Year-End Reporting for Payments to Foreign Persons

As you review your company's year-end reporting for Forms 1099 and W-2's, it is important for you not to overlook the reporting requirements for payments to foreign persons (including foreign individuals, foreign corporations, foreign partnerships, and other foreign legal entities or trusts). While the rules are similar to those for 1099's, there are some additional requirements regarding foreign payees.

The following provides general information regarding withholding and reporting requirements of payments to foreign persons.

In general, U.S. companies that make certain types of payments to foreign persons are required to withhold 30% of the payment and submit it electronically to the IRS. The types of payments that are required to be reported are Fixed or Determinable Annual or Periodical (FDAP) income. FDAP primarily includes, among other things, dividends, interest, royalties, rent, and U.S. source compensation or fees (including, for example, management fees where some or all of the services were performed in the U.S.). Payment of the income in question is generally considered to have taken place when the cash changes hands; thus, accrued amounts generally do not require withholding or reporting until paid. Please be aware, however, that if the distributive share of partnership income includes FDAP income, the withholding is still required even though the distributive share may not have been paid. The due date for submitting the withholding amounts varies from within 3 days after the end of the quarter-monthly period to submitting with Form 1042 by March 15th (as noted above, electronic payment is generally required).

Income tax treaties often reduce (sometimes to 0%) the applicable withholding tax rates; however, certain forms must still be obtained in advance in order for the payor to be relieved from responsibility to withhold the statutory 30% of the payment being made. Absent any treaty provisions and the completed forms (see below), 30% withholding is required. If the statutory 30% withholding is made and the payee subsequently qualifies for a reduced rate, they may be entitled to claim a refund by filing a U.S. income tax return.

In order to take advantage of reduced tax treaty withholding rates, a Form W-8BEN is normally required to be completed by the company receiving the payment (i.e. foreign vendors). The Form W-8BEN informs the payor (you) that the payee (foreign vendor, recipient) is a foreign entity that is/is not entitled to a particular article of a treaty and specifies the treaty rate of tax. The Form W-8BEN should be completed prior to the payment being made so that the payor knows the applicable withholding rate.

In order to prepare and submit a Form W-8BEN, the recipient of the payment must provide a U.S. taxpayer identification number (TIN). A foreign entity may not claim the reduced tax rate of withholding under an income tax treaty without a completed Form W-8BEN. Please note that Form W-8BEN-E is for use by entities.

Generally, Form 1042 is filed to report the appropriate information to your foreign vendors. If the applicable payment is properly reported, a related foreign payee that is not an individual will not be required to file a U.S. tax return, provided the total amount of all payments to that party for the year does not exceed $500,000. If the payee is an at least 25% related foreign corporation (such as a foreign parent company), the $500,000 limit generally does not apply, provided Forms 1042 are properly filed. If Forms 1042 and 1042-S are not properly filed, the foreign recipient of the payment may have a U.S. tax filing requirement. The original annual due date for filing Form 1042/1042-S is March 15th.

With respect to payments to your parent company or other foreign related parties, we recommend that the recipient obtains a U.S. tax identification number if it does not already have one, and that it completes a Form W-8BEN-E. This form needs to be on file with the U.S. payor (withholding agent), who will in turn be required to prepare and file Forms 1042/1042-S annually.

Keeping the above rules in mind, the following "Best Practices" procedures should help you and your company monitor its reporting requirements:

The year-end reporting of foreign payments can be a maze of reporting requirements, but if you plan accordingly and monitor your foreign vendors throughout the year, you should have fewer headaches during January's reporting period. In addition, getting started now will help you with future reporting requirements under FATCA which will be addressed in a future issue of Rödl Tax Matters.

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