Treasury and IRS plan to change rules for claiming refunds and credits for certain withholding taxes

Transcription

1 4 May 2015 International Tax Alert EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date Treasury and IRS plan to change rules for claiming refunds and credits for certain withholding taxes Executive Summary On 28 April 2015, the Department of the Treasury and the IRS released Notice (Notice) announcing their intention to amend regulations applicable to refund and credit claims for amounts withheld on payments to foreign persons under Sections 1441 through 1443 (Chapter 3 or NRA withholding) and on payments to foreign financial institutions (FFI) and certain nonfinancial foreign entities (NFFE) under Sections 1471 and 1472 (Chapter 4 or Foreign Account Tax Compliance Act (FATCA) withholding). The new regulations will provide that any claim for refund or credit made by the beneficial owner of a withheld payment will be available only to the extent that the relevant withholding agent deposited the amount withheld and such amount is in excess of the claimant s tax liability. The regulations will also provide for a pro rata allocation of the amount available to the claimant for refund or credit when a withholding agent has only partially satisfied its deposit requirements. The Notice requests public comments concerning the administration of the pro rata allocation and on potential exceptions to the rules described. The anticipated regulations are intended to apply to claims for refund or credit for amounts withheld for the 2015 calendar year and later.

2 Background Most types of US source fixed or determinable annual or periodical income (FDAP) not connected with a US trade or business and belonging to a foreign person are subject to a 30% withholding tax under Chapter 3, unless reduced or exempted under a statute or a US income tax treaty. Additionally, Chapter 4 generally requires withholding agents to withhold 30% of any withholdable payment to FFIs that are nonparticipating FFIs as well as to certain NFFEs who fail to provide information regarding any substantial US owners. As provided in Section 6302, every withholding agent who withholds tax pursuant to Chapter 3 or Chapter 4 is required to deposit such withheld tax with the Treasury. In addition, a withholding agent, whether US or foreign, must file Form 1042, Annual Withholding Tax Return for US Source Income of Foreign Persons, to report its federal income tax liability for the amounts of tax required to be withheld under Chapters 3 and 4 for the preceding calendar year. The withholding agent must also provide Form 1042-S, Foreign Person s US Source Income Subject to Withholding, to each payee, to report amounts of US taxes withheld with respect to amounts paid to such payee. Generally, a taxpayer whose refundable credits and payments exceed its tax liability is considered to have made an overpayment of tax. Section 6402 provides authority for IRS to make a credit or refund of an overpayment, and Treas. Reg. Section T(e) provides the general procedural requirements applicable to a claim for credit or refund of income tax made by a foreign person. The temporary regulations provide that, for an overpayment of tax that resulted from withholding under Chapter 3 or 4, a copy of the Form 1042-S must be attached to the income tax return on which the claim for refund or credit is made. Concerns addressed by the Notice The Notice was issued in response to concerns about situations in which persons subject to Chapter 3 or Chapter 4 withholding file claims for refunds or credits, but the withholding agent has failed to deposit the amounts withheld. Under current practice, refunds or credits generally are allowed based on the amount reported as withheld on Form 1042-S. According to the Notice, the allowance of refunds or credits based only on the amount reported as withheld heightens the risk that refunds or credits may be improperly granted for amounts that have not been deposited. Additionally, the Notice states that a refund or credit for amounts not deposited can create collectability issues because in some cases the relevant withholding agent is outside the United States. Regulations to be issued To address these concerns, the Notice describes regulations to be issued under Sections 33, 1462, 1464, and 1474 that would provide a general rule under which a refund or credit will be allowed with respect to an overpayment of withholding tax only to the extent the relevant withholding agent has deposited the amount withheld and such amount is in excess of the claimant s tax liability. The regulations would also provide that where a withholding agent deposits a portion of the amount of tax it has withheld under Chapter 3 or 4, a claimant will be entitled to an amount of refund or credit, under a pro rata allocation method that takes into account the portion of tax that the withholding agent has deposited. Specifically, under the pro rata allocation method, a withholding agent s deposits made to its Form 1042 account will be divided by the amount reported as withheld on all Forms 1042-S filed by the withholding agent to arrive at a deposit percentage. The deposit percentage will then apply to the claimant s amount of withholding tax reported on its From 1042-S, resulting in a deposit amount, which will be used solely for purposes of refund and credit claims related to Chapter 3 or 4, and will only entitle the claimant to a refund or credit if the deposit amount exceeds its tax liability. According to the Notice, permitting a partial refund or credit would allow a claimant to obtain a refund or credit even if the withholding agent has failed to fully deposit or pay the required amount, and is preferable to a tracing or another specific identification method (i.e., establishing that a particular deposit 2 International Tax Alert

3 of tax made by a withholding agent was specifically made with respect to an amount withheld from a particular claimant), which might be administratively burdensome. Nevertheless, Treasury and the IRS request comments on the feasibility of developing and implementing a more precise methodology at some future date. Needed procedures and mechanical rules The Notice acknowledges the need for written procedures and operational guidelines with respect to the deposit allocation rules in order to ensure that claimants are reasonably apprised of the status of their claims and that each claimant receives the proper amount of refund or credit under these rules. Some of the issues specifically identified in the Notice include: when to compute the initial deposit percentage for a withholding agent; how frequently to re-compute the deposit percentage to reflect additional deposits made by the withholding agent after Form 1042 has been filed; or the manner in which withholding agents and affected claimants will be informed of a deposit percentage (whether initial or recomputed) that is less than 100%. Potential exceptions Treasury and the IRS are also considering exceptions to the rules described in the Notice that are administrable and minimize the potential for fraud or the intentional under-deposit of withholding taxes. For example, the Notice specifies that Treasury and the IRS are considering whether to provide an exception for de minimis under-deposits or where a withholding agent has a history of complying with the withholding rules. However, the Notice specifies that any exception would apply solely for purposes of a claim for refund or credit of an amount withheld under Chapter 3 or 4 and only to treat a claimant that is the beneficial owner of the withheld payment as if a full deposit had been made. Any exception would not operate to deem a withholding agent that fails to satisfy its deposit requirements as satisfying those requirements. Treasury and the IRS have requested comments regarding the administration of the pro rata allocation and procedural rules, and potential exceptions that would be consistent with the purposes of the guidance described in the Notice. Comments are due on or before 29 June When issued, the regulations would apply to refund or credit claims for amounts withheld with respect to the 2015 calendar year and thereafter. Interestingly, the Notice observes that for all years, the IRS will continue to deny refund or credit claims when appropriate, including for fictitious withholding and other fraudulent claims. Implications In releasing the Notice, Treasury and the IRS are acknowledging that while the current refund and credit system historically has handled Chapter 3 withholding, the addition of FATCA withholding (with all of its nuances) could make the system more susceptible to erroneous or fraudulent refunds and credits. From a tax administration perspective, this is a legitimate and high priority concern necessitating the guidance contained in the Notice because the overall integrity of the refund system is essential to an effective withholding tax regime. The pro rata allocation method, as presently proposed would essentially apply a haircut across the board to all foreign persons requesting a refund or credit notwithstanding the deposit shortfall may have been attributable to only one of many transactions. As such, care should be taken to ensure that deposits are accurately reported so that they may be appropriately traced to the withholding agent. Stakeholders, especially foreign payees and withholding agents/ffis, should consider providing comments with respect to the proposed new rules including the potential exceptions and pro rata allocation method. Taxpayers should consider becoming an active participant in this process by submitting comments to the Treasury and IRS. International Tax Alert 3

4 For additional information with respect to this Alert, please contact the following: Ernst & Young LLP, International Tax Services, Washington, DC Lilo Hester George Fox Arlene Fitzpatrick Maria Martinez Lisa C. Findlay International Tax Services Global ITS, Alex Postma, London ITS Director, Americas, Jeffrey Michalak, Detroit National Director of ITS Technical Services, Jose Murillo, Washington Member Firm Contacts, Ernst & Young LLP (US) Northeast Johnny Lindroos, McLean, VA Financial Services Phil Green, New York Central Mark Muktar, Detroit Southeast Scott Shell, Charlotte, NC Southwest Amy Ritchie, Austin West Frederick Round, San Jose, CA Canada - Ernst & Young LLP (Canada) Albert Anelli, Montreal Kost Forer Gabbay & Kasierer (Israel) Sharon Shulman, Tel Aviv Mancera, S.C. (Mexico) Koen Van t Hek, Mexico City Central America - Ernst & Young, S.A. Rafael Sayagues, San José South America - Ernst & Young Serviços Tributários S.S. Gil F. Mendes, São Paulo 4 International Tax Alert

5 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. International Tax Services About Ernst & Young s International Tax Services practices Our dedicated international tax professionals assist our clients with their cross-border tax structuring, planning, reporting and risk management. We work with you to build proactive and truly integrated global tax strategies that address the tax risks of today s businesses and achieve sustainable growth. It s how Ernst & Young makes a difference EYGM Limited. All Rights Reserved. EYG No. CM5423 This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com