreign address, incomplete treaty claims. These are all fatal flaws in forms. Although the IRS does not considered an expired form a red flag, expiration dates need to be monitored. A Form W-8 will generally remain valid until the earlier of the last day of the third calendar year following the year in which the withholding certificate is signed or the day that a change in circumstances occurs that makes any information on the certificate incorrect. W-8 forms with U.S. TINs are no longer considered valid indefinitely even if you file a 1042-S each year. New rules apply indefinite validity periods for individuals if you also have government issued documentary evidence of foreign status on file, such as a copy of a passport, as long as there is no current U.S. residence or mailing address or other U.S. indicia in your files or on the W-8 forms; but, if a treaty claim is involved, the form will expire for treaty purposes. Red Flags that Challenge Treaty Status All of the above red flags apply and in addition, the following red flags, require curing before you may continue to honor the treaty claim on the W-8. The vendor s permanent residence address is not in the treaty country. As a withholding agent, you are notified of a new permanent residence address that is not in the treaty country. The vendor s mailing address is not in the treaty country or you have a mailing address that is not in the treaty country as part of your business information. The vendor has given you standing instructions to pay amounts to an address outside, or an account maintained outside, the treaty country. Critical parts of the treaty claim are missing in the treaty sections of Form W-8BEN (Individual) or W- 8BEN-E (entity), such as a missing TIN (U.S. or foreign) where one is required for the type of treaty claim. For an entity s claim, this includes completion of lines 14a, 14b and where required details in line 15 of the W-8BEN-E. For an individual s claim, it includes line 9 and details in line 10 where required for the type of treaty claim There is a long list of red flags related to FATCA claims. Almost every FATCA status has other unique red flags that could cause challenge to the FATCA status and are required items to look for. Specific requirements also attach to documentary evidence when required as part of the status claim and this covers a very broad range of information. However, GIINs (Global Intermediary Identification Numbers, assigned by the IRS) pose numerous red flag concerns worth raising in this paper since every traditional foreign bank or brokerage firm will be assigned a GIIN and most AP payments of FATCA withholdable income, apart from insurance premiums, will be made to either a foreign bank or brokerage firm. A critical red flag for these entities is a missing GIIN, or where you fail to match the GIIN with the entity on the IRS website within 90 days of receipt of the GIIN. New categories for non-financial foreign entities (NFFEs) will also be issued GIINs and require matching within 90 days. Direct Reporting and Sponsored Passive NFFEs will be given GIINs and will report their U.S. owners directly to the IRS. Matching on the IRS website is now mandated for GIINs, and FATCA withholding may be required for new payment relationships if the GIIN is not validated on the IRS GIIN website by the 91st day. Once matched, you are still not done. You will need to check to see if the GIIN is later removed from the IRS list and you will be deemed to know one year from date the IRS removes the entity from its listing. 12

13 Curing Red Flags and Missing Documentation The new regulations also provide terms for the curing of missing or deficient certifications, with retroactive effect allowed if a valid certification is received within the first 30 days from the date of first payment. Affidavits are required to supplement the certification if received after 30 days and government-issued documentary evidence is required along with the affidavit if the certification is received a year or more after the first date of payment. New regulations allow inconsequential errors (those defined as inconsequential in regulations) on forms if you have evidence in your files to cure the error, e.g., a copy of a government-issued ID that clarifies country of residence for the form fault of abbreviating the country on the W-8, or an individual s failure to print out their name on the W-8BEN (Individuals). But, the regulations make clear that missing mandated information is not an inconsequential error so if the form fails to provide the country of incorporation or the form is not signed, for example, these would be fatal flaws. If a cure of a previously submitted W-8 is needed, you may either require a new form or rely on the originally provided form if the rules for curing the specific red flag permit reliance on additional statements and documentation you obtain from the beneficial owner. Curing a U.S. address: For curing the red flag of a U.S. address, you may treat a vendor as a foreign person if you obtain government-issued documentary evidence establishing foreign status that does not contain a U.S. address. For entities, if there is no knowledge or reason to know the entity is a flow-through entity (partnerships, some LLCs, and simple or grantor trusts), curing merely requires that you obtain government-issued documentary evidence establishing foreign status that substantiates that the entity is actually organized or created under the laws of a foreign country. Special very complex curing standards apply if it is determined that the entity is acting as intermediary or when it is a flowthrough entity that looks to establishing status of beneficial owners, where a W-8IMY is required. Where documentary evidence is required it must establish the identity of person; have a permanent foreign residence address unless that is already in your files in other documentation; and for individuals, contain the individual s country of residence or citizenship, or if an entity, contain an entity s country of permanent residence or place of incorporation or organization. For entities and individuals, it must also be a certificate of residence from a tax official in their resident country or an individual s government-issued identification or an entity s government-issued documentation. A driver's license or passport might meet this requirement for an individual. However, a copy of an entity s articles of incorporation or representation on a credit report will no longer suffice since these are not evidence issued by the entity s government. An individual has further steps to comply with to effect a cure. He or she must also provide you with a reasonable explanation, in writing, supporting his or her claim of foreign status. To meet this requirement you can use a check list that outlines acceptable explanations. The statement needs to certify that the individual: is a student at a U.S. educational institution and holds the appropriate visa; is a teacher, trainee, or intern at a U.S. educational institution or a participant in an educational or cultural exchange visitor program, and holds the appropriate visa; is a foreign individual assigned to a diplomatic post or a position in a consulate, embassy, or international organization in the United States; or is a spouse or unmarried child under the age of 21 years of one of the persons described above, or 13

14 The individual must provide information demonstrating that he or she has not met the substantial presence test, or explain why they meet the closer connection exception described in Reg (b)-2, or certify that they are treated as a resident of a country other than the United States and are not treated as a U.S. resident or U.S. citizen for purposes of that income tax treaty. Curing a U.S. place of birth: If the red flag involves a U.S. place of birth, you will need to also obtain a copy of the individual s Certificate of Loss of Nationality or a reasonable written explanation of his or her renunciation of U.S. citizenship or of the reason he or she did not obtain U.S. citizenship at birth. If the red flag is only triggered by classification of the individual as a U.S. person in your account information, you only need to obtain documentary evidence evidencing an individual s citizenship in foreign country. Curing treaty claims: For curing treaty claims, a beneficial owner may be treated as a resident of the treaty country if the beneficial owner provides a reasonable explanation for giving a permanent residence address outside the treaty country or you obtain government-issued documentary evidence described above that establishes residency in the treaty country. However, where the mailing address is not in the treaty country, the beneficial owner may be treated as a resident of the treaty country only if you obtain government-issued documentary evidence supporting the claim of residence in the treaty country and the additional documentation does not contain an address outside the treaty country. For curing standing instructions for the withholding agent to pay amounts from its account to an address outside a treaty country, the vendor only needs to provide a reasonable explanation, in writing, establishing the vendor s residency in the applicable treaty country or you have documentary evidence (described above) establishing the vendor s residence in the applicable treaty country. Where critical parts of the treaty claim are missing on the form, a new form that is correctly completed must be obtained. If the treaty claim needs to be cured retroactively, an affidavit is necessary that covers application of the details of the treaty claim back to the date needed. Fifth, apply the presumption standards if no W-8 or W-9 is on file before payment If you fail to get the right certification before making a withholdable payment or if there are unresolved conflicts and red flags in the submitted documents or in your business files, presumption standards defined in the regulations are required to be applied to determine whether your vendor is in fact the beneficial owner of the income, whether the vendor has U.S. or foreign status, and in each case to specify the proper withholding and reporting treatment. Presumptions when paying undocumented entities Chapter 3 or FATCA withholdable payments: Paying Chapter 3 withholdable income The presumption of foreign status arises: if there is an EIN beginning with 98 ; if communications are mailed to a foreign address; if the payee s name indicates an entity on the per se list of foreign corporations in Reg (b)(8)(i) (other than a name which contains the designation corporation or company ); or if the only telephone number you have for the vendor is outside of the U.S.. Based on the foreign status presumption, you are to withhold 30% and report on Form 1042-S. If 14