These synopses are intended only as aids to the reader in

Internal Revenue

bulletin

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

T.D. 8734, page 5.

Final regulations relate to the withholding of income tax under

sections 1441, 1442, and 1443 of the Code on certain U.S.

source income paid to foreign persons, related tax deposit

and reporting requirements, and related requirements governing collection, refunds, and credits of withheld amounts.

Finding Lists begin on page 132.

Announcement of Disbarments and Suspensions begins on page 128.

Announcement Relating to Decisions of the Tax Court is on page 4.

Index for July-October begins on page 134.

Department of the Treasury

Internal Revenue Service

Bulletin No. 1997–44

November 3, 1997

Mission of the Service

ucts and services; and perform in a manner warranting

the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect

the proper amount of tax revenue at the least cost; serve

the public by continually improving the quality of our prod-

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying and

administering the law in a reasonable, practical manner.

Issues should only be raised by examining officers when

they have merit, never arbitrarily or for trading purposes.

At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that

care be exercised not to raise an issue or to ask a court to

adopt a position inconsistent with an established Service

position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue

is determined by Congress.

With this in mind, it is the duty of the Service to carry out that

policy by correctly applying the laws enacted by Congress;

to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;

and to perform this work in a fair and impartial manner, with

neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It

should be conducted with as little delay as possible and

with great courtesy and considerateness. It should never

try to overreach, and should be reasonable within the

bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax devices and

fraud.

At the heart of administration is interpretation of the Code. It

is the responsibility of each person in the Service, charged

with the duty of interpreting the law, to try to find the true

meaning of the statutory provision and not to adopt a

strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only

when we ascertain and apply the true meaning of the statute.

2

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold

on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking

and the disbarment and suspension list included in this part,

none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin of the

succeeding quarterly and semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S . Government Printing Office, Washington, DC 20402.

3

Announcement Relating to Court Decisions

It is the policy of the Internal Revenue

Service to announce at an early date

whether it will follow the holdings in certain cases. An Action on Decision is the

document making such an announcement.

An Action on Decision will be issued at

the discretion of the Service only on unappealed issues decided adverse to the

government. Generally, an Action on Decision is issued where its guidance would

be helpful to Service personnel working

with the same or similar issues. Unlike a

Treasury Regulation or a Revenue Ruling,

an Action on Decision is not an affirmative statement of Service position. It is not

intended to serve as public guidance and

may not cited as precedent.

Actions on Decisions shall be relied

upon within the Service only as conclusions applying the law to the facts in the

particular case at the time the Action on

Decision was issued. Caution should be

exercised in extending the recommendation of the Action on Decision to similar

cases where the facts are different. Moreover, the recommendation in the Action

on Decision may be superseded by new

legislation, regulations, rulings, cases, or

Actions on Decisions.

Prior to 1991, the Service published acquiescence or nonacquiescence only in

certain regular Tax Court opinions. The

Service has expanded its acquiescence

program to include other civil tax cases

where guidance is determined to be helpful. Accordingly, the Service now may acquiesce or nonacquiesce in the holdings

of memorandum Tax Court opinions, as

well as those of the United States District

Courts, Claims Court, and Circuit Courts

of Appeal. Regardless of the court deciding the case, the recommendation of any

Action on Decision will be published in

the Internal Revenue Bulletin.

The recommendation in every Action

on Decision will be summarized as acquiescence, acquiescence in result only, or

nonacquiescence. Both “acquiescence”

and “acquiescence in result only” mean

that the Service accepts the holdong of the

court in a case and that the Service will

follow it in disposing of cases with the

same controlling facts. However, “acquiescence” indicates neither approval nor

disapproval of the reasons assigned by the

court for its conclusions; whereas, “acquiscence in result only” indicates disagreement or concern with some or all of

those reasons. Nonacquiscence signifies

that, although no further review was

sought, the Service does not agree with

the holding of the court and, generally,

will not follow the decision in disposing

of cases involving other taxpayers. In reference to an opinion of a circuit court of

appeals, a nonacquiescence indicates that

the Service will not follow the holding on

a nationwide basis. However, the Service

will recognize the precedential impact of

the opinion on cases arising within the

venue of the deciding circuit.

The announcements published in the

weekly Internal Revenue Bulletins are

consolidated semiannually and annually.

The semiannual consolidation appears in

the first Bulletin for July and in the Cumulative Bulletin for the first half of the

y e a r, and the annual consolidation appears in the first Bulletin for the following

January and in the Cumulative Bulletin

for the last half of the year.

The Commissioner ACQUIESCES in

the following decisions:

Sun Microsystems, Inc. v. Commissioner, T.C.M. 1995–691

Royal Caribbean Cruises, Ltd. v.

United States, 108 F.3d 290 (11th Cir.

1997)2

The Commissioner does NOTACQUIESCE in the following decision:

Trans City Life Insurance Company v.

Commissioner, 106 T.C. 274 (1996)3

1Acquiescence relating to whether the spread income realized from a disqualifying disposition of stock purchased through the taxpayer’s incentive stock option

(“ISO”) plan constitutes wages under section 41(b)(2)(D) in determining whether certain qualified research expenses qualify for the credit for increasing research activities under section 41.

2Acquiescence relating to whether section 4471 of the Internal Revenue Code which imposes a one-time excise tax of $3 for each passenger who “embarks” or “disembarks” a commercial vessel in the United States, applies where the voyage begins and ends outside the United States, but make intermediate stops in the United

States, where passengers temporarily leave the ship.

3Nonacquiescence relating to whether the Commissioner committed an abuse of discretion in determining that certain reinsurance agreements between unrelated parties had a “significant tax avoidance effect” within the meaning of Internal Revenue Code section 845(b).

November 3, 1997

4

1997–44 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 1441.—Withholding of

Tax on Nonresident Aliens

26 CFR 1.1441–1: Requirement for the deduction

and withholding of tax on payments to foreign

persons.

T.D. 8734

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 31, 35a, 301,

502, 503, 509, 513, 514, 516,

517, 520, 521, and 602

General Revision of Regulations

Relating to Withholding of Tax

on Certain U.S. Source Income

Paid to Foreign Persons and

Related Collection, Refunds,

and Credits; Revision of

Information Reporting and

Backup Withholding

Regulations; and Removal of

Regulations Under Part 35a

and of Certain Regulations

Under Income Tax Treaties

A G E N C Y: Internal Revenue Service

(IRS), Treasury.

ACTION: Final and temporary regulations.

S U M M A RY: This document contains

final regulations relating to the withholding of income tax under sections 1441,

1442, and 1443 on certain U.S. source income paid to foreign persons, the related

tax deposit and reporting requirements

under section 1461, and the related requirements governing collection, refunds,

and credits of withheld amounts under

sections 1461 through 1463 and sections

6402 and 6413. Additionally, this document contains final regulations relating to

the statutory exemption under sections

871(h) and 881(c) for portfolio interest.

This document removes temporary employment tax regulations under the Interest and Dividend Compliance Act of 1983

and amends existing regulations under

sections 6041A and 6050N. This document finalizes changes to the proposed

regulations contained in project number

INTL–52–86 [1988–1 C.B. 892], published on February 29, 1988, under sec-

1997–44 I.R.B.

tions 6041, 6042, 6044, 6045, and 6049.

This document also finalizes proposed

regulations contained in project number

IA–33–95 [1996–1 C.B. 772], published

on December 21, 1995 , relating to the effective date of certain temporary employment tax regulations. This document finalizes related changes to the regulations

under sections 163(f), 165(j), 3401, 3406,

6109, 6114, 6413, and 6724. This document removes certain regulations under

income tax treaties.

EFFECTIVE DATES: These regulations

are effective January 1, 1999, except the

addition of §31.9999–0, the removal of

§ 3 5 a . 9 9 9 9 – 0 T and the addition of

§35a.9999–0, which are effective October

14, 1997.

FOR FURTHER INFORMATION CONTACT: Lilo Hester or Teresa Burridge

Hughes, telephone (202) 622-3840 (not a

toll-free number), for questions on the

regulations generally; Carl Cooper, telephone (202) 622-3840 (not a toll-free

number), for questions on portfolio interest and qualified intermediary agreements; Renay France, telephone (202)

622-4940 (not a toll-free number), for

questions on the regulations relating to

chapter 61 of the Internal Revenue Code

or section 3406.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been

reviewed and approved by the Office of

Management and Budget in accordance

with the Paperwork Reduction Act of

1995 (44 U.S.C. 3507) under control number 1545-1484. Responses to these collections of information are required to obtain

a benefit (to claim an exemption to, or a

reduction in, the withholding tax), and to

facilitate tax compliance (to verify entitlement to an exemption or a reduced rate).

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the collection of information displays a valid

OMB control number.

The estimate of the reporting burden in

these final regulations will be reflected in

5

the burdens of Forms W–8, 1042, 1042S,

8233, 8833, and the income tax return of a

foreign person filed for purposes of

claiming a refund of tax.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing the burden should be sent to the

Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer

for the Department of the Treasury, Office

of Information and Regulatory A ff a i r s ,

Washington, DC 20503.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

This document contains final amendments to the Income Tax Regulations

(CFR parts 1, 31, 35a and 301) under sections 163(f), 165(j), 871, 881, 1441, 1442,

1443, 1461, 1462, 1463, 3401, 3406,

6041, 6041A, 6042, 6045, 6049, 6050A,

6050N, 6109, 6114, 6402, 6413, and 6724

of the Internal Revenue Code (Code).

This document also removes certain regulations under income tax treaties.

On April 15, 1996, (61 FR 17614) the

IRS and Treasury published a notice of

proposed rulemaking under a number of

sections of the Code, dealing with the

withholding of tax under section 1441,

1442, or 1443 on amounts paid to foreign

persons, procedures for claiming foreign

status to avoid backup withholding under

section 3406 on certain payments, and the

reporting to the IRS of payments to foreign

persons. Reporting to the IRS may be required under sections 6011 and 1461 or

under the reporting provisions of chapter

61 of the Code, such as sections 6041,

6041A, 6042, 6044, 6045, 6049, 6050A, or

6050N, (the Form 1099 reporting provisions). Comments responding to the notice

were received and a public hearing was

held on July 24, 1996. After considering

the comments submitted in writing and at

the hearings, the proposed regulations are

adopted as revised by this Treasury decision. The revisions are discussed below.

November 3, 1997

Payments to domestic and foreign persons create a number of withholding and

information reporting obligations for both

the payor and the recipient of these payments under various provisions of the

Code. These procedures are important to

the operation of IRS matching systems.

Those systems are part of a compliance

program that allows the IRS to match information provided by payors with income reported on a payee’s income tax return and help detect U.S. taxpayers that

fail to file returns or underreport income.

The withholding of tax at source and the

reporting of payments to foreign persons

are also important to insure that foreign

persons comply with their U.S. tax obligations. The final regulations contained in

this document deal mostly with payments

to foreign persons, and the U.S. income

tax liability resulting from such payments.

Under sections 871(a) and 881(a) of the

Code, nonresident alien individuals and

foreign corporations are subject to a 30percent tax on most items of income they

receive from sources within the United

States that are not effectively connected

with the conduct of a trade or business in

the United States. Income taxable under

these provisions includes interest, dividends, royalties, compensation, other

fixed or determinable annual or periodical

(FDAP) income and certain gains. The

tax liability imposed under sections

871(a) and 881(a) is generally collected

by way of withholding at source under

chapter 3 of the Code pursuant to section

1441(a) (for payments to nonresident

alien individuals and foreign partnerships), section 1442(a) (for payments to

foreign corporations), or section 1443(a)

(for payments of certain income to foreign tax-exempt entities). Other special

withholding provisions apply under section 1443(b) (dealing with the withholding of the 4-percent tax imposed under

section 4948), section 1445 (dealing with

gains from the disposition of U.S. real

property) and section 1446 (dealing with

effectively connected income of foreign

partners in a partnership). The tax liability imposed under sections 871, 881,

1441, 1442, and 1443 also extends to payments to other foreign persons, including

foreign trusts and estates.

The 30-percent rate is often reduced

under the Code or an income tax treaty.

Under current regulations, a withholding

November 3, 1997

agent may generally rely on a statement

furnished by, or for, the beneficial owner

certifying eligibility for a reduced rate.

The procedural requirements for claiming

a reduced rate of withholding may vary

depending upon the type of income, the

status of the taxpayer, or whether an income tax treaty applies. For example, the

portfolio interest exception under sections

871(h) and 881(c) for U.S. interest on an

obligation in registered form is conditioned upon the beneficial owner of the

interest providing a statement of foreign

status to the U.S. withholding agent,

which can be provided on a Form W–8.

See §35a.9999–5(b), A–9. If a reduction

is claimed under an income tax treaty, the

withholding agent may generally rely on a

Form 1001 provided by, or for, the beneficial owner claiming residence in a treaty

country. For dividends, however, the current rules do not require certification of

foreign status in order to obtain a reduced

rate of withholding at source under an income tax treaty. Instead, the withholding

agent may generally rely on the address of

the payee and grant a reduced rate of

withholding at source if the recipient’s address is in a treaty country.

A withholding agent is generally required to file an annual income tax return

on Form 1042 to report amounts upon

which an amount was actually withheld

under chapter 3 of the Code or would

have been required to be withheld but for

an exemption under the regulations, or an

income tax treaty. An information return

on a Form 1042–S must be attached to the

Form 1042 and must report each recipient’s name and address, amounts paid,

and amounts withheld, if any. See

§1.1461–2(b) and (c).

A payor making payments to foreign

persons must also be aware of the information reporting provisions under chapter

61 of the Code and of other withholding

regimes, such as section 3406 (backup

withholding), section 3402 (wage withholding), and section 3405 (withholding

on pensions, annuities, etc.). Payors subject to these reporting and withholding

rules include both U.S. persons and foreign persons, subject to certain exceptions. Under chapter 61 of the Code,

many types of payments, such as interest,

dividends, royalties, broker proceeds, etc.

(reportable payments) must be reported

on a Form 1099 if paid to certain U.S.

6

persons. The form is filed with the IRS

and a copy is furnished to the recipient of

the payment. In addition, section 3406 requires those same U.S. payees to furnish a

taxpayer identifying number (TIN) to the

payor, generally on a Form W–9, and, for

reportable interest and dividends, a certification that the payee is not subject to notified payee underreporting. Failure to

provide a TIN would generally require the

payor to backup withhold on the payment

at the rate of 31-percent. A payor that

fails to obtain a TIN or other required information in the manner required or to

backup withhold when required under

section 3406 may also be liable, under

section 3403, for interest and penalties, in

addition to any amount that should have

been withheld under section 3406.

Payments to foreign persons are exempt from Form 1099 information reporting and backup withholding. However,

the exemption is generally conditioned

upon the recipient furnishing a certificate

supporting its foreign status. The existing

regulations under the information reporting provisions of chapter 61 contain guidance to help payors determine when payments are made to a foreign person.

Generally, depending upon the type of

payment involved, a payor may rely on a

certification of foreign status made on

Form W–8, Form 1001, Form 4224, or, in

the case of certain payments outside the

United States, on alternative evidence of

foreign status. See, for example,

§35a.9999–3, A–34. Therefore, even if

an amount paid to a foreign person is exempt from withholding under chapter 3 of

the Code (e.g., gain from the sale of securities), a payor must nevertheless comply

with specified certification procedures in

order to avoid being subject to penalties

for failure to comply with the information

reporting and the backup withholding

procedures (only amounts subject to reporting under the Form 1099 reporting

provisions are subject to backup withholding under section 3406; see section

3406(b) and §31.3406(a)–1(a) and, for

example, §31.3406(b)(2)–1(a)).

As explained in the preamble to the

proposed regulations, the IRS and Treasury have reviewed the current withholding and reporting procedures applicable to

cross-border payment flows and have

concluded that changes are necessary to

accommodate the size and growth of in-

1997–44 I.R.B.

ternational financial markets. The IRS

and Treasury have concluded that allowing the benefit of the reduced rate at

source, rather than through a refund procedure, continues to be desirable. A

regime based on reduction of withholding

at source avoids the administrative costs

and delays that can occur when applying

for a refund of overwithheld amounts.

This regime, however, depends on withholding agents performing important

compliance functions. They must obtain

documentation substantiating claims of

foreign status and of reduced rates of

withholding and must provide information to the IRS.

One of the important objectives of the

revisions is to eliminate unnecessary burdens that the lack of standardization and

coordination of current procedures may

impose on withholding agents. While it is

unavoidable that different information be

required for different types of income or

recipients, the forms currently in use

apply different standards of proof and are

not uniform in the manner in which the

information is furnished to withholding

agents. The final regulations unify the

documentation requirements and seek to

facilitate compliance by clarifying uncertainties that may exist under current rules

(e.g., the scope of due diligence standards

imposed on withholding agents).

These regulations also address important issues relating to payments to intermediaries (e.g., nominees, agents, etc.),

including whether intermediaries should

certify status on behalf of beneficial owners and, if so, how. Intermediary procedures under current rules have proved difficult to implement in a number of cases.

In particular, U.S. source interest on

obligations in registered form do not qualify as portfolio interest under sections

871(h) and 881(c) unless the U.S. withholding agent receives a statement that

the beneficial owner of the obligation is

not a U.S. person (see section 871(h)(2)(B)(ii)). When the payment is made to a

foreign person acting as an intermediary

on behalf of the beneficial owner or of

other intermediaries, the current regulations require that the beneficial owner

certification be passed up through the

chain of intermediaries to the U.S. withholding agent. See §35a.9999–5(b), A–9.

The final regulations offer alternative procedures and respond to the concerns ex-

1997–44 I.R.B.

pressed by various representatives of the

financial community regarding compliance costs.

The final regulations are also responsive to the Congressional mandate in section 342 of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) that

Treasury consider a range of options for

replacing the address/self-certification

method of administering income tax

treaty benefits. The IRS and Treasury

have studied several options for improving the withholding procedures to respond

to this mandate, including a system of

certification of residence in a treaty coun try and refund systems. At hearings held

in February of 1985 on proposed regulations issued in 1984 under section 1441,

comments from the public and several

U.S. treaty partners made it apparent that

certification requirements, as proposed,

would create too many administrative

problems for payments made through

nominees. The final regulations reflect

these comments. The procedures adopted

for documenting eligibility for benefits

under tax treaties are similar to those applicable to portfolio interest on obligations in registered form.

Streamlining the current procedures

and implementing workable intermediary

certification procedures represent a substantial simplification and reduction of

burden. The IRS and Treasury expect that

this, in turn, should result in greater compliance and improve the ability of withholding agents and the IRS to detect abusive claims of foreign status or of benefits

under U.S. income tax treaties or under

the Code.

On December 21, 1995, at 60 FR

66243, a notice of proposed rulemaking

(IA–33–95) was published proposing to

add §31.9999–0. This document finalizes

the proposed regulations. The effective

date of this addition is October 14, 1997.

Explanation of Provisions and Revisions

A. Comments and Changes to §1.871–14

and Related Reporting Require m e n t s

Under Section 6049

Consistent with the proposed regulations, the final regulations incorporate

without substantive changes the relevant

provisions from the existing temporary

regulations implementing the repeal of

7

the 30-percent tax on portfolio interest

(Questions and Answers Relating to the

Repeal of 30-percent Withholding by Section 127 of the Tax Reform Act of 1984

and to the Application of Information Reporting and Backup Withholding in Light

of such Repeal). These provisions deal

with bearer obligations, convertible obligations, and pass-through certificates. Section 1.871–14(b)(1) incorporates the provisions in §35a.9999–5(a), A–1 and the

rules in §5f.103–1(c) defining a bearer

obligation. It also reflects the rules in

§5f.103–1(c) regarding obligations in registered form that are convertible into

bearer form. At the request of commentators, the definition of an obligation in registered form contained in §5f.103–1(c) is

restated in §1.871–14(c)(1)(i). The definition restates the rules in §35a.9999–5(c),

A–18, regarding the effect of convertibility features on the status of an obligation

as an obligation in bearer or registered

form. Further, at the request of commentators, the provisions in §35a.9999–5(b),

A–12 through 15 regarding obligations issued in registered form and targeted to

foreign markets are retained without substantive changes. Comments received

from U.S. agencies and instrumentalities

indicate that they have relied on these

procedures in the past and that they plan

to do so again.

One commentator requested additional

clarifications under §1.165–12(c). In response to these comments, the $1 million

minimum denomination requirement

under §1.165–12(c)(1)(ii) is eliminated in

order to conform that provision to

§1.165–12(c)(3)(iii). In addition, in

§1.165–12(c), the term United States is

replaced with the term United States and

its possessions to coordinate the provisions with §1.163–5(c)(2)(i)(C) and (D).

In §1.165–12(c)(1)(iii), a provision was

added to explain that a holder delivering a

bearer obligation to a financial institution

or exempt organization may rely on a

written statement furnished by the institution or organization. Further, although

the commentator suggested adding a sentence to §1.165–12(c)(1) to clarify that

each of paragraphs (i) through (iii) must

be satisfied in order to avoid holder sanctions, this change is unnecessary because

the need to meet all of the requirements in

each of these clauses is sufficiently clear.

The commentator proposed various

November 3, 1997

changes to the rules governing the foreign

targeting of bearer obligations on original

issuance. However, the final regulations

do not address these changes which are

outside the scope of this project.

The proposed regulations regarding the

certification requirements for obligations

in registered form are finalized without

substantive changes. As in the proposed

regulations, a TIN is not required to be

stated on a Form W–8 used to claim the

benefit of the portfolio interest exemption, regardless of whether the debt obligation is publicly traded.

Several commentators have asked that,

in the case of portfolio interest on obligations in registered form, the provisions

dealing with late-received documentation

be conformed to similar provisions under

proposed §1.1441–1(f)(5). Under proposed §§1.871–14(c)(3) and 1.1441–

1(f)(5), the failure to timely receive appropriate documentation (i.e., in most

cases, a Form W–8) may be cured by obtaining the documentation later. Under

the proposed regulations, the cure procedures apply for purposes of withholding

under section 1441 and for purposes of

meeting the requirement under sections

871(h) and 881(d) that the U.S. withholding agent receive a statement. However,

proposed §1.871–14(c)(3) requires that

the documentation be received before the

expiration of the limitations period of the

beneficial owner. In contrast, proposed

§1.1441–1(f)(5) requires that the documentation be received before the expiration of the limitations period of the withholding agent. Commentators have asked

that the relevant limitations period for

qualifying interest as portfolio interest

under sections 871(h) and 881(d) be that

of the withholding agent and not of the

beneficial owner. This comment is not

adopted because of the special conditions

for interest to qualify as portfolio interest.

Under section 871(h)(2)(B)(ii), interest

on an obligation in registered form is

portfolio interest only if the U.S. withholding agent receives a statement that

the beneficial owner of the obligation is

not a U.S. person. The legislative history

to the amended provisions (see section

1810(d)(3)(B) of the Tax Reform Act of

1986 (Public Law 99–514)) specifies that

the statement may be received late, but no

later than the expiration of the beneficial

owner’s statute of limitation. This indi-

November 3, 1997

cates that, if the required statement is received after the beneficial owner’s statute

of limitation has expired, the interest can

no longer qualify as portfolio interest. Although the withholding agent is permitted

to receive documentation at any time

within its own limitations period and establish an applicable reduction in the

withholding rate after the fact (e.g., under

an income tax treaty), such cure procedure is not effective to confer portfolio interest status to the interest if it occurs after

the beneficial owner’s statute of limitations has expired. A cross-reference to

§1.1441–1(b)(7) (i.e., proposed §1.1441–

1(f)(5) as renumbered under the final reg ulations) is included in §1.871–14(c)(3)

to clarify the difference between the two

cure procedures.

B. Comments and Changes to §1.1441–1

1. Coordination With Other Withholding

and Information Reporting Provisions

Commentators noted that withholding

and information reporting requirements

applicable to payments to foreign persons

are governed by a complex web of statutory provisions and that the relationship

of these provisions among themselves

may be difficult to understand. In response to these comments, a number of

changes have been made to help payors

and their advisers locate relevant guidance.

As suggested, the table of contents in

§1.1441–0 has been expanded. Section

1.1441–1(b)(4) and (5) has been added to

provide an overview of how the withholding and reporting procedures under chapter 3 of the Code relate to the information

reporting provisions under chapter 61 of

the Code and other withholding regimes

under sections 3402 (wage withholding),

3405 (withholding on pensions, annuities,

etc.), and 3406 (backup withholding).

Provisions explaining the interaction of

applicable withholding and reporting provisions in the case of payments to foreign

intermediaries or foreign partnerships

have been added also. See explanation of

those rules, under the heading “Clarification of Reporting and Withholding Obligations for Payments to and by Foreign Intermediaries” of this preamble. Where

appropriate, additional cross references to

chapter 61 and to sections 3402, 3405,

and 3406 have been added in §1.1441–1

8

and cross-references in regulations under

sections 3402, 3405 and 3406 have also

been added.

As a general matter, a withholding

agent (whether U.S. or foreign) must ascertain whether the payee is a U.S. or a

foreign person. If the payee is a U.S. person, the withholding provisions under

chapter 3 of the Code do not apply; however, information reporting under chapter

61 of the Code may apply; further, if a

TIN is not furnished in the manner required under section 3406, backup withholding may also apply. If the payee is a

foreign person, however, the withholding

provisions under chapter 3 of the Code

apply instead. To the extent withholding

is required under chapter 3 of the Code, or

is excused based on documentation that

must be provided, none of the information

reporting provisions under chapter 61 of

the Code apply, nor do the provisions

under section 3406. If, however, withholding under chapter 3 of the Code does

not apply irrespective of documentation

(e.g., in the case of foreign source income

or gross proceeds dealt with under section

6045), documentation may nevertheless

have to be furnished to the withholding

agent under the provisions of chapter 61

of the Code in order to be excused from

Form 1099 information reporting and,

possibly, from backup withholding under

section 3406. Determinations of payee’s

status are generally made at each level of

the chain of payment, until, ultimately,

the payment is made to the beneficial

owner. The following example illustrates

how these rules interact under the final

regulations.

For example, assume that a U.S. bank

acting as a paying agent of a U.S. issuer

of an obligation pays interest to a U.S.

brokerage firm. Chapter 3 withholding

does not apply to that payment because

the payee is a U.S. person. Form 1099 information reporting under section 6049 is

not required because the brokerage firm is

an exempt recipient (i.e., a securities

dealer), meaning that it is exempt from

having the payment reported on a Form

1099. See §1.6049–4(c)(1)(i). The U.S.

brokerage firm may or may not have to

provide a Form W–9 to the U.S. bank to

establish its exempt recipient status depending on whether it meets one of the

“eyeball” tests under §1.6049–4(c)(1)(ii).

Assume further that the U.S. brokerage

1997–44 I.R.B.

firm credits the interest to the account of a

customer. If the brokerage firm does not

hold a Form W–9 (or a Form W–8) and

cannot otherwise ascertain the exempt recipient status of the customer under

§1.6049–4(c)(1)(ii), it is required to

backup withhold 31-percent under section

3406. See §31.3406(a)–1(b). If it determines that the customer is a U.S. person

(e.g., the firm holds a Form W–9 for the

customer), then chapter 3 does not govern

the payment. Instead, the payment is governed by sections 3406 and 6049. If,

however, the U.S. brokerage firm determines that the customer is a foreign person (e.g., it holds a valid Form W–8), then

chapter 3 governs the payment and the

payment is not reportable for purposes of

section 6049, meaning that it is also not

subject to backup withholding under section 3406. Thus, Form 1042 reporting

and withholding at a 30-percent rate are

required unless the income is exempt

under the Code or an income tax treaty.

For example, if the interest is of a kind

that may qualify as portfolio interest, then

withholding is excused if the brokerage

firm holds a valid Form W–8 from the

customer (but would still be reportable on

Form 1042–S).

If the payment to the customer is an

amount exempt from withholding under

chapter 3 of the Code without the need to

furnish documentation (e.g., foreign

source interest income), documentation

may nevertheless be required for purposes

of chapter 61 of the Code. In this example, the U.S. brokerage firm must report

the payment of foreign source interest on

a Form 1099 unless the customer is an exempt recipient or is a foreign person. If

the customer’s status as an exempt recipient cannot be ascertained on an “eyeball”

basis under §1.6049–4(c)(1)(ii), the brokerage firm must obtain a Form W–9 or a

Form W–8 from the customer. If the documentation that the brokerage firm receives reliably indicates an exempt recipient or foreign status, no information

reporting or withholding is required. If

documentation is not obtained or is not reliable, Form 1099 information reporting

is required under section 6049 and backup

withholding is required under section

3406.

Assume, however, that the customer is

not the beneficial owner of the payment

of U.S. and foreign source interest in-

1997–44 I.R.B.

come. Instead, it is a foreign bank acting

on behalf of the beneficial owner. With

respect to the payment that is U.S. source

interest, the brokerage firm would be permitted to pay the interest free of withholding (assuming it would qualify as portfolio interest if appropriate documentation

were received) if it held a Form W–8 (or

alternative documentary evidence) from

the ultimate beneficial owner that is transmitted by the foreign bank or if it held a

Form W–8 from the foreign bank as a

qualified intermediary who, under the

final regulations, is permitted to certify on

behalf of its own customer. See §1.1441–

1(e)(5). In either case, the brokerage firm

must report the payment on a Form 1042

and must also make an information return

on Form 1042–S. The Form 1042–S must

state the name of the beneficial owner as

shown on the Form W–8 (or alternative

documentary evidence) or the name of the

foreign bank if the bank is a qualified intermediary.

Continuing with the same example, the

foreign bank also has obligations under

sections 1441, 6049, and 3406 when it, in

turn, makes a payment to its own customer. However, to the extent it received

a valid Form W–8 (or alternative documentary evidence) from the beneficial

owner and furnished a copy to the U.S.

brokerage firm (or complied with the documentation requirements as a qualified intermediary), it would meet its obligation

under applicable withholding and reporting provisions and, accordingly, would be

exempt from withholding any amount

from the payment and from reporting the

payment. See §§1.1441–1(b)(6) and

1.6049–5(b)(14).

With respect to the foreign source interest paid to the foreign bank acting as an

intermediary, the only requirement imposed on the U.S. brokerage firm is to obtain the Form W–8 of the foreign bank

(and not of the beneficial owner). Because the exemption sought by the foreign

bank is an exemption from Form 1099 information reporting and backup withholding, the foreign bank may do so by establishing its foreign status with a Form W–8

or by establishing its status as an exempt

recipient. Under the final regulations, a

foreign bank’s status as an exempt recipient can be established on an “eyeball” test

basis if the bank’s name reasonably indicates that it is a bank. However, as is the

9

case for U.S. income subject to chapter 3

withholding, the foreign bank, acting as

an agent for its own customer, may be required to report the foreign source payment under section 6049 and to backup

withhold under 3406 when it, in turn,

pays the amount to its customer if the foreign bank is a U.S. payor (e.g., it is a controlled foreign corporation). If it is not a

U.S. payor or a U.S. middleman, it has no

withholding or reporting obligations

under chapter 3 of the Code due to the nature of the payment (i.e., foreign source

income), unless it makes the payment in

the United States. If the foreign bank

makes a payment to its customer in the

United States, then the payment is reportable under section 6049 and the bank

must obtain a Form W–8 or a Form W–9

from its customer, unless the exempt status of the customer can be established on

an “eyeball” basis. If the customer is a

U.S. person who is not an exempt recipient, the bank must report the payment on

a Form 1099 and, if the customer has not

provided a Form W–9 as required under

section 3406, backup withholding is required. The provisions of §1.6049–

5(b)(14) do not apply to exempt the foreign bank from its reporting and withholding obligations because it has not

provided the required documentation to

the U.S. withholding agent or certified on

behalf of the beneficial owner.

These examples are illustrative only.

D i fferent rules may apply depending

upon a number of factors, the most significant being the nature of the payment

(FDAP or not FDAP, U.S. source or foreign source), the status of the payor (U.S.

or foreign), the status of the payee (U.S.

or foreign, beneficial owner or intermediary), where the payment is made (in the

U.S. or outside the U.S.), and where the

account is held (on-shore or offshore).

2. U.S. Agent of Foreign Person

Under the proposed regulations, a payment to a U.S. person gives rise to withholding liability if the payor has actual

knowledge that the U.S. person is acting

as an agent for a foreign person. Commentators suggested that the withholding

liability should be imposed on the last

U.S. person who makes the payment to a

foreign person. At a minimum, commentators asked that the final regulations limit

the obligation to withhold to situations

November 3, 1997

where the withholding would seem jeopardized. This comment is accepted.

Under the final regulations, a U.S. person

making a payment to a U.S. financial institution is not required to withhold even

if it knows that the payee is collecting the

payment for a foreign person, if the U.S.

person has no reason to believe that the financial institution will not comply with

its obligation to withhold when it makes

the payment to the foreign person. See

§1.1441–1(b)(2)(ii).

3. Payments to Wholly-owned Entities

The final regulations under §1.1441–

1(b)(2)(iii) provide guidance on applicable withholding procedures for payments

to a domestic or foreign wholly-owned

entity that is disregarded for federal tax

purposes (i.e., treated as a branch of its

single owner) under §301.7701–1(c)(2).

As a general rule, a payment to a disregarded wholly-owned entity is treated as a

payment to its owner. Thus, for example,

if a foreign person owns a domestic disregarded entity, a person making a payment

to the disregarded entity is treated as the

withholding agent because the owner is a

foreign person. However, because the

fact that the entity is disregarded for tax

purposes generally may not be apparent to

a person making a payment to the entity,

the person making the payment can rely

on documentation received from the recipient to determine its withholding and

reporting obligations. Thus, if the person

receives a Form W–9 from the entity representing that the recipient is a domestic

corporation, the person may rely on the

form to treat the entity as a U.S. person

unless it has actual knowledge or reason

to know that the representation is incorrect. If the entity is a wholly-owned entity disregarded for federal tax purposes,

then it must furnish documentation representing the status of its owner. For example, if the disregarded domestic entity is

owned by a foreign person, it must furnish a Form W–8 from its single owner.

In that case, a person making a payment

to the entity may rely on the Form W–8

that the entity provides for its foreign

owner and comply with withholding and

reporting requirements accordingly. A

domestic disregarded entity that does not

furnish a certificate is subject to Form

1099 information reporting on payments

that are reportable and subject to backup

November 3, 1997

withholding under section 3406 because,

lacking the words “inc.”, “incorporated”,

“corp.” or “corporation” in its name, it

could not be treated as an exempt recipient on an “eyeball” basis. If the entity

had one of these words in its name, it

would be a per se corporation for U.S. tax

purposes because any of these words

would indicate that the entity is organized

under a corporate statute; thus, it could

not be a disregarded entity. The TIN to be

stated on the Form W–9 or the Form W–8,

if required, is that of the single owner and

not that of the disregarded entity.

D i fferent documentation procedures

apply if the benefit of a reduced rate is

claimed under an income tax treaty and

the entity is not treated as fiscally transparent in the applicable treaty jurisdiction. See §§1.1441–6(b)(4) and 1.894–

1T(d).

4. Payments to U.S. Branches of Foreign

Institutions

Commentators also suggested that a

payment to a U.S. branch of a foreign

bank or other financial institution should

not be subject to withholding. Instead,

the U.S. branch should be responsible for

withholding when it makes the payment

to the foreign person. In addition, commentators have asked that the regulations

eliminate the requirement for a U.S.

branch to furnish a certificate representing that the payment it receives is effectively connected with the conduct of a

U.S. trade or business. In response to

these comments, the rules governing payments to the U.S. branch of certain foreign financial institutions have been modified to alleviate the certification burden

for those U.S. branches that operate in a

manner equivalent to U.S. companies.

Therefore, §1.1441–4(a)(2)(ii) of the

final regulations provides that a payment

to a U.S. branch of either a foreign financial institution that is registered with the

Federal Reserve Board or of a foreign insurance company that is required to file

an annual “NAIC” statement with a State

Insurance Commissioner is presumed to

be a payment of effectively connected income for withholding purposes. Section

1.1441–1(b)(2)(iv) has been added to provide that a U.S. branch may rebut this presumption by furnishing a Form W–8 to

the withholding agent certifying that the

payment that it receives is not effectively

10

connected with its conduct of a U.S. trade

or business. For a description of the form

that a U.S. branch must furnish, see

§1.1441–1(e)(3)(v). Under the final regulations, the U.S. branch that furnishes a

Form W–8 may agree with the withholding agent to assume responsibility for all

withholding and reporting obligations for

the payments it receives from the withholding agent. In the absence of such an

agreement, the withholding agent remains

responsible for the withholding and reporting obligations associated with the

payment. This means, for example, that,

if the U.S. branch receives the payment

on behalf of its home office and the home

office is covered by a qualified intermediary agreement that the IRS has concluded

with the foreign financial institution, the

U.S. branch must give to the withholding

agent the home office’s Form W–8. If the

branch receives the payment for its own

customers, it must give to the withholding

agent all of the required certificates for its

customers.

Similar withholding procedures are

available to other U.S. branches to the extent permitted by the district director or

the Assistant Commissioner (International). Procedures for obtaining such

permission existed under prior regulations

under §1.1441–4(f). These provisions are

restated in §1.1441–1(b)(2)(iv)(E) of the

final regulations.

The final regulations do not eliminate

the requirement to report on a Form 1042

or 1042–S payments to these branches,

including payments for which the branch

has assumed withholding and reporting

responsibility. In such a case, however,

the reporting is made to the branch as recipient of the amount for which it has assumed withholding responsibility rather

than to the beneficial owner. See

§1.1461–1(b)(2)(vi) and (c)(4)(v). Although commentators asked that these reporting requirements be eliminated for

payments of effectively connected income, the IRS and Treasury believe that

the reporting serves an important compliance function.

5. Beneficial Owner

The definition of the term beneficial

owner is clarified to indicate that ownership is determined on the basis of existing

principles governing the determination of

tax ownership, including substance-over-

1997–44 I.R.B.

form principles, such as those reflected in

section 7701(l) dealing with conduit

transactions. The special definition of

beneficial owner in proposed §1.1441–

1(c)(6)(ii)(B) for purposes of tax treaties

has been eliminated. See the explanation

below under §1.1441–6 for claims of tax

treaty-reduced rates for payments to entities that are treated as fiscally transparent

in the U.S. or in the applicable treaty jurisdiction, or both.

6. Forms

a. Format and Design

Many comments were received regarding the format and design of the revised

Form W–8. In particular, several commentators suggested that the IRS retain

separate forms for effectively connected

income and payments to foreign governments. The IRS is considering these comments and agrees that it may be more convenient to keep certain forms separate

from the basic beneficial owner Form

W–8. The revised forms will be released

for public comments before they are finalized.

b. Content of Forms

The final regulations are modified in

several respects regarding the Form W–8.

A Form W–8 furnished by the beneficial

owner is generally payee-specific and applies to all income received from the

withholding agent to whom furnished, except to the extent provided in forms and

instructions (e.g., effectively connected

income). See §1.1441–1(e)(2)(i). Entitlement to different types of reduced rates

may require different types of information

or representations on a Form W–8. For

example, entitlement to exemption from

withholding on portfolio interest requires

only proof of foreign status. Claims of

treaty benefits may require a certified TIN

(that is, a TIN that the IRS has certified as

belonging to a person who is a resident of

a country with which the U.S. has an income tax treaty in effect; see §1.1441–

6(c) for procedures to have a TIN certified by the IRS). A withholding agent is

responsible for making sure that the information or representations relevant to a

particular type of income or applicable

rate appear on the form and for requesting

a new form where an existing form fails

to support a claim of reduced rate for a

1997–44 I.R.B.

different type of income. For example, a

beneficial owner who furnishes a Form

W–8 for portfolio interest (and therefore,

does not complete the information on the

form relating to claims of treaty benefits)

would be required to furnish a new form

to the withholding agent if it receives

from the same withholding agent other income for which it claims a reduced rate of

withholding under a tax treaty. The new

form could serve both for portfolio interest and the other income for which treaty

benefits are claimed.

In response to comments, the final regulations clarify that, where a person, other

than an individual, does not have a tax

residence in any country, the required permanent residence address is the address of

the person’s principal office, even though

the principal office is not in its country of

incorporation (as was required in the proposed regulations). Because of this

change, the final regulations require that

the entity’s country of organization or incorporation be stated on the form. See

§1.1441–1(e)(2)(ii).

c. Signature of Forms under Power of

Attorney

Some commentators have asked that

custodians be permitted to execute the

Form W–8 on behalf of their customers,

based upon a power of attorney. This suggestion is not adopted. Like a tax return,

a Form W–8 must be signed under penalties of perjury. As such, the IRS and Treasury view the signature of a Form W–8 as

governed by the same rules that govern

the signature of a tax return. Therefore,

the final regulations clarify in §1.1441–

1(e)(4)(i) that a withholding certificate

may be signed by any person authorized

to sign a declaration under penalties of

perjury on behalf of the person issuing the

certificate as provided under section 6061

(for individuals), 6062 (for corporations),

or 6063 (for partnerships).

d. Facsimile and Electronic Transmission

Commentators have asked that withholding agents be allowed to rely on a

faxed copy or electronically transmitted

Form W–8 as if they were original forms.

The proposed regulations permit a faxed

Form W–8 to indicate foreign status for

purposes of the grace period under proposed §1.1441–1(f)(2)(i)(B), but do not

allow it to be used for other purposes.

11

The question of whether and to what extent a faxed certificate ought to be allowed instead of an original certificate

arises because, under current law, a faxed

document (like a photocopy) has weaker

evidentiary value than an original document. This question is not unique to the

Form W–8 and is currently under study

by the IRS. Pending completion of the

study, the final regulations allow a withholding agent to rely on a faxed form only

for purposes of presuming foreign status

in order to reduce the rate of withholding

during a 90-day grace period. However,

an original form must be provided before

the grace period expires.

On the other hand, the proposed regulations provide general authority for the

electronic transmission of Forms W–8,

subject to procedures issued by the IRS.

The final regulations retain this rule and,

regulations issued together with these

final regulation propose to amend

§1.1441–1(e)(4)(iv) of the final regulations by prescribing the standards that

electronic systems must meet in order to

e ffect an acceptable transmission of

Forms W–8. The IRS believes that the

evidentiary value of documents transmitted with electronic systems meeting these

standards would equate with that of an

original document. See project REG–

107872–97, published elsewhere in this

issue of the Federal Register. The option

to use electronic transmission systems

should help alleviate the burden of having

to mail original Forms W–8 in paper

form.

e. Single Form for Related Withholding

Agents

Commentators have asked that several

withholding agents be allowed to rely on

a single Form W–8. In response to this

comment, a number of changes were

made to the final regulations. First, under

§1.1441–1(e)(4)(ix)(A), a withholding

agent may rely on the Form W–8 furnished for another account at the same

branch location, at a different branch location of the same entity, or at a different

branch location of a related person if the

entity or group of entities uses a universal

account system or uses another type of

coordinated account information system

that allows the withholding agent to easily

access information regarding the nature of

the certificate furnished, the information

November 3, 1997

on the certificate, and its validity status.

In addition, the system must allow the

withholding agent to keep a record of how

and when it accesses the information and,

if applicable, of how and when it communicates relevant facts affecting the reliability of the certificate to the location

where the certificate is kept. Second, the

rule in proposed §1.1441–1(e)(2)(i) allowing the beneficial owner to provide a

single Form W–8 with respect to a family

of mutual funds is extended to investors

in affiliated partnerships and corporations

under §1.1441–1(e)(4)(ix)(B) of the final

regulations. Further, the final regulations

also adopt a suggestion that a withholding

agent be able to rely on representations

from a broker that it holds a valid withholding certificate from a beneficial

owner. See §1.1441–1(e)(4)(ix)(C). The

final regulations clarify that a withholding

agent has knowledge of all information in

the system. See §1.1441–7(b)(3).

f. Forms from Foreign Partnerships

In response to comments, the provisions under proposed §1.1441–1(e)(3)(iii)

dealing with withholding certificates furnished by a foreign partnership have been

moved to §1.1441–5(c), which contains

most of the withholding provisions governing payments to foreign partnerships

(see explanation of the changes under

§1.1441–5).

g. Forms from Non-Qualified

Intermediaries

In response to comments, provisions

have been added to clarify the manner in

which a non-QI must transmit documentation to the withholding agent and the information that it must contain. Proposed

§1.1441–1(e)(3)(iv) (renumbered as

§1.1441–1(e)(3)(iii) in the final regulations) is expanded to explain the manner

in which withholding certificates or other

appropriate documentation is passed up a

chain of non-QIs. The final regulations

allow the intermediary to furnish copies

of an original Form W–8 so as to avoid

requesting multiple originals for different

accounts that the intermediary may hold

on behalf of the same beneficial owner.

See §1.1441–1(e)(3)(iii).

Also, proposed §1.1441–1(e)(3)(iv)(C)

and (D) (renumbered as §1.1441–1(e)(3)(iii)(C) and (D) in the final regulations)

has been modified and paragraph (e)(3)-

November 3, 1997

(iv) has been added in response to comments that the regulations should explain

the information required from a non-qualified intermediary to insure proper withholding by a withholding agent making a

payment to a non-qualified intermediary.

In particular, if different withholding rates

apply to different owners of the payment

flowing through an intermediary, the withholding agent must know which rate applies to each portion of the payment.

Where such information is necessary, the

final regulations provide that the intermediary must, in a statement attached to the

withholding certificate from the non-qualified intermediary, provide (and update as

often as is necessary) sufficient information for the withholding agent or payor to

determine the proportion of each payment

subject to withholding that is attributable

to each person to whom the intermediary

certificate relates, including persons for

whom the intermediary has not attached a

withholding certificate or other appropriate

documentation. Such statement is not necessary, however, if the allocation information is known to the withholding agent due

to the account structure that it uses (for example, the withholding agent uses separate

accounts for different categories of income

and applicable withholding rates).

h. Validity Period

Comments were received under

§1.1441–1(e)(4)(ii) regarding the period

of validity of a properly executed Form

W–8. Commentators requested that, irrespective of whether a Form W–8 includes

a TIN, all forms should be valid indefinitely, or at least those furnished for a

claim of effectively connected income.

Some commentators suggested that a

Form W–8 should not expire where a

payor continues to send all correspondence to a mailing address that is also the

permanent address on a Form W – 8 .

These suggestions are not adopted because the IRS and Treasury believe that it

is important for taxpayers to re-certify

status periodically. Similar re-certification is also important for effectively connected income, since income may cease

to be effectively connected due to a

change in the taxpayer’s business structure, without the withholding agent becoming aware of such changes. However,

the final regulations provide relief by presuming that payments made to certain

12

U.S. branches are effectively connected

income, thereby avoiding the need to provide a certificate in such a case. See

§1.1441–4(a)(2)(ii).

Also, §1.1441–1(e)(4)(ii)(B) is modified to make all intermediary certificates

and certificates for non-withholding foreign partnerships valid indefinitely. (The

indefinite validity period does not apply

to the withholding certificates or documentary evidence required to be attached

to a certificate from a non-qualified intermediary, a U.S. branch of a foreign institution, or a foreign non-withholding partnership.) In addition, Forms W – 8

furnished by an integral part of a foreign

government, a foreign central bank of

issue, or the Bank for International Settlements are valid indefinitely. For these

certificates, the information required is

likely to change only infrequently. What

may change more frequently is the withholding rate information that an intermediary or foreign partnership may have to

furnish to a withholding agent on a separate statement, which the intermediary or

partnership must update as often as is necessary to insure that the withholding agent

withholds at the proper rates. See

§1.1441–1(e)(3)(iv) and (5)(v) for a description of the statement and §1.1441–

1(e)(4)(ii)(D) for related validity rules.

i. Effect of Changes in Circumstances

Proposed §1.1441–1(e)(4)(ii)(D), dealing with changes in circumstances affecting the validity of a Form W–8, is revised

to clarify the due diligence imposed on a

non-qualified intermediary who becomes

aware of a change in the circumstances

a ffecting the validity of a withholding

certificate that it has received and transmitted to the U.S. withholding agent or

another intermediary. The final regulations provide that, in such a case, the nonqualified intermediary must inform the

person to whom it provided the affected

withholding certificate (i.e., the U.S.

withholding agent or the other intermediary). It must also obtain a new withholding certificate or other documentation to

replace the certificate or documentation

that is no longer valid due to changes in

circumstances. The same rules apply to

foreign partnerships that are not withholding foreign partnerships and to a U.S.

branch that passes through documentation

to a U.S. withholding agent.

1997–44 I.R.B.

The final regulations also clarify that a

withholding agent does not have a duty to

inquire into possible changes of circumstances. In other words, a withholding

agent may assume that circumstances

have not changed unless it knows of facts

suggesting that changes in circumstances

have occurred that may affect the validity

of documentation. Changes in circumstances relevant to the information and

certification provided on a withholding

certificate, a statement, or in documentary

evidence affect the validity of the certificate, statement, or documentary evidence

as of the date that the withholding agent

has actual knowledge or reason to know

of the changes. The final regulations are

revised to clarify that point and give withholding agents the same 90-day period as

is given for a new account for perfecting

documentation (i.e., inquire into the

change of circumstances and obtain a new

certificate, if necessary). See §§1.1441–

1(b)(3)(iv) and 1.6049-5(d)(2)(ii).

j. Acceptable Substitute Form

In addition, proposed §1.1441–1(e)(4)(vi) is modified in response to comments that asked that the meaning of the

cross-reference to §31.3406(h)-3(c)(1)

defining an acceptable substitute form be

clarified. The revised provisions enumerate the type of information and certifications that must appear on any substitute

form for purposes of the regulations under

chapter 3 of the Code. The rules are similar to the rules contained in §31.3406(h)–

3(c)(1). Under the final regulations, a

withholding agent must provide a copy of

the instructions to the recipient only to the

extent specified in the form and in the instructions to the official form. As is the

case for the Form W–9, the IRS expects

that the form instructions will waive the

obligation to furnish the official Form

W–8 instructions to customers. Further,

withholding agents are also authorized to

develop customized substitute Forms

W–8 and incorporate them as part of account opening documents.

k. Guidance Regarding Reliance on

Withholding Certificates

Several commentators asked for clearer

guidance on the extent to which withholding agents may rely on forms and the extent of their duty to inquire into the truthfulness of information stated on forms. In

1997–44 I.R.B.

response to these comments, the final regulations contain a number of clarifications. Section 1.1441–1(e)(4)(viii) has

been added to provide that a withholding

agent may rely on a foreign entity’s certification of corporate (or other) status on a

Form W–8. In the case of a withholding

certificate by or for a foreign entity whose

name is on the list of per se foreign corporations described in §301.7701–2(b)(8)(i)

that claims to be a partnership, the certificate must represent that the entity’s partnership status was grandfathered under

the regulations and has not been terminated. Further, a withholding agent that

receives a beneficial owner certificate

from a foreign financial institution may

rely on such certificate to treat the institution as the beneficial owner unless it has

information in its records that would indicate otherwise, or unless the certificate

contains information that would contradict such claim (e.g., sub-account numbers or names). If a foreign intermediary

receives payments both in its capacity as

an intermediary and for its own account,

it must furnish two certificates in order to

allow the withholding agent to apply the

proper withholding rate and report the

amounts accordingly. Additional reliance

guidance has been added regarding claims

of benefits under a tax treaty (see explanation under §1.1441–6, below). Further,

the provisions dealing with a withholding

agent’s due diligence are also expanded

and clarified (see explanation under

§1.1441–7, below).

7. Non-qualified Intermediaries

Some commentators requested that the

regulations eliminate the requirement that

non-qualified intermediaries (non-QIs)

pass through Forms W–8 to the U.S. withholding agent because investors and intermediaries will not disclose customer information to third parties. In particular,

some commentators recommended that

the regulations eliminate any reference to

the intermediary procedures currently applicable under §35a.9999–5(b), A – 9 ,

dealing with certification required in

order for interest to qualify as portfolio

interest. These suggestions are not

adopted. The qualified intermediary

regime is designed to provide these benefits, but only where the intermediary follows procedures to insure adequate withholding compliance. In addition, as

13

explained in the preamble to the proposed

regulations, the intermediary procedures

provided in §35a.9999–5(b), A–9 are retained because, if the qualified intermediary regime does not apply to the intermediary, these procedures may be useful.

The final regulations also do not adopt

a suggestion that, for income for which no

TIN needs to be provided, the intermediary

only reports the aggregate amount on Form

1042 without having to report individual

amounts for each beneficial owner on a

Form 1042–S. Commentators have suggested that a financial institution acting as

an intermediary should be required to indicate only the proportion of a payment subject to withholding and the applicable rate.

Should the proportion change, the certificate furnished by the intermediary would

have to be modified to reflect the change in

circumstances. This suggestion is not

adopted because permission to report aggregate amounts is limited to payments

made to qualified intermediaries. In the

case of a qualified intermediary, the IRS

may rely on audit procedures in the qualified intermediary agreement described in

§1.1441–1(e)(5)(iii) to determine whether

the intermediary has properly advised the

U.S. withholding agent regarding each

portion of a payment to which different

withholding rates should apply. The IRS’

ability to check the representations made

by a non-QI is limited, particularly if the

non-QI is not owned by U.S. persons. In

that case, it must rely on reconciling the

amounts paid as reported on Forms

1042–S, disclosure of the identity of beneficial owners (or further intermediaries),

and exchanges of information under tax

treaties. In that context, disclosure of the

exact amounts allocated to each beneficial

owner (or further intermediary) is important to the compliance regime applicable to

non-QIs.

8. Qualified Intermediaries

a. Scope of Qualified Intermediary

Provisions

Under the proposed regulations, a withholding agent may rely on the certification of a foreign person made on behalf of

others to reduce the rate of withholding.

If the foreign person has a qualified intermediary agreement with the IRS, the intermediary may certify without having to

furnish the certificates or other documen-

November 3, 1997

tation of the persons for whom it acts.

Many comments were received regarding

the proposal, which are discussed below.

In response to comments, the final regulations are modified to allow a foreign

branch of a U.S. financial institution to be

a qualified intermediary (QI) in the same

manner as a foreign financial institution.

However, U.S. branches of U.S. or foreign financial institutions are not permitted to obtain QI status. Such difference in

treatment conforms to the distinction in

the final regulations between accounts

maintained outside the United States and

accounts maintained on-shore. See

§1.1441–1(e)(5)(ii)(A) and (B). This distinction is appropriate because it reflects

the policy that the Form W–8 (signed

under penalties of perjury) is the preferred

means of establishing foreign status for

transactions in the United States. On the

other hand, documentary evidence provides appropriate evidence of foreign status for transactions outside the United

States, especially in those countries where

financial institutions must document the

identity of customers opening new accounts or for whom they process certain

transactions.

At the request of commentators, the definition of a clearing organization for purposes of §1.1441–1(e)(5)(ii)(A) is revised so that clearing organizations that,

as members of other clearing organizations, do not hold physical securities, are

nevertheless considered to hold obligations for members and, therefore, qualify

for QI status. Further, the final regulations allow QI status for foreign corporations that receive U.S. income for which

the benefit of a reduced rate is claimed

under an income tax treaty by their shareholders (because the shareholders derive

the income as residents of an applicable

treaty jurisdiction within the meaning of

§1.894–1T(d)(1)). By allowing these corporate entities to be QIs, the regulations

intend to facilitate the processing of treaty

benefits claims by reverse hybrid entities

with large shareholdings. See discussion

under §1.1441–6, below. Also at the request of commentators, a transition rule is

added to §1.1441–1(e)(5)(i) whereby institutions that are otherwise eligible for

QI status and that satisfy certain criteria

(as will be published by the IRS) are permitted to act as QIs while awaiting confirmation of their QI status.

November 3, 1997

Commentators were divided on

whether the regulations should allow a QI

to assume primary withholding responsibility as proposed in §1.1441–1(e)(5)(iv).

In view of these comments, the final regulations retain the provisions that permit

the shifting of primary responsibility for

withholding and reporting under chapter 3

of the Code. However, because of IRS

concerns regarding compliance and comments received from foreign institutions,

the final regulations provide that the responsibility for Form 1099 information

reporting and related backup withholding

under section 3406 may not be assigned

to a QI, unless the QI is a foreign branch

of a U.S. bank or another U.S. person or

establishes that the obligations related to

information reporting and backup withholding can adequately be carried out by a

U.S. branch of the QI (even though the

branch itself cannot be a QI). Some commentators suggested that, if a QI is allowed to assume primary withholding responsibility, it should be allowed to do so

only for all the payments that it receives

from a payor with respect to a particular

account. Permitting a QI to assume withholding responsibility with respect to

some but not all payments to an account

would make it difficult for payors to determine the correct amount of withholding on payments to a single account. This

comment has been adopted and the final

regulations are modified accordingly to

provide that if a QI assumes primary

withholding responsibility for an account,

it must do so for all payments to the account. The decision to assume or not assume withholding responsibility may be

made on an account-by-account basis.

See §1.1441–1(e)(5)(iv).

As is the case for non-QIs, the regulations describe in greater detail the information that must be provided by a QI in

order for the withholding agent or payor

to comply with applicable reporting and

withholding obligations. Section 1.1441–

1(e)(3)(ii)(C) requires an allocation statement to be attached to the intermediary

withholding certificate, if necessary to

provide sufficient information to allow

the withholding agent to determine the

applicable withholding rate or rates on

payments to the QI. Such a statement

may not be necessary if the withholding

agent allocates the assets among separate

accounts for each type of income and ap-

14

plicable withholding rates, as directed by

the intermediary at the time that the assets

are acquired. The assets with respect to

which payments of reportable amounts

are received must be allocated to one of

the three categories described below. If

the withholding agent maintains a system

of separate accounts to keep track of different withholding rates for diff e r e n t

classes of income or payees, it would

maintain at least three separate accounts

corresponding to the three categories of

assets. For this purpose, a reportable

amount is defined in §1.1441–1(e)(3)(vi)

as income subject to withholding under

chapter 3 of the Code. For reasons explained under the heading “U.S. Source

Bank Deposit Interest and Short-term

OID” of this preamble, U.S. bank deposit

interest and U.S. short-term OID amounts

are also included in the definition of reportable amount. However, reportable

amounts do not otherwise include

amounts that are not subject to chapter 3

withholding (e.g., foreign source income,

broker proceeds).

The three categories of assets are described in §1.1441–1(e)(5)(v). They are

(1) assets related to documented non-U.S.

payees; (2) assets related to documented

U.S. payees (whether or not exempt recipients); and (3) assets related to undocumented payees (i.e., payees for whom the

QI holds no documentation or holds documentation that is unreliable). Reportable

amounts paid with respect to assets in category 1 (documented non-U.S. payees)

may benefit from a reduced rate of withholding under the Code (e.g., portfolio interest) or under a treaty (i.e., to the extent

the QI further indicates subcategories of

assets associated with different withholding rates under an applicable treaty).

Reportable amounts paid with respect

to category 2 (documented U.S. payees)

are not subject to withholding or reporting

under chapter 3 of the Code. However,

the payor must report the payment on a

Form 1099 by treating the payment of a

reportable amount as made directly to any

U.S. person for whom it receives a Form

W–9 to the extent the U.S. person is not

an exempt recipient. The final regulations

clarify that a QI must agree to disclose the

identity of these U.S. persons, regardless

of local secrecy laws. The identity of

U.S. payees that are exempt recipients

under an applicable provision of the regu-

1997–44 I.R.B.

lations under chapter 61 of the Code need

not be disclosed to the withholding agent.

If a Form W–9 furnished by the QI to the

payor on behalf of a U.S. payee that is not

an exempt recipient is not reliable (e.g.,

missing information or obviously incorrect TIN), the U.S. payor must backup

withhold under section 3406.

Reportable amounts paid with respect

to assets in category 3 (undocumented

owners) are treated as amounts paid to a

foreign person if the payment is an

amount subject to chapter 3 withholding.

See §1.1441–1(b)(2)(v) and (3)(v)(B).

Therefore, withholding applies at the

unreduced 30-percent rate. Reportable

amounts that are U.S. bank deposit interest or U.S. short-term original issue discount paid with respect to asserts in category 3 are treated as paid to a U.S. person

who is not an exempt recipient. Therefore, 31-percent backup withholding applies to those amounts and reporting on

Form 1099 is required. See §1.6049–5(d)(3)(iii) and explanation below under

paragraph 10 (U.S. source bank deposit

interest and short-term OID).

If a QI assumes primary withholding

responsibility, it must also attach a statement to its withholding certificate if necessary for the U.S. withholding agent to

determine how much of each payment is

allocable to U.S. payees. All assets are

presumed allocable to foreign persons unless the QI indicates that it is acting for

U.S. persons. The QI must provide the

same information about U.S. payees that

are not exempt recipients as is required in

the case of a QI that has not assumed primary withholding responsibility.

b. Agreements with Qualified

Intermediaries

The IRS intends to finalize the revenue

procedure published in A n n o u n c e m e n t

96–3 (1996–18 I.R.B. 7) dealing with

agreements between the IRS and certain

institutions that wish to be a qualified intermediary for purposes of the U.S. tax

withholding and reporting provisions (including the provisions of the Announcement regarding the documentation of beneficial ownership or foreign payee status

(section 4.03)). A preliminary review of

applicable know-your-customer procedures in several countries indicates that

these procedures will generally provide

adequate information regarding the na-

1997–44 I.R.B.

tionality and residence status of account

holders and their status as owners or intermediaries. The IRS intends that the documentation requirements imposed on QIs

under their agreements with the IRS will

not be more burdensome than those imposed on withholding agents, payors, or

middlemen under applicable withholding

and reporting regulations.

The Announcement provides that a QI

would generally be subject to the same

Form 1042 and 1042–S reporting requirements as apply to withholding agents

under §1.1461–1(b) and (c). After further

r e v i e w, the IRS intends to finalize the

rules so that a QI will be required to file

an annual Form 1042 return with the IRS.

Generally, a Form 1042–S will not be required if a schedule in the form described

below is attached to the Form 1042.

Reporting on a Form 1042 would consist of providing the following information to the IRS: the amount of reportable

U.S. source income received by the QI

during the calendar year, identified by

pool, listing each payor’s name, address,

EIN, income type and rate of withholding; information regarding overpayments

or balance due; a statement regarding the

audit conducted by the QI’s internal audi tor, providing a description of the audit

conducted and including the auditor’s

opinion and summary of findings. The

audit statement should define the scope

and objective of the audit and report on

the QI’s compliance with the terms of the

QI agreement.

In addition, the Form 1042 must attach

a schedule providing information on payments of reportable U.S. source income

made by the QI and allocated to specified

pools. Under a pool reporting system,

separate pools would generally be required for each type of income (e.g., interest, dividends, etc.). These pools may

have to be further subdivided into pools

consisting of income allocable to one of

the three assets categories identified in the

regulations under §1.1441–1(e)(5)(v)(B).

Additional pools may be required for

other purposes, including differentiating

among applicable withholding rates. For

example, assume that a QI pays portfolio

interest and U.S. source dividends in a

calendar year. The rates applicable to

portfolio interest are zero (interest allocable to pool of documented foreign owners), zero (interest allocable to pool of

15

U.S. owners who are exempt recipients),

and 30% (interest allocable to pool of undocumented owners), and the rates applicable to dividends are 30% (dividends

allocable to pool of residents in non-treaty

countries), 15% (dividends allocable to

pool of residents in treaty country eligible

for this rate), zero (dividends allocable to

pool of U.S. owners that are exempt recipients), and zero (dividends allocable to

pool of foreign pension fund owners

claiming an exemption under a tax

treaty). In such a case, the QI may have

to report the interest and dividend income

in seven different pools.

The IRS will not require a QI to report

beneficial ownership information if this

information is otherwise reasonably available in appropriate cases, either under exchange of information provisions, under

income tax treaties or under other procedures stated in the agreement to verify

compliance with conditions for benefits

claimed under income tax treaties. Appropriate cases for which the IRS may require beneficial ownership information

include cases in which the IRS needs to

verify compliance with conditions under

an applicable tax treaty for reduced rates.

This includes, for example, whether an

entity claiming benefits under a tax treaty

is a resident of the applicable treaty count r y, derives the income (within the

meaning of the regulations under §1.894–

1T(d)), and meets any applicable conditions imposed under limitation on benefits

provisions in the treaty. The IRS intends

to limit requests for beneficial owner’s

identity to cases where compliance concerns are significant due to the size of investments involved or the extent of bank

secrecy laws in effect in the local jurisdiction.

The QI will not be required to provide a

Form 1042–S to its account holders. In

fact, providing such a form would not be

consistent with the collective-type refund

procedures which the IRS intends to develop. These procedures will allow QIs

to request refunds of overwithheld

amounts on behalf of their customers. In

such a system, a Form 1042–S, which can

also serve as proof of tax withheld at

source, would have to be monitored by

the IRS in order to insure that refunds are

not claimed twice for the same amount.

Collective-type refund procedures are intended to be the exclusive means by

November 3, 1997

which taxpayers can obtain refund of

overwithheld amounts that they have received through a QI. Special procedures

will have to be developed in order to reconcile this regime with regular refund

procedures applicable to U.S. taxpayers

that receive U.S. source investment income in an account with a QI.

With respect to audits, the proposed

regulations provide that the IRS may, in

appropriate cases, agree to rely on an

audit of a QI performed by an approved

auditor where, for example, under an income tax treaty or local laws, the IRS

would be given access to appropriate aud i t o r s ’ records to verify compliance.

Records may include workpapers of, reports prepared by, and methodology employed by, the approved external auditors.

An auditor is approved if it is subject to

regulatory supervision under the laws of

the country in which a significant part of

the QI’s activities are expected to occur,

its internal procedures must require it to

verify that the financial institution complies with the terms of the QI agreement

and to report non-compliance findings

under the QI agreement in the same manner as it is required to report other findings of non-compliance with applicable

local laws and regulatory requirements,

and its relevant records (i.e., workpapers

and reports) must be available to the IRS.

Several comments were received asking

that audits be performed solely by internal

auditors. The IRS, however, does not believe that it is appropriate to rely solely on

internal auditors to perform compliance

checks. The IRS intends to permit internal

auditors to certify that appropriate procedures, internal controls, and systems are in

effect and are sufficient to insure the QI’s

compliance with the agreement, such as

procedures to obtain documentation upon

opening of accounts, to monitor that the

address on an account does not change to

a U.S. address or to an address outside the

treaty country (if treaty benefits are

claimed), to organize and process such information in a way relevant to U.S. tax

withholding and reporting, to communicate the information to withholding agents

timely and updating the pool information

when necessary; procedures by which underwithholding and overwithholding are

identified and addressed; and the existence

of adequate manuals and programs f o r

training and advising appropriate person-

November 3, 1997

nel in standard operating procedures.

However, it is important that compliance

with these procedures be verified periodically by persons who are not also employed by the QI. The IRS does not believe that internal auditors provide

sufficient assurances that audits will be

performed with required impartiality,

even if internal auditors are required to

operate independently and to report exclusively to the QI’s board of directors.

However, the IRS intends to use external

audits only periodically, either when it becomes aware (e.g., based on a Form 1042

or an internal audit report) that there may

be compliance problems or as part of its

regular audit program.

In addition, with respect to collection

of taxes due, the IRS intends to waive the

requirement of a bond in appropriate

cases, particularly where the QI has assets

in the United States from which tax can

be collected or where occurrences of underwithholding are expected to be minimal due to the nature of the QI’s established procedures.

In QI agreements, the IRS intends to

address the manner in which a QI may

pay to, or receive a payment from, another intermediary. A QI making a payment to another intermediary must normally obtain the underlying beneficial

owner information from the intermediary,

unless the intermediary is itself a QI. In

the alternative, the QI may agree to a private arrangement with the intermediary

that would be identical to a QI agreement,

except that it would not be concluded

with the IRS and the intermediary would

have no reporting obligations to the IRS.

Under this regime, similar to that described for authorized foreign agents in

§1.1441–7(c)(2), the QI assumes responsibility for failures by the intermediary to

comply with the documentation and withholding procedures. The intermediary

would agree, under its private arrangement with the QI, to be audited in the

same manner as if it were a QI. Auditors

reports would be furnished to the QI and

be available for inspection by the IRS. A

QI would normally obtain an indemnification from the intermediary as a protection against its own U.S. tax liability arising from failures by the intermediary.

Further, the IRS will permit QIs that assume primary withholding responsibility

to be combined in a chain of payment

16

with QIs that do not assume primary withholding responsibility. For example, a

U.S. withholding agent may pay to a QI

that assumes primary withholding responsibility (QI1) and withhold no amount.

QI1 may, in turn, pay a customer that is a

QI that does not assume primary withholding responsibility (QI2). In such a

case, QI1 must withhold on payments to

QI2 in the same manner that a U.S. withholding agent would have had to withhold

if it were paying the amount to QI2. QI2

may also be dealing with a third tier, QI3,

that assumes primary withholding responsibility. In such a case, QI2 would inform

QI1 that the portion of the payment allocable to QI3 (without having to disclose

QI3’s identity to QI1) is allocable to a QI

that has assumed primary withholding responsibility. Accordingly, neither QI1 nor

QI2 would withhold on the portion of the

payment allocable to QI3.

9. Clarification of Reporting and

Withholding Obligations for Payments

to and by Foreign Intermediaries

Commentators have asked for clarification of how the procedures applicable to

payments to foreign intermediaries relate

to the exempt recipient rules under chapter 61 and to a foreign intermediary’s reporting and withholding obligations under

chapter 61 of the Code and section 3406.

Under chapter 61 of the Code and section 3406, the reporting and backup withholding requirements depend, in part,

upon the status of the payee as an exempt

recipient. Generally, exempt recipients

include corporations and financial institutions. See §1.6049–4(c)(1)(ii). The category of persons treated as exempt recipients may vary depending upon the type of

income being paid. For this purpose, the

payee is generally identified as the person

to whom the payment is actually made.

This person is not necessarily the beneficial owner of the income. For example, a

custodian receiving a payment may be a

payee for purposes of chapter 61 of the

Code, even though it is not the beneficial

owner of the amounts that it receives on

behalf of a customer. Under the final regulations, a payment to a nominee or agent

is treated as a payment to an exempt recipient, which, as a result, is exempt from

information reporting and backup withholding. See §1.6049–4(c)(1)(ii)(O).

Treating a U.S. intermediary as an exempt

1997–44 I.R.B.

recipient avoids multiple information reporting and insures that the liability for

information reporting and, if applicable,

backup withholding, falls upon the last

person in a chain of intermediaries, that is

the intermediary that has the direct relationship with the customer.

When a payment is made to a foreign

intermediary, however, the IRS may not

be able to obtain information and, thus,

collect the tax that may be due from the

ultimate owner if the payment to the foreign intermediary is exempt from information reporting (assuming that the intermediary is an exempt recipient). If the

payment to the foreign intermediary involves amounts subject to withholding

under chapter 3 of the Code (e.g., U.S.

source dividends, U.S. source interest on

obligations in registered form, or U.S.

source royalties), a U.S. tax is collected at

source at a 30-percent rate (assuming that

the intermediary has furnished no reliable

information concerning the beneficial

owners of those payments; see applicable

presumptions rules, as revised). If, however, the payment is not subject to chapter

3 withholding (e.g., broker proceeds or

foreign source income) and the beneficial

owner is a U.S. person, the lack of information regarding the beneficial owner is

of greater concern to the IRS.

The regulations proposed in 1988 and

in 1996 set forth procedures for payments

to intermediaries that are, in part, designed to address some of these concerns

(see, for example, the 1996 proposal to

apply 30-percent withholding to U.S.

source bank deposit interest unless beneficial owner documentation is obtained).

The final regulations clarify how withholding and reporting under chapter 3 of

the Code interacts with Form 1099 reporting and backup withholding.

Under §1.1441–1(b)(2)(v)(A), a payment to a foreign intermediary (if reliably

identified as such by the payor) that has

not assumed primary withholding responsibility, is treated as a payment made directly to the person or persons for whom

the intermediary (whether or not a QI)

collects the payment. If that person is undocumented (i.e., has not furnished a reliable withholding certificate or other appropriate documentation), the person is

presumed to be foreign under §1.1441–

1(b)(3)(v)(B) to the extent the payment

consists of an amount subject to chapter 3

1997–44 I.R.B.

withholding. Therefore, for example, if a

U.S. source dividend is paid to a foreign

intermediary that furnishes a Form W–9

for another person and such U.S. person is

not an exempt recipient, the payor must

treat the U.S. person as the payee for purposes of the Form 1099 reporting provisions under section 6042 and backup

withholding under section 3406. If the

U.S. person is not an exempt recipient,

the payment is reportable even though the

person who actually receives the payment

is the foreign intermediary. The foreign

intermediary is an exempt person by

virtue of being a foreign person and a

nominee. However, as clarified under the

final regulations, the fact that the intermediary may be an exempt person is not relevant because, under the final rules, it is

not a payee with respect to a payment associated with underlying documentation

attached to the certificate. See §§1.6049–

5(d)(3)(i) and 1.1441–1(b)(3)(v)(B).

If, however, the amount paid to the person identified as a foreign intermediary is

not of a type that is subject to chapter 3

withholding (e.g., foreign source income,

broker proceeds), then §1.6049–5(d)(3)(ii) provides that the amount is treated

as paid to an exempt recipient and, as

such, exempt from reporting and backup

withholding under section 3406. T h i s

rule is subject to two exceptions. First, a

U.S. payor with actual knowledge that the

person for whom the intermediary collects the payment (including broker proceeds and foreign source income) is a

U.S. person is required to report the payment (and backup withhold in the absence

of a TIN) if the U.S. person is not an exempt recipient. See §1.6049–5(d)(3)(iv),

Example 7. A second exception is made

for U.S. source bank deposit interest and

short-term OID. Because these amounts

are not subject to withholding, this exception appears under §1.6049–5(d)(3)(iii)

and not under section 1441. As explained

under the heading “U.S. Source Bank Deposit Interest and Short-term OID” of this

preamble, a payment of such amounts to a

foreign intermediary (or certain foreign

partnerships) is reportable unless the intermediary establishes that the payee

(other than an intermediary or a flowthrough entity) is a foreign person or an

exempt recipient.

Further, provisions have been added to

explain how the U.S. withholding and re-

17

porting requirements apply to payments

made by a foreign intermediary, certain

U.S. branches, or certain foreign partnerships. A foreign intermediary that furnishes a valid intermediary withholding

certificate to the withholding agent is considered to have complied with its own reporting and withholding obligations under

chapters 3 and 61 of the Code and sections 3402, 3405, or 3406. See, for example, §1.1441–1(b)(6) applicable to payments of amounts subject to chapter 3

withholding by a foreign intermediary or

a U.S. branch and corresponding provisions in §1.6049–5(b)(14) for interest and

§1.6042–3(b)(1)(vi) for dividends. Similar provisions are made under §1.1441–

5(c)(3)(v) for payments by foreign partnerships that are not withholding foreign

partnerships. For example, a foreign custodian bank that is not a qualified intermediary and acts as an agent for a nonresident alien individual who holds U.S.

publicly traded obligations in registered

form is not required to withhold under

section 1441 when it credits the customer’s account if it has furnished the

i n d i v i d u a l ’s Form W–8 (or alternative

documentary evidence) to the U.S. withholding agent in compliance with

§1.1441–1(e)(3)(iii). If, however, the foreign custodian bank knows that the Form

W–8 (or alternative documentary evidence) is not reliable and has not so informed the U.S. withholding agent who,

as a result, has not withheld, then the bank

is not relieved from its obligation to withhold under section 3406 because it has not

acted in compliance with the regulations

under section 1441.

These rules apply when the withholding agent/payor holds a valid intermediary withholding certificate. The final regulations add provisions to clarify

applicable presumptions when the status

of the intermediary is not reliably established or parts of the intermediary withholding certificate are not reliable. See a

description of these provisions under the

heading “Presumptions—Payments to

Foreign Intermediaries” of this preamble.

10. U.S. Source Bank Deposit Interest

and Short-Term OID

Some commentators objected to the requirement that eligibility for the exemption from U.S. tax on U.S. source bank

deposit interest be subject to the same

November 3, 1997

beneficial ownership documentation requirements that apply to portfolio interest,

suggesting lack of statutory authority and

an increase in burden in the context of interbank financing transactions.

In view of these comments, the final

regulations do not require a withholding

agent to withhold 30-percent on bank deposit interest under section 1441 in the

absence of beneficial owner documentation. Instead, documentation regarding

the beneficial owner is required under

sections 6049 and 3406 for purposes of

avoiding information reporting and

backup withholding. This documentation

requirement also applies to short-term

OID. See §1.6049–5(d)(3)(iii). Therefore, the final regulations provide that a

payment to a foreign intermediary of U.S.

source short-term OID or of U.S. source

interest on deposits with U.S. banks and

other financial institutions described in

sections 871(i)(2)(A) and 881(d) is

treated as made to a foreign payee or an

exempt recipient only to the extent that the

payor can treat the payment as made to a

foreign beneficial owner under

§1.1441–1(d)(4) or (e)(1)(ii) or if the payment is made to a qualified intermediary

that has assumed primary withholding responsibility or to a withholding foreign

partnership. In all other cases, the foreign

intermediary is not treated as an exempt

recipient and its certification that it is a

foreign person is not sufficient to make the

payment non-reportable under §1.6049–

5(b)(12). Under §1.6049–5(d)(3)(iii), the

payment is treated as made directly to the

unidentified owners for whom the intermediary receives the payment and, as

such, is treated as made to a U.S. payee

who is not an exempt recipient.

The regulations provide special rules to

help a payor determine whether the person to whom it makes the payment is a

foreign or a U.S. person, and, if presumed

to be a foreign person under these rules,

whether it is an intermediary or is acting

for its own account. These presumptions

are helpful if the payment is to a foreign

person that qualifies as an exempt recipient on an “eyeball” basis (e.g., a foreign

bank with the word “bank” in its name).

In such a case, no documentation is required to be provided by such person and

the payor may have no ability to determine whether the person is U.S. or foreign and whether it is acting as an inter-

November 3, 1997

mediary or for its own account. A person

receiving a payment is presumed to be a

foreign person for the purpose of these

rules if the payor has actual knowledge of

the payee’s employer identification number and that number begins with the two

digits “98,” if the payor’s communications

with the payee are mailed to an address in

a foreign country, or if the name indicates

that the payee is a per se corporation under

§301–7701–2(b)(8)(i), or the payment is

made outside the United States. The final

regulations under §1.6049–5(d)(4)(iii)

presume that a person receiving a payment

of U.S. bank deposit interest or U.S. shortterm OID is not acting for its own account

(note that this presumption is different

form the general presumption under

§1.1441–1(b)(3)(v)(A) that presumes a

foreign person to be acting for its own account unless it furnishes certain documentation establishing its status as an intermediary). Thus, in the absence of

documentation and any evidence that the

foreign person is acting for its own account, a payor would presume that the

payment is made to unidentified owners

for whom the person receives the payment, required to be reported under section 6049 and subject to 31-percent

backup withholding under section 3406.

A payee may rebut this presumption by

furnishing an indication of beneficial

ownership to the payor. Such indication

may be provided in any manner as the

parties may choose, but must be reflected

in the payor’s records. An indication by a

foreign person that it is not an intermediary does not have to be made under penalties of perjury.

In order to minimize disruptions to

high-volume wholesale banking transactions and to the sale and repurchase (repo)

market, the final regulations exempt from

these documentation requirements deposits with banks and other financial institutions that remain on deposit for a period of two weeks or less, and amounts of

original issue discount arising from any

repo transaction that is completed within

a period of two weeks or less. Further,

amounts paid with respect to certain

bearer obligations are also exempt.

11. Presumptions—In General

Proposed §1.1441–1(f), dealing with

presumptions of U.S. or foreign status in

the absence of reliable documentation, is

18

restated with a number of clarifications,

in §§1.1441–1(b)(3) and 1.6049–5(d)(2)

through (5). The presumptions in

§1.1441–1(b)(3) apply to amounts that

are subject to chapter 3 withholding. The

same presumptions apply under §1.60495(d)(2) to payments that are not subject to

chapter 3 withholding (e.g., foreign

source income, sales proceeds), with a

few differences. As under the proposed

regulations, payments that a payor or

withholding agent cannot reliably associate with documentation are presumed to

be made to a U.S. payee who is not an exempt recipient, in which case 31-percent

backup withholding applies if the payment is otherwise a reportable payment

(within the meaning of the applicable information reporting provisions under

chapter 61 of the Code). As an exception

to this rule, a payee is presumed to be foreign if it is an exempt recipient for whom

indicia of foreign status exist. Special

rules are also provided for scholarships

and pensions, for which no backup withholding applies under section 3406, and

for certain payments to offshore accounts.

See §1.1441–1(b)(3)(iii).

In determining the extent to which the

withholding agent can consider that it can

rely on documentation to determine the

extent of its withholding obligations, the

final regulations rely on a concept of “reliable association” of a payment with

withholding certificates or other documentation. This concept replaces the requirement under §1.1441–1(f)(1)(ii) of

the proposed regulations that the withholding agent hold required documentation. The definition of “reliable association” is set forth in §1.1441–1(b)(2)(vii).

As in the proposed regulations, a withholding agent cannot reliably associate a

payment with documentation if the documentation is lacking or is unreliable.

These provisions apply regardless of

whether documentation is otherwise required. For example, a payment of U.S.

source royalties to a corporation with the

word “Inc.” in its name requires no documentation from the payee under section

6050N because the payee’s status as an

exempt recipient is inferred from its name

(i.e., on an “eyeball” basis) under

§1.6049–4(c)(1)(ii)(A)(1). In such a case,

the payor must consider that there is a per

se lack of documentation. T h e r e f o r e ,

under §1.1441–1(b)(3)(iii)(A), a payment

1997–44 I.R.B.

to such an exempt recipient is presumed

made to a foreign person if certain indicia

of foreign status are present. If these indicia are present, the payor, if also a withholding agent, must withhold 30-percent

from the payment under section 1441.

The final regulations modify the presumptions for certain payments to offshore

accounts. Under the proposed regulations,

a payment to a foreign account is presumed

to be made to a U.S. person. Thus, the

payor must file a Form 1099 for the payee,

but the payment is not subject to backup

withholding. See proposed §§1.1441– 1(f)(2)(ii) and 31.3406(g)–1(e). The final regulations provide that, in the case of a payment to a foreign account of an amount

subject to chapter 3 withholding, the payment is presumed to be made to a foreign

person and not to a U.S. person. Thus, the

withholding agent must withhold on the

payment at a 30-percent rate. In that case,

the foreign status presumption insures that

a tax is paid on such amounts since, under

§31.3406(g)–1(e), no backup withholding

would apply to an undocumented account

if the account holder were presumed to be a

U.S. person. See §1.1441–1(b)(3)(iii)(D).

The final regulations adopt the rule in the

proposed regulations for payments involving amounts that are not subject to chapter

3 withholding (i.e., payee is presumed to be

a U.S. person who is not an exempt recipient, subject to Form 1099 reporting but not

to backup withholding). See §§1.1441–

1(b)(3)(iii) and 1.6049-5(d)(2)(i).

The final regulations include presumptions regarding the characteristics of a

payee so that a payor or withholding

agent may determine whether to treat the

payee as an owner of an account or as an

intermediary (see §1.1441–1(b)(3)(v)(A)), and as an individual, a trust, an

estate, a corporation or a partnership. See

§1.1441–1(b)(3)(ii). The final regulations

also make a number of clarifications to

the presumption provisions in response to

comments. First, the revised rules clarify

that the presumptions are mandatory. A

payor that withholds a lesser amount or

does not report a payment contrary to

what the presumptions would require may

be liable for the amount of the tax in addition to interest and penalties, even if the

withholding agent acted on the basis of

actual knowledge. Although the liability

for the tax may be eliminated if the withholding agent establishes that it withheld

1997–44 I.R.B.

the proper amount (based on its actual

knowledge or otherwise), liability for interest and penalties may be assessed.

This rule is consistent with the requirement under the regulations to provide

documentation before a payment is made

so that a withholding agent may not rely

on actual knowledge to reduce a withholding or reporting obligation. Treating

the presumptions as mandatory rather as

mere safe harbors is necessary to avoid

undermining the requirement that withholding agents obtain documentation

prior to the time of a payment.

On the other hand, a withholding agent

or payor may not rely on the presumptions

if it has actual knowledge (or, in the case

of amounts subject to chapter 3 withholding, reason to know) of facts that would

require it to withhold an amount greater

than would otherwise be required based

upon an applicable presumption or to report a payment that would be exempt from

reporting under an applicable presumption. See §1.1441–1(b)(3)(ix) and (b)(7).

The final regulations clarify that if,

under the rules, a payment is presumed to

be made to a U.S. payee, the determination of whether to report on a Form 1099

or backup withhold is governed by the

provisions under chapter 61 of the Code

and section 3406 and not by chapter 3 of

the Code. See §1.1441–1(b)(3)(i). Also,

the final regulations clarify that a withholding agent that withholds in accordance with an applicable presumption is

not liable under another withholding provision for that payment, even if the payee

is subsequently determined to have a status different from its presumed status.

See §1.1441–1(b)(3)(ix)(A).

12. Presumptions—Grace Period

Several comments were received regarding the grace period provisions under

proposed §1.1441–1(f)(2)(ii). Under the

proposed rules, a withholding agent or

payor may presume that an account holder

for whom specified indicia of foreign status exist at the time that a payment is first

credited to the account may be treated as a

foreign person, even if no documentation

has been received before the account is

first credited. This presumption has two

consequences: first, backup withholding is

deferred until the end of the grace period

(and may never be required if foreign sta-

19

tus documentation is provided when or before the grace period terminates); second,

an amount must be withheld under chapter

3 of the Code without the benefit of a reduced rate under the Code or an income

tax treaty if the amount is income subject

to chapter 3 withholding. At the expiration of the grace period, the account

holder is treated as a U.S. or foreign person, depending upon whether documentation is furnished, and, if so, what type of

documentation is furnished.

Commentators argued that a withholding agent should be allowed to rely on the

apparent status of the beneficial owner to

grant a reduced rate of withholding for

payments made during the grace period.

They point to the prohibition against depleting the account below 31-percent of

the amounts paid and argue that this prohibition protects the government’s interest

that the proper amount of tax be collected

upon expiration of the grace period if entitlement to a reduced rate is not confirmed. This comment is accepted but

only if the withholding agent has received

a faxed Form W–8. Thus, for example, a

reduced rate of withholding for portfolio

interest or under a tax treaty can apply to

amounts credited during the grace period

based on a faxed Form W–8.

Commentators also argued that any

backup withholding should not be retroactively imposed after the expiration of the

90-day grace period when documentation

is still lacking at that time, because of the

difficulty to deduct and deposit a tax after

the fact. In response to these comments,

the final regulations are revised to impose

backup withholding only to payments

credited to the account after the expiration

of the grace period if, at that time, documentation is still lacking or unreliable.

The presumption that the account holder

was a foreign person during the grace period is not reversed. Thus, if amounts

credited during the grace period were subject to withholding at less than the full 30percent rate, and, at the end of the grace

period, the documentation is still lacking

or unreliable, then the payor must make an

adjustment in order to correct the underwithholding, so that all amounts credited

during the grace period are withheld upon

at the full 30-percent rate (to the extent

they are amounts subject to chapter 3 withholding). Under the final regulations,

amounts credited to the account during the

November 3, 1997

grace period could be subject to no or reduced withholding if the withholding agent

receives a faxed Form W–8. Consistent

with the 30-day grace period under

§31.3406(d)–3(c), the provisions are revised to treat reinvestment as withdrawals.

The grace period is terminated if withdrawals or other events leave a balance in

the account that is insufficient to cover potential backup withholding liability. See

§1.6049–5(d)(2)(ii) and §1.1441– 1(b)(3)(iv) of the final regulations, as renumbered.

For purposes of withholding under

chapter 3 of the Code, the 90-day grace

period applies to all payments that are exempted from the TIN requirement under

§1.1441–6(b)(2)(ii). For purposes of information reporting on amounts not subject to withholding, the 90-day grace period applies to all payments reportable as

dividends, interest, royalties, and broker

proceeds. Although comments were received asking that the grace period be extended to existing accounts, the final regulations do not do so. A grace period

should not be necessary for existing accounts where the expiration of withholding certificates is a predictable event for

which withholding agents and payors can

plan accordingly. On the other hand, the

grace period is extended to situations

where the validity of documentation expires because of a change of circumstances. In such a case, it is reasonable to

allow time to obtain new or corrected

documentation to account for changes affecting the validity of documentation in

an unexpected manner. The final regulations also extend the availability of a

grace period for purposes of payments for

which a Form 8233 is required (i.e., claim

of treaty benefits for compensation to

nonresident alien for personal services).

This benefit is intended to facilitate withholding on these payments to beneficial

owners who are awaiting their social security number or ITIN. The final regulations clarify that the grace period provisions apply at the option of the payor or

withholding agent. Therefore, a payor or

withholding agent is not required to implement procedures offering a grace period to its customers.

13. Presumptions—Payments to Foreign

Intermediaries

At the request of commentators, the

final regulations clarify how the presump-

November 3, 1997

tions apply to payments to foreign intermediaries in the absence of reliable documentation both for purposes of chapter 3

and chapter 61 information, and sections

3402, 3405, and 3406. Under §1.1441–

1(b)(3)(v)(A), a payee who has not provided a valid intermediary withholding

certificate or whose intermediary withholding certificate is defective because,

for example, the information on the certificate regarding the intermediary is lacking or unreliable, must generally be

treated as an undocumented owner of the

payment. Under §1.1441–1(b)(3)(ii), an

undocumented owner is presumed to be

an individual, a trust, or an estate, if the

payee appears to be such a person. In the

absence of reliable indication that the

payee is an individual, a trust, or an estate, the payee is presumed to be a corporation if it can be treated as a corporation

under the “eyeball” test described in

§1.6049–4(c)(1)(ii)(A)(1) or is presumed

to be one of the persons enumerated under

§1.6049–4(c)(1)(ii)(B) through (Q) if it

can be so treated under an “eyeball” test

basis. If it cannot be so treated, then it is

presumed to be a partnership.

If the payee is presumed to be an individual, a trust, an estate, or a partnership,

it is presumed under §1.1441–1(b)(3)(iii)

to be a U.S. person who is not an exempt

recipient and the information reporting

provisions under chapter 61 of the Code

and section 3406 would govern the

payor’s reporting and withholding obligations with respect to the payment. If the

payee is presumed to be a corporation or

another exempt recipient under §1.60494(c)(1)(ii)(B) through (Q), then it is also

presumed to be a U.S. person. However,

if the amount paid consists of an amount

that is subject to withholding under chapter 3 of the Code (e.g., U.S. source interest or dividends), the payee is presumed

to be a foreign person if there are indicia

of foreign status, in which case withholding at the 30-percent rate is required

under chapter 3 of the Code. See

§1.1441–1(b)(3)(iii)(A).

If the payment can be treated as made

to a foreign intermediary but the intermediary’s withholding certificate is unreliable either because the withholding agent

or payor has not been given sufficient information to determine the proper amount

of withholding or because some or all of

the underlying certificates that are required to be attached are lacking or are

20

unreliable, the payment is presumed made

to a foreign nominee acting for an undocumented owner. Therefore, the payment

is subject to withholding under chapter 3

of the Code at the unreduced 30-percent

rate to the extent it consists of income

subject to such withholding under chapter

3 of the Code. See §1.1441–1(b)(3)(v)(B). Additional presumptions are provided under §1.1441–1(b)(3)(v)(C) and

(D) to deal with lacking or unreliable information regarding the allocation of a

payment among beneficial owners or

other payees and lacking or unreliable information regarding whether the intermediary’s certificate identifies all of the persons to whom the payment relates.

Section 1.6049–5(d)(3)(ii) clarifies, however, that if the payment is not an amount

subject to chapter 3 withholding, then the

payment is presumed to be made to an exempt recipient not reportable under section 6042, 6045, or 6049 (except for certain payments of U.S. bank deposit

interest or U.S. short-term OID under

§1.6049–5(d)(3)(iii)).

The lack of reliable information regarding beneficial owners or the allocation of

the payments among them raise an issue

as to how the amounts should be reported

on a Form 1099 (if, for example, the withholding agent has a Form W–9 from a

beneficial owner but has no or unreliable

information regarding how much the payment is allocable to such person) or on a

Form 1042–S. The final regulations

under §1.1461–1(c)(4)(iv) provide that

payments to an intermediary or foreign

partnership for the account of undocumented owners or partners are reportable

on a single Form 1042–S made out to the

i n t e r m e d i a r y, and bearing the mention

“unknown owners.” The final regulations, however, do not contain guidance

for situations where the withholding agent

or payor is lacking reliable allocation information. This matter is under consideration by the IRS and comments are solicited regarding appropriate procedures

before guidance is issued.

The final regulations contain similar

provisions for payments to foreign partnerships under §1.1441–5(d). See the explanation under §1.1441–5, below.

15. Late-received Form W–8—Cure

Procedures

Generally, a Form W–8 or other applicable documentation must be furnished to

1997–44 I.R.B.

the withholding agent or payor prior to

the time of payment. The proposed regulations in §1.1441–1(f)(5) prescribe procedures allowing a Form W–8 or other

documentation to be furnished late (i.e.,

after the 90-day grace period), subject to

interest and penalties. They also contemplate the possibility that, upon examination, the IRS might require the withholding agent or payor to furnish additional

proof in support of the claim of foreign

status or eligibility for a reduced rate of

withholding under the Code or a tax

treaty. Commentators asked for an exemption from interest and penalties when

it is determined that there is no underlying

tax liability once the documentation has

been provided or, at least, that the liability

be abated where the withholding agent

has acted in good faith.

The final regulations do not eliminate

the possibility that interest and penalties

may apply because the liability for those

items is clearly contemplated under section 1463. However, several revisions are

made to relieve liability in certain cases.

See §1.1441–1(b)(7), restating the provisions of proposed §1.1441–1(f)(5). First,

in order to eliminate the possibility of a

double interest charge when the respective unsatisfied tax liabilities of the withholding agent and of the beneficial owner

run concurrently, the regulations are modified to limit collection to one amount of

interest only. In that regard, interest will

not be assessed against the withholding

agent if it otherwise is assessed or collected against the beneficial owner. Next,

in order to clarify that the cure rules apply

to all cases for which documentation must

be provided to the withholding agent,

cross references have been added under

§§1.1441–4(f), 1.1441-5(f), 1.1441–6(f),

1.1441–8(e), 1.1441–9(c), and 1.1443–

1(b)(3). In addition, the final regulations

make this relief available on a retroactive

basis for all open years. This action is intended to eliminate any ongoing controversy with the IRS regarding an issue that

is unclear under current law. The final

regulations clarify that the period for calculating penalties and interest is limited to

the time that the liability remains outstanding, i.e., starting with the due date

for filing the return under section 6601

(i.e., March 15 of the year following the

year in which the payment was made) and

ending with the date that the tax is consid-

1997–44 I.R.B.

ered paid (i.e., the time that the documentation is furnished establishing the proper

amount of tax due or that the tax is actually

paid, whichever is earlier). Also, commentators asked for a clarification of how late

deposit penalties would apply when the

withholding agent fails to withhold. This

issue remains under consideration.

16. Due diligence with respect to

information returns required under

chapter 61 of the Code.

The Interest and Dividend Tax Compliance Act of 1983 provided that the

penalty for the failure to file an information return, furnish a copy of it to a payee,

or supply a TIN can be waived if it is

shown that the filer exercised due diligence in filing the return, furnishing it to

a payee, or supplying the payee’s TIN.

The due diligence standard applied to failures on information returns reporting dividends under section 6042, patronage dividends under section 6044, and interest or

OID under section 6049. The IRS issued

regulations in question and answer form

providing the prerequisites to establish

due diligence. See §§35a.9999–1 through

35a.9999–5.

The Omnibus Budget Reconciliation

Act of 1989, Public. Law 101-239, 103

Stat. 2393, repealed sections 6676 and

6678 with the enactment of uniform information reporting penalties under sections

6721 through 6724 and replaced due diligence with a reasonable cause standard

under newly enacted section 6724. However, Congress provided that the separate

and higher due diligence waiver standard

for returns filed under sections 6042,

6044, and 6049 be considered to meet

reasonable cause. H. Rep. No. 247, 101st.

Cong., 1st. Sess., at 1385 (1989).

These final regulations remove the

Q/As under Part 35a, effective January 1,

1999. Because due diligence will remain

in effect, the IRS will retain the relevant

Q/As set forth in Part 35a. These final

regulations redesignate the relevant Q/As

under §301.6724–1(g).

17. Effective Dates

Many comments were received regarding the effective dates of the final regulations. Commentators argued that the January 1, 1998 effective date in the proposed

regulations should be extended because of

the anticipated time required to complete

21

QI agreements and for withholding agents

to make the administrative and operating

systems changes that will be necessary to

comply with the regulations. However,

commentators have argued that provision

should also be made for a financial institution to elect earlier adoption of the new requirements where possible.

The final regulations accommodate

these concerns. The effective date is

changed to January 1, 1999. In view of

the later effective date and comments that

staggered effective dates make system adjustments more difficult and costly, all

special delayed effective dates rules are

eliminated. Also, transition rules are

modified for existing certificates. Valid

withholding certificates that are held on

December 31, 1998, remain valid until the

earlier of December 31, 1999 or the due

date of expiration of the certificate under

rules currently in effect (unless otherwise

invalidated due to changes in the circumstances of the person whose name is on

the certificate). Further, certificates dated

prior to January 1, 1998 that are valid as

of January 1, 1998, remain valid until the

end of 1998, irrespective of the fact that

their validity expires during 1998 (other

than by reason of changes in the circumstances of the person whose name is on

the certificate).

The final regulations do not accelerate

the effective date of certain provisions as

had been requested by several commentators. Although doing so would provide

relief to a number of taxpayers, it would

also complicate the many system adjustments that withholding agents, particularly financial institutions with large volume of cross-border payments, must

implement before the effective date of

these regulations. The IRS and Treasury

feel that the benefits of accelerating certain provisions would not sufficiently outweigh the added costs and burdens to

many withholding agents.

C. Comments and Changes to §1.1441–2

1. Amounts subject to withholding

Under §1.1441–1 of current regulations, an amount is subject to withholding

only if it is from sources within the

United States. The final regulations under

§1.1441–2(a) clarify that an amount can

be sourced within the United States irrespective of the fact that the source is un-

November 3, 1997

determined at the time of payment. This

clarification addresses the Tax Court’s

ruling in A l b e rt J. Miller v.

Commissioner, T.C. Memo 1997–134, 73

T.C.M. (CCH) 2319, that an amount

whose source cannot be determined at the

time paid is sourced outside the United

States for purposes of sections 871(a) or

881(a) and the withholding provisions of

chapter 3 of the Code.

2. Fixed or Determinable Annual or

Periodical Income

The definition of the term fixed or de terminable annual or periodical (FDAP)

income under existing regulations under

section 1441 is retained in the final regulations and clarified. In particular,

§1.1441–2(b)(1)(iii) addresses three types

of uncertainties that a withholding agent

may encounter: 1) the proportion of the

payment that constitutes income cannot

be determined when a payment is made

(e.g., a payment made on an obligation

that may include interest, but the exact

amount of interest cannot be determined

because the determination is contingent

upon future events); 2) the proportion of

the payment that constitutes U.S. source

income cannot be determined at the time

of payment; or 3) the fact that the payment may be income in the future cannot

be anticipated at the time of payment.

Only in the third case would the payment

not constitute FDAP income. In the first

two cases, income is actually being paid.

The only uncertainty is the amount that

the recipient should include in income

and this uncertainty does not prevent the

payment from constituting fixed or determinable annual or periodical income for

purposes of section 871(a) or 881(a) and

the withholding provisions of chapter 3 of

the Code. See also the additional provisions under §§1.1441–2(b)(1)(iii) and

1.1441–3(d)(1) dealing with determinability and rules of withholding for

items whose source cannot be determined

at the time of payment.

3. Original Issue Discount

In response to comments, the final regulations regarding withholding on original

issue discount (OID) are simplified. As a

general principle, withholding is required

on a payment that is treated as taxable

OID under section 871(a)(1)(C) or

881(a)(3)(A) to the extent the withholding

November 3, 1997

agent knows the amount that is OID. That

amount is known to the withholding agent

if it knows how long the beneficial owner

has held the obligation on which a payment is made, the terms of the obligation,

and the extent to which the beneficial

owner purchased the obligation at a premium. A withholding agent has knowledge if the information is obtainable upon

exercising reasonable efforts. The information is not considered obtainable in the

case of payments with respect to publicly

traded securities where the withholding

agent, consistent with normal industry

practices, does not have a direct customer

relationship with the person who has actual knowledge of the relevant information or has no access to this information in

the normal course of its business due to

the manner in which the obligation is held

(e.g., in street name or through intermediaries). In the case of a withholding agent

maintaining a direct customer relationship

with the beneficial owner, knowledge regarding the owner’s holding period and

acquisition premium is considered to be

reasonably available to the withholding

agent. Because of the complexities that

may be involved in calculating the amount

taxable to the owner and, thus, subject to

withholding, withholding agents may rely

on the most recently published “List of

OID Instruments” or similar list published

by the IRS (currently contained in IRS

Publication 1212 (available from the IRS

Forms Distribution Centers)).

Notwithstanding the rules described in

the preceding paragraph, withholding is

required with respect to OID that would

qualify as portfolio interest except for the

fact that documentation required under

section 871(h)(5) is not furnished to the

withholding agent. In the absence of information regarding the amount of OID,

the withholding agent may rely on IRS

Publication 1212. The final regulations

clarify that no withholding applies to

amounts that are not otherwise subject to

chapter 3 withholding (e.g., OID on

obligations in bearer form that qualifies as

portfolio interest).

3. Securities Lending Transactions

The final regulations add paragraph

(b)(4) to cross-reference the regulations

under sections 871 and 881 dealing with

securities lending transactions and equivalent transactions. Thus, the character of

22

the income arising from these transactions

applies for purposes of determining the

amount of withholding under chapter 3 of

the Code. Similar rules apply for purposes of information reporting and backup withholding on interest and dividends.

See §§1.6042–3(a)(2) and 1.6049–

5(a)(5). See §1.1441–1(b)(4)(i) for documenting interest equivalent amounts for

which the beneficial owner claims a portfolio interest exemption.

4. Relief for Deemed Payments of

Income

Several comments were received regarding the difficulty for a withholding

agent to withhold on an amount of income

that is not represented by cash or property

(i.e., deemed payments of income). The

final regulations in §1.1441–2(d) provide

relief in cases in which the withholding

agent does not have custody of, or control

o v e r, property of the taxpayer who is

deemed to receive income under section

871(a) or 881(a) or does not have knowledge of the events that give rise to the

deemed payment. Relief, however, does

not apply for deemed payments arising

between related parties or as part of a prearranged plan to avoid withholding.

Therefore, a withholding obligation arising out of a deemed payment resulting

from an allocation of income under section 482 is not eliminated because the parties are related. Examples are provided

for cancellation of debt and constructive

income arising from correcting prior underwithholding by paying the amount of

tax due to the IRS. Withholding on

deemed distributions with respect to stock

is not excused under these rules. For

these amounts, the IRS and Treasury believe that an exemption from withholding

would be inappropriate in view of the ongoing investment or business relationship

between the parties. Under the final regulations, withholding is required at the

time of the deemed distribution even if

the income from the distribution is prorated over time (such as a redemption premium under section 305(c)). The IRS and

Treasury considered comments asking

that withholding be deferred until income

is includable in the shareholder’s income

but concluded that the withholding procedures necessary to implement such an exception and insure proper withholding

would be too complex.

1997–44 I.R.B.

D. Comments and Changes to §1.1441–3

1. Withholding on Interest Payments

No obligation to withhold is imposed

under current law on the payment of stated

interest on an obligation that was purchased between interest payment dates.

Under §1.61–7(c), interest received on the

interest payment date is treated as a return

of basis to the extent it represents accrued

unpaid interest as of the date of purchase

as reflected in the new holder’s basis for

the obligation. Therefore, when the new

holder receives a payment of the stated interest, the holder’s tax liability is limited

to the amount of interest accrued after the

date of purchase (subject to additional adjustments reflecting possible acquisition

premiums or market discounts). Because

of the difficulty for a withholding agent to

determine the amount accrued to the

holder and other adjustments affecting the

actual amount taxable to the holder, withholding on the entire amount of stated interest is permitted under the regulations.

Although commentators have asked that

the withholding agent be permitted to

withhold on the amount that it knows is

taxable, the final regulations do not modify the proposed regulations on this point

because the IRS and Treasury consider

that withholding on the entire amount is

justified to the extent that, under existing

rules, withholding on sales of obligations

between interest payment dates is not required.

This comment is taken into account,

however, in regulations that are proposed

together with these final regulations to require withholding on sales of obligations

between interest payment dates. These

proposed regulations are intended to conform the withholding regime for sale of

bonds between interest payment dates to

that implemented for OID obligations

under the final regulations. See project

REG–114000–97 published elsewhere in

this issue of the Federal Register.

2. Withholding on Distributions

The proposed regulations regarding

withholding on corporate distributions are

expanded and clarified in view of comments. Section 1.1441–3(c)(1) and (2)(i)

are revised to clarify that the withholding

procedures are elective. In other words, a

distributing corporation or the custodian

or nominee may choose to withhold on

1997–44 I.R.B.

the entire amount distributed and, thus, to

not take advantage of the election to limit

withholding to the estimated earnings and

profits amount. An election by the distributing corporation to determine withholding based on the estimated earnings

and profits amount for distributions it

makes directly to a foreign person does

not mean that a custodian or nominee who

receives payments of distributions for the

account of foreign investors must do the

same when it makes a payment of these

distributions to the foreign investors. Instead, the custodian may choose to disregard the estimate of earnings and profits

and to withhold on the entire distribution.

The revisions reflect the fact that each

withholding agent must be able to make

this decision independently because of its

own potential tax liability under section

1461 in the event of underwithholding.

The final regulations clarify that the

amounts of tax that the withholding agent

pays to satisfy the tax liability under section 1461 if underwithholding has occurred is not subject to withholding even

if it constitutes a constructive dividend.

This rule applies irrespective of the fact

that the satisfaction of the tax liability

may be additional income to the shareholder unless the additional payment results from a contractual arrangement between the parties regarding the

shareholder’s satisfaction of its tax liability by the distributing corporation. With

this rule, the final regulations eliminate,

for this situation, the question as to

whether a taxpayer realizes income when

the withholding agent satisfies a tax liability under section 1461.

Further, proposed §1.1441–3(c)(2)(iii)

(renumbered as §1.1441–3(c)(2)(ii)(C) in

the final regulations) is revised so that an

erroneous estimate by the distributing

corporation is imputed to an intermediary

not only in situations in which the IRS

challenges the estimate but also in situations in which the distributing corporation

unilaterally determines that its estimate is

in error. Some commentators questioned

whether a reference to interest in

§1.1441–3(c)(3)(ii)(B) regarding consequences in the event of underwithholding

had been omitted in error. Interest is not

mentioned in the provision because, to the

extent underwithholding is corrected by

the due date of filing the annual return

under §1.1461–1(b), no interest charge

23

applies. On the other hand, if the withholding agent corrects the underwithholding as part of an amended return filed

after the due date for filing the annual return, then an interest charge would apply,

as reflected in §1.1441–3(c)(3)(ii)(B)(2)(ii).

In response to another comment,

§1.1441–3(c)(3)(ii) is added to allow custodians and nominees to rely on estimates

made by mutual funds regarding their

capital gain dividends and exempt interest

dividends. Some commentators also

asked that §1.1441–3(c)(3)(ii) be revised

to provide that an adjustment to the

amount of withholding is not a distribution for all purposes and not just for purposes of section 562(c). This comment is

not accepted because there are circumstances in which the adjustment may constitute a distribution—such would be the

case, if, for example, the adjustment cannot be made by adjusting the withholding

on a subsequent distribution because the

affected shareholder is no longer a shareholder or the adjustment occurs after the

end of the taxable year.

F i n a l l y, §1.1441–3(c)(4) has been

added to coordinate the general distribution provisions with the regulations under

section 1445. Under §1.1445–5(b)(1), no

withholding is required under section

1445 on a distribution from a U. S. real

property holding corporation (USRPHC)

if the distribution is subject to withholding under section 1441 or 1442. Given

the change in the withholding procedures

applicable to corporate distributions, the

exemption from withholding under section 1445 may now lead to underwithholding on distributions from a USRPHC.

In order to correct this situation, the final

regulations give taxpayers a choice between two withholding regimes. A USRPHC may choose to withhold under section 1441, provided it withholds on the

entire amount of the distribution, regardless of estimated earnings or profits.

However, the rate of withholding may be

reduced under income tax treaty provisions, although not below the 10-percent

rate applicable under section 1445 (unless

the treaty provides otherwise for distributions from USRPHCs). For purposes of

applying the treaty, the entire amount of

the distribution is treated as a dividend.

Alternatively, the USRPHC may withhold

under a mixed regime. Under this regime,

November 3, 1997

withholding applies under section 1441

on the portion of the distribution that represents estimated earnings and profits and

under section 1445 on the remainder of

the distribution. The mixed withholding

regime is mandatory for distributions

from publicly-traded real estate investment trusts (REITs). In other words, a

REIT may not, with respect to its distributions, choose to apply the withholding

regime of section 1441 to the entire distribution. Instead, the REIT must withhold

under section 1441 on the portion of the

distribution that is not designated as a

capital gain dividend or a return of basis.

Withholding under section 1445 is also

required on the portion of the distribution

that the REIT designates as a capital gain

dividend in accordance with §1.1445–8.

3. Withholding on undetermined amounts

The final regulations also address the

practical difficulties of withholding on an

amount when, at the time of payment,

there is not sufficient information to calculate which portion, if any, is taxable or to

determine the source of the income. For

these purposes, provisions have been

added under §1.1441–3(d)(1) that require a

withholding agent to withhold on the entire

amount when such uncertainties exist.

This requirement in part reflects the policy

that withholding generally should apply to

payments that leave the U.S. taxing jurisdiction. The requirement to withhold in

the event of uncertainty is similar to the

provisions under existing regulations

under §1.1441–3(d)(1) (restated as

§1.1441–3(d)(2) of the final regulations)

requiring withholding of an amount sufficient to assure that the tax withheld is no

less than 30-percent of the recognized

gain. In order to minimize overwithholding, the final regulations provide an alternative to withholding on the entire amount

when uncertainties exist. Instead, the withholding agent may make a reasonable estimate of the amount from U.S. sources or of

the taxable amount and set aside a corresponding portion in escrow until the

amount subject to withholding can be determined. Under this alternative, setting

aside an amount is not an event of withholding for purposes of §1.1461–1(a) that

would give rise to the requirement to pay

the tax. Instead, the payment of the tax can

be postponed until a determination can be

made of the amount of withholding liabil-

November 3, 1997

ity under this section. The provisions

under §1.1441– 1(d)(1) do not apply to uncertainties that are specifically addressed

under other provisions of the regulations,

such as lack of information regarding the

identity or status of the beneficial owner or

payee (see §1.1441–1(b)(3) for applicable

presumptions in those cases and the grace

period provisions set forth in §1.1441–

1(b)(3)(iv)) or withholding on original

issue discount amounts (see §1.1441–

2(b)(3)).

E. Comments and Changes to §1.1441–4

1. Notional Principal Contracts

Commentators have questioned

whether it is appropriate to treat income

from notional principal contracts as

FDAP income, particularly since it is unclear at the outset whether the arrangement will generate any income. The IRS

and Treasury believe that the statute contemplates very few exceptions to the concept of FDAP, and the only clear exception is for gain from the disposition of

property. Income from notional principal

contracts is not gain from the disposition

of property, nor is it the equivalent of

gain. However, the final regulations minimize the burden associated with characterizing the income as FDAP because the

liability for withholding under chapter 3

of the Code is eliminated for such income. See §1.1441–4(a)(3). Reporting

under section 1461 or 6041, however,

continues to be required under the final

regulations. However, in response to

comments, the reporting burden has been

reduced and clarified (see §§1.1441–

4(a)(3), 1.1461–1(c)(2)(i)(C) and (ii)(D),

1.6041–1(d)(5) and 1.6041–4(a)(4) of the

final regulations).

Under the final regulations, notional

principal contract payments are exempt

from withholding. However, if paid to a

foreign person, they are presumed effectively connected income and, as such, are

required to be reported on a Form

1042–S. The effectively connected income presumption under §1.1441–4(a)(3)

can be rebutted by providing to the withholding agent a valid withholding certificate representing that the payments are

not effectively connected with the conduct of a U.S. trade or business. In such a

case, no reporting is required on a Form

1042–S for these amounts. A financial in-

24

stitution (as defined in §1.165–12(c)(1)(iv)) may, instead of a withholding certificate, represent in a master agreement

that governs the transactions in notional

principal contracts between the parties

(such as an International Swaps and Derivatives Association (ISDA) Agreement,

including the Schedule thereto) or in the

confirmation on the particular notional

principal contract transaction, that the

counterparty is a U.S. person or is a nonU.S. office of a foreign person. These representations are not required to be made

under penalties of perjury.

In the final regulations, swap payments

include payments on notional principal

contracts described in §1.988–2(e), dealing with foreign currency swaps. Also,

income on notional principal contracts

does not, for purposes of these rules, include amounts characterized as embedded

interest under §1.446–3(g)(4). Such

amounts, if not effectively connected with

the conduct of a U.S. trade or business

and from U.S. sources, are subject to

chapter 3 withholding and are reportable

on a Form 1042 and 1042-S.

Under §1.6041–1(d)(5), a payment on a

notional principal contract, including embedded interest, is a reportable payment,

unless paid to an exempt recipient (i.e., a

person described in §1.6049–4(c)(1)(ii)),

paid outside the United States (unless the

payor has actual knowledge that the payee

is a U.S. person), treated as effectively

connected with a U.S. trade or business

under §1.1441–4(a)(3), or paid by a nonU.S. payor or a non-U.S. middleman. If

none of these exceptions applies, and the

payor does not hold a Form W–9, then a

payment is presumed under §1.6049–

5(d)(2)(i) to be made to a U.S. person that

is not an exempt recipient, in which case

backup withholding would be required

under section 3406.

The final regulations under §§1.6041–

1(d)(5) and 1.1461–1(c)(2)(i)(C) adopt

the suggestion that nonperiodic payments

are reportable only at the time that an actual payment is made. The final regulations require reporting of net income

rather than gross amounts from notional

principal contracts. Further, in response

to comments, the final regulations in

§§1.1441-4(a)(3) and 1.6041–1(d)(5)

specify that the reporting requirements

apply only prospectively, i.e., to payments

made after December 31, 1998.

1997–44 I.R.B.

2. Form 8233 Procedures

The current regulations prescribe a procedure by which a withholding agent may

grant a reduced rate under an income tax

treaty on payments to nonresident aliens

for services rendered in the U.S., generally

in connection with a sporting, cultural, scientific, or artistic event. The procedure involves submitting a Form 8233 to the IRS

for review and approval as instructed

under §1.1441-4(b)(2). The regulations

provide, in effect, that the withholding

agent may not grant an exemption from

withholding until after a 10-day period beginning with the date that the Form 8233,

as reviewed and approved by the withholding agent, is mailed by the withholding

agent to the IRS. The proposed regulations

extend the 10-day period to 20 days.

Commentators objected to the 20-day

period and asked for the retention of the

10-day period. In addition, they suggested that, instead of making the treaty

exemption effective only after the submission of Form 8233, the exemption

should be retroactive to the date of first

payment covered by the certificate if the

completed Form 8233 contains the nonresident alien’s TIN, and if the withholding agent is not subsequently notified by

the IRS within the 20-day period that the

exemption is not valid. After further consideration, the comments are adopted.

The 10-day waiting period is continued

and the approval of the Form 8233 is

made retroactive to the date of first payment covered by the certificate. However, the final regulations clarify that the

IRS review process does not exonerate

the withholding agent from liability for

underwithholding. In its review, the IRS

simply insures that the form contains all

of the requested information, that the

country of residence stated on the form is

a country with which the U.S. has an income tax treaty, that the reduced rate that

the withholding agent plans to apply is the

proper rate under the applicable treaty,

and that, based solely on information contained on the form, the reduced rate appears applicable. The IRS approval of the

form makes no determination regarding

whether the withholding agent’s reliance

on the form is reasonable, based on facts

that the withholding agent knows or has

reason to know at the time of the payment

and that are not disclosed to the IRS as

part of the review process. In addition,

1997–44 I.R.B.

the final regulations allow the 90-day

grace period to apply to payments covered by a Form 8233, in order to allow

time for foreign persons who come to the

United States for the first time and must

complete a Form 8233 shortly after arrival to apply for and obtain an individual

taxpayer identifying number. See

§1.1441–1(b)(3)(iv).

The final regulations modify the proposed rule under §1.1441–1(b)(6) reducing the amount of certain compensation

income by the personal exemption under

section 151. The proposed regulations

allowed a reduction for the full amount of

the exemption. Commentators noted that

allowing a reduction for the full amount

of the allowable personal exemption may

lead to inappropriate claims of multiple

exemptions for nonresident aliens who

come to the U.S. frequently for short-term

events or assignments with different organizations. Commentators were concerned

that they would have no ability to keep

track of prior claims of the personal exemption. For this reason, the proration

rule now currently in effect, is continued

in the final regulations.

3. Reimbursed Expenses

Commentators asked that the regulations provide an exemption from withholding for reimbursed expenses paid to a

nonresident alien individual in relation to

performance of services in the U.S. as an

independent contractor. A change to the

regulations is not necessary, however. If

the payments are exempt from tax under

the Code, they are exempt from withholding under §1.1441–4(b)(1)(iv). If, on the

other hand, those payments are not exempt under the Code, then it would be inappropriate to provide for an exemption

from withholding under section 1441.

F. Comments and Changes to §1.1441–5

In response to comments, many partnership provisions have been consolidated in this section. A new paragraph (a)

has been added to describe the steps necessary to determine the status of the payee

for withholding purposes. The withholding procedures applicable to domestic

partnerships are stated in paragraph (b).

The withholding procedures applicable to

foreign partnerships are stated in paragraph (c). Paragraph (d) describes applicable presumptions in the absence of docu-

25

mentation. Paragraph (e) is reserved for

rules applicable to estates and trusts.

Paragraph (f) contains the effective date

provisions. Corresponding provisions

have been added in §1.6049–5(d)(4), dealing with payments of reportable amounts

under chapter 61 of the Code to address

reporting of payments of amounts that are

not subject to chapter 3 withholding.

Paragraph (c)(1) provides guidance for

identifying the payee in the case of a payment to a foreign partnership. As a general rule, a payment to a foreign partnership is treated as a payment directly to the

partners, whether or not documentation

has been provided for the partners, with

two exceptions: a payment to a “withholding foreign partnership” and a payment to a foreign partnership that has furnished a certificate upon which the

withholding agent can rely to treat the

payment as effectively connected with the

conduct of a U.S. trade or business are

treated as a payment to the foreign partnership and not to the partners.

Paragraph (c)(2) restates the rule proposed under §1.1441–1(e)(5), dealing

with qualified intermediaries, for foreign

partnerships that are withholding foreign

partnerships. In order to avoid confusion,

a withholding foreign partnership is no

longer named a qualified intermediary.

Paragraph (c)(3) deals with foreign

partnerships that are not withholding partnerships. Paragraph (c)(3)(iii) incorporates the withholding certificate provisions

that were in proposed §1.1441–1(e)(3)(iii). Those rules parallel the rules applicable to non-QIs under §1.1441–1(e)(3)(iii) of the final regulations. In

particular, the regulations require that a

statement be attached to the withholding

certificate if necessary to provide information sufficient for the withholding

agent to determine each partner’s distributive share of income subject to withholding. The rules governing the statement

are stated in paragraph (c)(3)(iv) and parallel similar rules in §1.1441–1(e)(3)(iv)

of the final regulations applicable to nonQIs. At the request of commentators,

paragraph (c)(3)(iii) clarifies that a foreign partnership receiving income that is

effectively connected with the conduct of

a U.S. trade or business is not required to

furnish separate certificates for each of its

partners. Instead, it may furnish one single withholding certificate, even though

November 3, 1997

the partnership is not a withholding foreign partnership. See also paragraph

(c)(1)(ii)(C). This procedure is reasonable because, in such a case, the partnership is subject to withholding procedures

under section 1446.

Paragraph (d) describes the presumptions upon which a withholding agent can

rely when making payments to a partnership for which certain documentation is

lacking or unreliable. First, under paragraph (d)(2), a recipient that is presumed

to be a partnership (based on presumptions set forth in §1.1441–1(b)(3)(ii)) is

presumed to be a foreign partnership if

certain indicia of foreign status are present. If, based on such a presumption, the

withholding agent has determined that the

payment is made to a foreign partnership

(presumably acting for the account of its

partners since intermediary status generally cannot be presumed in the absence of

valid documentation), uncertainties may

remain regarding the status of the partners, the allocation of a payment among

them, or whether all the partners have

been accounted for. Under the final regulations, a payment that cannot be reliably

associated with a withholding certificate

from a partner is presumed made to a foreign payee. As a result, the withholding

agent is required to withhold 30-percent

from the payment, without a reduction.

Also, any part of a payment that it is not

reliably allocated to a partner is presumed

allocable to the partner with the highest

withholding rate or the highest U.S. tax liability (as the withholding agent can best

estimate) if the withholding rates are

equal. Third, if the withholding agent

does not have a reliable certification that

all the partners are accounted for, and, as

a result, the withholding agent cannot reliably determine the distributive share of

any one or more partners, then none of the

payment can be reliably associated with

any one partner and the entire payment is

presumed made to a foreign payee.

These procedures parallel those applicable to foreign intermediaries under

§1.1441–1(b)(3)(v). They differ from the

presumptions stated in the proposed regulations under §1.1441–1(f)(4)(ii) which

provided that the amounts were paid to a

U.S. payee that is not an exempt recipient.

Thus, the final regulations, by presuming

that the amounts are paid to a foreign

payee, require that a 30-percent amount

November 3, 1997

be withheld on amounts subject to withholding under chapter 3 of the Code

rather than a 31-percent amount under the

backup withholding provisions of section

3406. However, for amounts that are not

subject to chapter 3 withholding,

§1.16049–5(d)(4) retains the provisions

in the proposed regulations that the payments are presumed made to a non-exempt recipient U.S. payee. In such a case,

31-percent backup withholding applies

instead of 30-percent withholding.

The final regulations under §1.1441–

5(d)(3)(iv) clarify that a foreign partnership that is a withholding foreign partnership determines who the payee is and the

status of the payee, based on the provisions of §1.1441–1(b)(2) and §1.1441–

5(c) and (d) in the same manner as if it

were making payments directly to the

partners other than in their capacity as

partners. In the absence of documentation regarding the partners, the partners

are presumed to be foreign persons rather

than U.S. persons, including for amounts

that are not subject to chapter 3 withholding. A presumption of U.S. status for

amounts not subject to chapter 3 withholding would not be meaningful because

a foreign partnership is not a payor for

purposes of chapter 61 of the Code and

backup withholding under section 3406

when making payments to its partners.

Therefore, payments made by a foreign

partnership to its partners are not reportable under chapter 61 and are not subject to backup withholding. Instead, a

foreign partnership must file an annual return on Form 1065 and report each partner’s distributive share on Forms K-1,

which forms are filed with the IRS with a

copy to each partner. Such filing requirements apply in all cases in which the foreign partnership derives U.S. income, irrespective of whether the tax liability has

been satisfied by withholding at source or

whether all the partners are foreign. See

section 6031 and §§1.6031–1(c) and

1.6031(b)–1T. However, in order to reduce the burden on foreign partnerships

that are not withholding foreign partnerships, the IRS and Treasury are planning

to issue regulations under section 6031

that would eliminate the filing requirement under section 6031 for foreign partnerships that are not engaged in a U.S.

trade or business, that furnish appropriate

documentation for each of their partners,

26

and whose partners’ U.S. tax liability has

been fully satisfied at source.

Commentators asked that foreign partnerships be allowed to certify under penalties of perjury that all the partners are foreign and to use the same sub-accounting

procedures that qualified intermediaries

may use. In particular, where a partner is

entitled to reduced withholding under the

regulations without providing a TIN, commentators argue that there should not be a

requirement that the partnership’s intermediary withholding certificate specify that

partner’s distributive share of the item of

income paid to the partnership. Also, they

argue that there should not be a requirement that a separate Form 1042–S be filed

under the partner’s name. Instead, the

partnership’s intermediary withholding

certificate should indicate the aggregate

distributive shares of all members entitled

to a single rate, and reporting should be

done on the aggregate amount under the

partnership’s account. These comments

are similar to those received for non-QIs

and are not adopted for the same reasons

that they are rejected for non-QIs. It is important to retain the distinction between

foreign partnerships that qualify as withholding agents (i.e., those that are withholding foreign partnerships or are subject

to section 1446) and those that are not

qualified to act as withholding agents. If a

foreign partnership is not a withholding

foreign partnership, it should not be permitted to certify the status of its partners

on their behalf.

Commentators asked that a foreign entity holding a passive invest

This text is long and has been trimmed here. Open the source document for the complete record.