# These synopses are intended only as aids to the reader in > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Airs%3Ad9736774b16563b3 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text 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 pos [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3Ad9736774b16563b3. Public record. Not legal advice.