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

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

[TD 8734]

RIN 1545-AU43; 1545-AT77

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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: 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.

[[Page 53388]]

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, published on February 29, 1988, under sections 6041, 6042, 6044,

6045, and 6049. This document also finalizes proposed regulations

contained in project number IA-33-95, 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 Sec. 31.9999-0, the removal of Sec. 35a.9999-0T

and the addition of Sec. 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 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 Affairs, 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.

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 30-percent 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 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

[[Page 53389]]

provided on a Form W-8. See Sec. 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 Sec. 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. 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,

Sec. 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

Sec. 31.3406(a)-1(a) and, for example, Sec. 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

international 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 Sec. 35a.9999-5(b), A-9. The final regulations offer alternative

procedures and respond to the concerns expressed 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 country

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

[[Page 53390]]

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 Sec. 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 Sec. 1.871-14 and Related Reporting

Requirements 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 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 Sec. 35a.9999-

5(a), A-1 and the rules in Sec. 5f.103-1(c) defining a bearer

obligation. It also reflects the rules in Sec. 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 Sec. 5f.103-1(c) is restated in

Sec. 1.871-14(c)(1)(i). The definition restates the rules in

Sec. 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 Sec. 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

Sec. 1.165-12(c). In response to these comments, the $1 million minimum

denomination requirement under Sec. 1.165-12(c)(1)(ii) is eliminated in

order to conform that provision to Sec. 1.165-12(c)(3)(iii). In

addition, in Sec. 1.165-12(c), the term United States is replaced with

the term United States and its possessions to coordinate the provisions

with Sec. 1.163-5(c)(2)(i) (C) and (D). In Sec. 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

Sec. 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 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 Sec. 1.1441-1(f)(5). Under proposed Secs. 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

Sec. 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 Sec. 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

indicates 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 Sec. 1.1441-

1(b)(7) (i.e., proposed Sec. 1.1441-1(f)(5) as renumbered under the

final regulations) is included in Sec. 1.871-14(c)(3) to clarify the

difference between the two cure procedures.

B. Comments and Changes to Sec. 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 Sec. 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

[[Page 53391]]

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 Sec. 1.1441-1 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 Sec. 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 Sec. 1.6049-4(c)(1)(ii). Assume further

that the U.S. brokerage 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 Sec. 1.6049-4(c)(1)(ii), it is required to backup

withhold 31-percent under section 3406. See Sec. 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 Sec. 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 income. 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 Sec. 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 Secs. 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 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,

[[Page 53392]]

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 Sec. 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. Different 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 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 Sec. 1.1441-1(b)(2)(ii).

3. Payments to Wholly-Owned Entities

The final regulations under Sec. 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

Sec. 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 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.

Different 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 Secs. 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, Sec. 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

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

Sec. 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

[[Page 53393]]

extent permitted by the district director or the Assistant Commissioner

(International). Procedures for obtaining such permission existed under

prior regulations under Sec. 1.1441-4(f). These provisions are restated

in Sec. 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 Sec. 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-form principles, such as those reflected in section

7701(l) dealing with conduit transactions. The special definition of

beneficial owner in proposed Sec. 1.1441-1(c)(6)(ii)(B) for purposes of

tax treaties has been eliminated. See the explanation below under

Sec. 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 Sec. 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 Sec. 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

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 Sec. 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

Sec. 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 Sec. 1.1441-

1(f)(2)(i)(B), but do not allow it to be used for other purposes. 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 Sec. 1.1441-1(e)(4)(iv) of the final regulations by prescribing

the standards that electronic systems must meet in order to effect 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 Sec. 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

[[Page 53394]]

information system that allows the withholding agent to easily access

information regarding the nature of the certificate furnished, the

information 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 Sec. 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 Sec. 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

Sec. 1.1441-1(e)(4)(ix)(C). The final regulations clarify that a

withholding agent has knowledge of all information in the system. See

Sec. 1.1441-7(b)(3).

f. Forms from Foreign Partnerships. In response to comments, the

provisions under proposed Sec. 1.1441-1(e)(3)(iii) dealing with

withholding certificates furnished by a foreign partnership have been

moved to Sec. 1.1441-5(c), which contains most of the withholding

provisions governing payments to foreign partnerships (see explanation

of the changes under Sec. 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 Sec. 1.1441-1(e)(3)(iv)

(renumbered as Sec. 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 Sec. 1.1441-1(e)(3)(iii).

Also, proposed Sec. 1.1441-1(e)(3)(iv) (C) and (D) (renumbered as

Sec. 1.1441-1(e)(3)(iii) (C) and (D) in the final regulations) has been

modified and paragraph (e)(3)(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 Sec. 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 U.S. branches are effectively connected

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

case. See Sec. 1.1441-4(a)(2)(ii).

Also, Sec. 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

Sec. 1.1441-1(e) (3)(iv) and (5)(v) for a description of the statement

and Sec. 1.1441-1(e)(4)(ii)(D) for related validity rules.

i. Effect of Changes in Circumstances. Proposed Sec. 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 affecting 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 non-qualified 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.

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

[[Page 53395]]

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 Secs. 1.1441-1(b)(3)(iv) and 1.6049-

5(d)(2)(ii).

j. Acceptable Substitute Form. In addition, proposed Sec. 1.1441-

1(e)(4)(vi) is modified in response to comments that asked that the

meaning of the cross-reference to Sec. 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

Sec. 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

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 Sec. 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

Sec. 1.1441-6, below). Further, the provisions dealing with a

withholding agent's due diligence are also expanded and clarified (see

explanation under Sec. 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 Sec. 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 explained in the preamble to the proposed regulations, the

intermediary procedures provided in Sec. 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 Sec. 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 documentation 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 Sec. 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 Sec. 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,

[[Page 53396]]

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

Sec. 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 Sec. 1.1441-6, below. Also at the request of

commentators, a transition rule is added to Sec. 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.

Commentators were divided on whether the regulations should allow a

QI to assume primary withholding responsibility as proposed in

Sec. 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 Sec. 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 applicable 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 different 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 Sec. 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 Sec. 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 regulations

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

Sec. 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 Sec. 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 Announcement 96-23 (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

[[Page 53397]]

procedures will generally provide adequate information regarding the

nationality 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 Sec. 1.1461-1 (b) and (c). After further

review, 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 auditor,

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

Sec. 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 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 country, derives the income (within the meaning of the

regulations under Sec. 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 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

auditors 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 for training and advising appropriate

personnel 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

[[Page 53398]]

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 Sec. 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 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 Sec. 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

Sec. 1.6049-4(c)(1)(ii)(O). Treating a U.S. intermediary as an exempt

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 Sec. 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 Sec. 1.144-1(b)(3)(v)(B) to the extent the payment

consists of an amount subject to chapter 3 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 Secs. 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 Sec. 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

[[Page 53399]]

under section 3406. This 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 Sec. 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 Sec. 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 flow-through entity) is a foreign person or

an exempt recipient.

Further, provisions have been added to explain how the U.S.

withholding and reporting 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, Sec. 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

Sec. 1.6049-5(b)(14) for interest and Sec. 1.6042-3(b)(1)(vi) for

dividends. Similar provisions are made under Sec. 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 individual's Form W-8 (or

alternative documentary evidence) to the U.S. withholding agent in

compliance with Sec. 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 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 Sec. 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 Sec. 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 Sec. 1.6049-5(b)(12). Under Sec. 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 intermediary 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 Sec. 301-7701-2(b)(8)(i), or the

payment is made outside the United States. The final regulations under

Sec. 1.6049-5(d)(4)(iii) presume that a person receiving a payment of

U.S. bank deposit interest or U.S. short-term OID is not acting for its

own account (note that this presumption is different from the general

presumption under Sec. 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

[[Page 53400]]

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 Sec. 1.1441-1(f), dealing with presumptions of U.S. or

foreign status in the absence of reliable documentation, is restated

with a number of clarifications, in Secs. 1.1441-1(b)(3) and 1.6049-

5(d) (2) through (5). The presumptions in Sec. 1.1441-1(b)(3) apply to

amounts that are subject to chapter 3 withholding. The same

presumptions apply under Sec. 1.6049-5(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 Sec. 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

Sec. 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 Sec. 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 Sec. 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. Therefore, under Sec. 1.1441-1(b)(3)(iii)(A), a payment

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 Secs. 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

Sec. 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 Sec. 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 Secs. 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 Sec. 1.1441-1(b)(3)(v)(A)), and as an individual, a

trust, an estate, a corporation or a partnership. See Sec. 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 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 Sec. 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 Sec. 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

Sec. 1.1441-1(b)(3)(ix)(A).

12. Presumptions--Grace Period

Several comments were received regarding the grace period

provisions under proposed Sec. 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 status 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

[[Page 53401]]

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 30-percent 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 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 Sec. 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 Sec. 1.6049-5(d)(2)(ii) and Sec. 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 Sec. 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 presumptions 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

Sec. 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

Sec. 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 Sec. 1.6049-4(c)(1)(ii)(A)(1) or is presumed to be

one of the persons enumerated under Sec. 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 Sec. 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 Sec. 1.6049-4(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 Sec. 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 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 Sec. 1.1441-

1(b)(3)(v)(B). Additional presumptions are provided under Sec. 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

[[Page 53402]]

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 Sec. 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

Sec. 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 intermediary,

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 Sec. 1.1441-5(d). See the explanation under

Sec. 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 the withholding agent or payor prior to the time of

payment. The proposed regulations in Sec. 1.1441-1(f)(5) prescribe

procedures allowing a Form W-8 or other documentation to be furnished

late (i.e., after the 90-day grace period), subject to interest and

penalties. They also contemplate the possibility that, upon

examination, the IRS might require the withholding agent or payor to

furnish additional proof in support of the claim of foreign status or

eligibility for a reduced rate of withholding under the Code or a tax

treaty. Commentators asked for an exemption from interest and penalties

when it is determined that there is no underlying tax liability once

the documentation has been provided or, at least, that the liability be

abated where the withholding agent has acted in good faith.

The final regulations do not eliminate the possibility that

interest and penalties may apply because the liability for those items

is clearly contemplated under section 1463. However, several revisions

are made to relieve liability in certain cases. See Sec. 1.1441-

1(b)(7), restating the provisions of proposed Sec. 1.1441-1(f)(5).

First, in order to eliminate the possibility of a double interest

charge when the respective unsatisfied tax liabilities of the

withholding agent and of the beneficial owner run concurrently, the

regulations are modified to limit collection to one amount of interest

only. In that regard, interest will not be assessed against the

withholding agent if it otherwise is assessed or collected against the

beneficial owner. Next, in order to clarify that the cure rules apply

to all cases for which documentation must be provided to the

withholding agent, cross references have been added under Secs. 1.1441-

4(f), 1.1441-5(f), 1.1441-6(f), 1.1441-8(e), 1.1441-9(c), and 1.1443-

1(b)(3). In addition, the final regulations make this relief available

on a retroactive basis for all open years. This action is intended to

eliminate any ongoing controversy with the IRS regarding an issue that

is unclear under current law. The final regulations clarify that the

period for calculating penalties and interest is limited to the time

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

date for filing the return under section 6601 (i.e., March 15 of the

year following the year in which the payment was made) and ending with

the date that the tax is considered paid (i.e., the time that the

documentation is furnished establishing the proper amount of tax due or

that the tax is actually paid, whichever is earlier). Also,

commentators asked for a clarification of how late deposit penalties

would apply when the withholding agent fails to withhold. This issue

remains under consideration.

16. Due Diligence With Respect to Information Returns Required Under

Chapter 61 of the Code

The Interest and Dividend Tax Compliance Act of 1983 provided that

the penalty for the failure to file an information return, furnish a

copy of it to a payee, or supply a TIN can be waived if it is shown

that the filer exercised due diligence in filing the return, furnishing

it to a payee, or supplying the payee's TIN. The due diligence standard

applied to failures on information returns reporting dividends under

section 6042, patronage dividends under section 6044, and interest or

OID under section 6049. The IRS issued regulations in question and

answer form providing the prerequisites to establish due diligence. See

Secs. 35a.9999-1 through 35a.9999-5.

The Omnibus Budget Reconciliation Act of 1989, Public Law 101-239,

103 Stat. 2393, repealed sections 6676 and 6678 with the enactment of

uniform information reporting penalties under sections 6721 through

6724 and replaced due diligence with a reasonable cause standard under

newly enacted section 6724. However, Congress provided that the

separate and higher due diligence waiver standard for returns filed

under sections 6042, 6044, and 6049 be considered to meet reasonable

cause. H. Rep. No. 247, 101st. Cong., 1st. Sess., at 1385 (1989).

These final regulations remove the Q/As under Part 35a, effective

January 1, 1999. Because due diligence will remain in effect, the IRS

will retain the relevant Q/As set forth in Part 35a. These final

regulations redesignate the relevant Q/As under Sec. 301.6724-1(g).

17. Effective Dates

Many comments were received regarding the effective dates of the

final regulations. Commentators argued that the January 1, 1998

effective date in the proposed regulations should be extended because

of the anticipated time required to complete QI agreements and for

withholding agents to make the administrative and operating systems

changes that will be necessary to comply with the regulations. However,

commentators have argued that provision should also be made for a

financial institution to elect earlier adoption of the new requirements

where possible.

The final regulations accommodate these concerns. The effective

date is changed to January 1, 1999. In view of the later effective date

and comments that staggered effective dates make system adjustments

more difficult and costly, all special delayed effective dates rules

are eliminated. Also, transition rules are modified for existing

certificates. Valid withholding certificates that are held on December

31, 1998, remain valid until the earlier of December 31, 1999 or the

due date of expiration of the certificate under rules currently in

effect (unless otherwise invalidated due to changes in the

circumstances of the person whose name is on the certificate). Further,

certificates dated prior to January 1, 1998 that are valid as of

January 1, 1998, remain valid until the end of 1998, irrespective of

the fact that their validity expires during 1998 (other than by reason

of changes in the circumstances of the person whose name is on the

certificate).

The final regulations do not accelerate the effective date of

certain provisions as had been requested by several commentators.

Although doing so would provide relief to a number of

[[Page 53403]]

taxpayers, it would also complicate the many system adjustments that

withholding agents, particularly financial institutions with large

volume of cross-border payments, must implement before the effective

date of these regulations. The IRS and Treasury feel that the benefits

of accelerating certain provisions would not sufficiently outweigh the

added costs and burdens to many withholding agents.

C. Comments and Changes to Sec. 1.1441-2

1. Amounts Subject to Withholding

Under Sec. 1.1441-1 of current regulations, an amount is subject to

withholding only if it is from sources within the United States. The

final regulations under Sec. 1.1441-2(a) clarify that an amount can be

sourced within the United States irrespective of the fact that the

source is undetermined at the time of payment. This clarification

addresses the Tax Court's ruling in Albert J. Miller v. Commissioner,

T.C. Memo 1997-134, 73 T.C.M. (CCH) 2319, that an amount whose source

cannot be determined at the time paid is sourced outside the United

States for purposes of sections 871(a) or 881(a) and the withholding

provisions of chapter 3 of the Code.

2. Fixed or Determinable Annual or Periodical Income

The definition of the term fixed or determinable annual or

periodical (FDAP) income under existing regulations under section 1441

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

Sec. 1.1441-2(b)(1)(iii) addresses three types of uncertainties that a

withholding agent may encounter: (1) The proportion of the payment that

constitutes income cannot be determined when a payment is made (e.g., a

payment made on an obligation that may include interest, but the exact

amount of interest cannot be determined because the determination is

contingent upon future events); (2) the proportion of the payment that

constitutes U.S. source income cannot be determined at the time of

payment; or (3) the fact that the payment may be income in the future

cannot be anticipated at the time of payment. Only in the third case

would the payment not constitute FDAP income. In the first two cases,

income is actually being paid. The only uncertainty is the amount that

the recipient should include in income and this uncertainty does not

prevent the payment from constituting fixed or determinable annual or

periodical income for purposes of section 871(a) or 881(a) and the

withholding provisions of chapter 3 of the Code. See also the

additional provisions under Secs. 1.1441-2(b)(1)(iii) and 1.1441-

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

whose source cannot be determined at the time of payment.

3. Original Issue Discount

In response to comments, the final regulations regarding

withholding on original issue discount (OID) are simplified. As a

general principle, withholding is required on a payment that is treated

as taxable OID under section 871(a)(1)(C) or 881(a)(3)(A) to the extent

the withholding agent knows the amount that is OID. That amount is

known to the withholding agent if it knows how long the beneficial

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

the obligation, and the extent to which the beneficial owner purchased

the obligation at a premium. A withholding agent has knowledge if the

information is obtainable upon exercising reasonable efforts. The

information is not considered obtainable in the case of payments with

respect to publicly traded securities where the withholding agent,

consistent with normal industry practices, does not have a direct

customer relationship with the person who has actual knowledge of the

relevant information or has no access to this information in the normal

course of its business due to the manner in which the obligation is

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

withholding agent maintaining a direct customer relationship with the

beneficial owner, knowledge regarding the owner's holding period and

acquisition premium is considered to be reasonably available to the

withholding agent. Because of the complexities that may be involved in

calculating the amount taxable to the owner and, thus, subject to

withholding, withholding agents may rely on the most recently published

``List of OID Instruments'' or similar list published by the IRS

(currently contained in IRS Publication 1212 (available from the IRS

Forms Distribution Centers)).

Notwithstanding the rules described in the preceding paragraph,

withholding is required with respect to OID that would qualify as

portfolio interest except for the fact that documentation required

under section 871(h)(5) is not furnished to the withholding agent. In

the absence of information regarding the amount of OID, the withholding

agent may rely on IRS Publication 1212. The final regulations clarify

that no withholding applies to amounts that are not otherwise subject

to chapter 3 withholding (e.g., OID on obligations in bearer form that

qualifies as portfolio interest).

3. Securities Lending Transactions

The final regulations add paragraph (b)(4) to cross-reference the

regulations under sections 871 and 881 dealing with securities lending

transactions and equivalent transactions. Thus, the character of the

income arising from these transactions applies for purposes of

determining the amount of withholding under chapter 3 of the Code.

Similar rules apply for purposes of information reporting and backup

withholding on interest and dividends. See Secs. 1.6042-3(a)(2) and

1.6049-5(a)(5). See Sec. 1.1441-1(b)(4)(i) for documenting interest

equivalent amounts for which the beneficial owner claims a portfolio

interest exemption.

4. Relief for Deemed Payments of Income

Several comments were received regarding the difficulty for a

withholding agent to withhold on an amount of income that is not

represented by cash or property (i.e., deemed payments of income). The

final regulations in Sec. 1.1441-2(d) provide relief in cases in which

the withholding agent does not have custody of, or control over,

property of the taxpayer who is deemed to receive income under section

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

rise to the deemed payment. Relief, however, does not apply for deemed

payments arising between related parties or as part of a pre-arranged

plan to avoid withholding. Therefore, a withholding obligation arising

out of a deemed payment resulting from an allocation of income under

section 482 is not eliminated because the parties are related. Examples

are provided for cancellation of debt and constructive income arising

from correcting prior underwithholding by paying the amount of tax due

to the IRS. Withholding on deemed distributions with respect to stock

is not excused under these rules. For these amounts, the IRS and

Treasury believe that an exemption from withholding would be

inappropriate in view of the ongoing investment or business

relationship between the parties. Under the final regulations,

withholding is required at the time of the deemed distribution even if

the income from the distribution is prorated over time (such as a

redemption premium under section 305(c)). The IRS and Treasury

considered comments asking that withholding be deferred until income is

includable in the

[[Page 53404]]

shareholder's income but concluded that the withholding procedures

necessary to implement such an exception and insure proper withholding

would be too complex.

D. Comments and Changes to Sec. 1.1441-3

1. Withholding on Interest Payments

No obligation to withhold is imposed under current law on the

payment of stated interest on an obligation that was purchased between

interest payment dates. Under Sec. 1.61-7(c), interest received on the

interest payment date is treated as a return of basis to the extent it

represents accrued unpaid interest as of the date of purchase as

reflected in the new holder's basis for the obligation. Therefore, when

the new holder receives a payment of the stated interest, the holder s

tax liability is limited to the amount of interest accrued after the

date of purchase (subject to additional adjustments reflecting possible

acquisition premiums or market discounts). Because of the difficulty

for a withholding agent to determine the amount accrued to the holder

and other adjustments affecting the actual amount taxable to the

holder, withholding on the entire amount of stated interest is

permitted under the regulations. Although commentators have asked that

the withholding agent be permitted to withhold on the amount that it

knows is taxable, the final regulations do not modify the proposed

regulations on this point because the IRS and Treasury consider that

withholding on the entire amount is justified to the extent that, under

existing rules, withholding on sales of obligations between interest

payment dates is not required.

This comment is taken into account, however, in regulations that

are proposed together with these final regulations to require

withholding on sales of obligations between interest payment dates.

These proposed regulations are intended to conform the withholding

regime for sale of bonds between interest payment dates to that

implemented for OID obligations under the final regulations. See

project REG-114000-97 published elsewhere in this issue of the Federal

Register.

2. Withholding on Distributions

The proposed regulations regarding withholding on corporate

distributions are expanded and clarified in view of comments. Section

1.1441-3(c)(1) and (2)(i) are revised to clarify that the withholding

procedures are elective. In other words, a distributing corporation or

the custodian or nominee may choose to withhold on the entire amount

distributed and, thus, to not take advantage of the election to limit

withholding to the estimated earnings and profits amount. An election

by the distributing corporation to determine withholding based on the

estimated earnings and profits amount for distributions it makes

directly to a foreign person does not mean that a custodian or nominee

who receives payments of distributions for the account of foreign

investors must do the same when it makes a payment of these

distributions to the foreign investors. Instead, the custodian may

choose to disregard the estimate of earnings and profits and to

withhold on the entire distribution. The revisions reflect the fact

that each withholding agent must be able to make this decision

independently because of its own potential tax liability under section

1461 in the event of underwithholding. The final regulations clarify

that the amounts of tax that the withholding agent pays to satisfy the

tax liability under section 1461 if underwithholding has occurred is

not subject to withholding even if it constitutes a constructive

dividend. This rule applies irrespective of the fact that the

satisfaction of the tax liability may be additional income to the

shareholder unless the additional payment results from a contractual

arrangement between the parties regarding the shareholder's

satisfaction of its tax liability by the distributing corporation. With

this rule, the final regulations eliminate, for this situation, the

question as to whether a taxpayer realizes income when the withholding

agent satisfies a tax liability under section 1461.

Further, proposed Sec. 1.1441-3(c)(2)(iii) (renumbered as

Sec. 1.1441-3(c)(2)(ii)(C) in the final regulations) is revised so that

an erroneous estimate by the distributing corporation is imputed to an

intermediary not only in situations in which the IRS challenges the

estimate but also in situations in which the distributing corporation

unilaterally determines that its estimate is in error. Some

commentators questioned whether a reference to interest in Sec. 1.1441-

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

had been omitted in error. Interest is not mentioned in the provision

because, to the extent underwithholding is corrected by the due date of

filing the annual return under Sec. 1.1461-1(b), no interest charge

applies. On the other hand, if the withholding agent corrects the

underwithholding as part of an amended return filed after the due date

for filing the annual return, then an interest charge would apply, as

reflected in Sec. 1.1441-3(c)(3)(ii)(B)(2)(ii).

In response to another comment, Sec. 1.1441-3(c)(3)(ii) is added to

allow custodians and nominees to rely on estimates made by mutual funds

regarding their capital gain dividends and exempt interest dividends.

Some commentators also asked that Sec. 1.1441-3(c)(3)(ii) be revised to

provide that an adjustment to the amount of withholding is not a

distribution for all purposes and not just for purposes of section

562(c). This comment is not accepted because there are circumstances in

which the adjustment may constitute a distribution--such would be the

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

withholding on a subsequent distribution because the affected

shareholder is no longer a shareholder or the adjustment occurs after

the end of the taxable year.

Finally, Sec. 1.1441-3(c)(4) has been added to coordinate the

general distribution provisions with the regulations under section

1445. Under Sec. 1.1445-5(b)(1), no withholding is required under

section 1445 on a distribution from a U. S. real property holding

corporation (USRPHC) if the distribution is subject to withholding

under section 1441 or 1442. Given the change in the withholding

procedures applicable to corporate distributions, the exemption from

withholding under section 1445 may now lead to underwithholding on

distributions from a USRPHC. In order to correct this situation, the

final regulations give taxpayers a choice between two withholding

regimes. A USRPHC may choose to withhold under section 1441, provided

it withholds on the entire amount of the distribution, regardless of

estimated earnings or profits. However, the rate of withholding may be

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

percent rate applicable under section 1445 (unless the treaty provides

otherwise for distributions from USRPHCs). For purposes of applying the

treaty, the entire amount of the distribution is treated as a dividend.

Alternatively, the USRPHC may withhold under a mixed regime. Under this

regime, withholding applies under section 1441 on the portion of the

distribution that represents estimated earnings and profits and under

section 1445 on the remainder of the distribution. The mixed

withholding regime is mandatory for distributions from publicly-traded

real estate investment trusts (REITs). In other words, a REIT may not,

with respect to its distributions, choose to apply the withholding

regime of section

[[Page 53405]]

1441 to the entire distribution. Instead, the REIT must withhold under

section 1441 on the portion of the distribution that is not designated

as a capital gain dividend or a return of basis. Withholding under

section 1445 is also required on the portion of the distribution that

the REIT designates as a capital gain dividend in accordance with

Sec. 1.1445-8.

3. Withholding on Undetermined Amounts

The final regulations also address the practical difficulties of

withholding on an amount when, at the time of payment, there is not

sufficient information to calculate which portion, if any, is taxable

or to determine the source of the income. For these purposes,

provisions have been added under Sec. 1.1441-3(d)(1) that require a

withholding agent to withhold on the entire amount when such

uncertainties exist. This requirement in part reflects the policy that

withholding generally should apply to payments that leave the U.S.

taxing jurisdiction. The requirement to withhold in the event of

uncertainty is similar to the provisions under existing regulations

under Sec. 1.1441-3(d)(1) (restated as Sec. 1.1441-3(d)(2) of the final

regulations) requiring withholding of an amount sufficient to assure

that the tax withheld is no less than 30 percent of the recognized

gain. In order to minimize overwithholding, the final regulations

provide an alternative to withholding on the entire amount when

uncertainties exist. Instead, the withholding agent may make a

reasonable estimate of the amount from U.S. sources or of the taxable

amount and set aside a corresponding portion in escrow until the amount

subject to withholding can be determined. Under this alternative,

setting aside an amount is not an event of withholding for purposes of

Sec. 1.1461-1(a) that would give rise to the requirement to pay the

tax. Instead, the payment of the tax can be postponed until a

determination can be made of the amount of withholding liability under

this section. The provisions under Sec. 1.1441-1(d)(1) do not apply to

uncertainties that are specifically addressed under other provisions of

the regulations, such as lack of information regarding the identity or

status of the beneficial owner or payee (see Sec. 1.1441-1(b)(3) for

applicable presumptions in those cases and the grace period provisions

set forth in Sec. 1.1441-1(b)(3)(iv)) or withholding on original issue

discount amounts (see Sec. 1.1441-2(b)(3)).

E. Comments and Changes to Sec. 1.1441-4

1. Notional Principal Contracts

Commentators have questioned whether it is appropriate to treat

income from notional principal contracts as FDAP income, particularly

since it is unclear at the outset whether the arrangement will generate

any income. The IRS and Treasury believe that the statute contemplates

very few exceptions to the concept of FDAP, and the only clear

exception is for gain from the disposition of property. Income from

notional principal contracts is not gain from the disposition of

property, nor is it the equivalent of gain. However, the final

regulations minimize the burden associated with characterizing the

income as FDAP because the liability for withholding under chapter 3 of

the Code is eliminated for such income. See Sec. 1.1441-4(a)(3).

Reporting under section 1461 or 6041, however, continues to be required

under the final regulations. However, in response to comments, the

reporting burden has been reduced and clarified (see Secs. 1.1441-

4(a)(3), 1.1461-1(c)(2)(i)(C) and (ii)(D), 1.6041-1(d)(5) and 1.6041-

4(a)(4) of the final regulations).

Under the final regulations, notional principal contract payments

are exempt from withholding. However, if paid to a foreign person, they

are presumed effectively connected income and, as such, are required to

be reported on a Form 1042-S. The effectively connected income

presumption under Sec. 1.1441-4(a)(3) can be rebutted by providing to

the withholding agent a valid withholding certificate representing that

the payments are not effectively connected with the conduct of a U.S.

trade or business. In such a case, no reporting is required on a Form

1042-S for these amounts. A financial institution (as defined in

Sec. 1.165-12(c)(1)(iv)) may, instead of a withholding certificate,

represent in a master agreement that governs the transactions in

notional principal contracts between the parties (such as an

International Swaps and Derivatives Association (ISDA) Agreement,

including the Schedule thereto) or in the confirmation on the

particular notional principal contract transaction, that the

counterparty is a U.S. person or is a non-U.S. office of a foreign

person. These representations are not required to be made under

penalties of perjury.

In the final regulations, swap payments include payments on

notional principal contracts described in Sec. 1.988-2(e), dealing with

foreign currency swaps. Also, income on notional principal contracts

does not, for purposes of these rules, include amounts characterized as

embedded interest under Sec. 1.446-3(g)(4). Such amounts, if not

effectively connected with the conduct of a U.S. trade or business and

from U.S. sources, are subject to chapter 3 withholding and are

reportable on a Form 1042 and 1042-S.

Under Sec. 1.6041-1(d)(5), a payment on a notional principal

contract, including embedded interest, is a reportable payment, unless

paid to an exempt recipient (i.e., a person described in Sec. 1.6049-

4(c)(1)(ii)), paid outside the United States (unless the payor has

actual knowledge that the payee is a U.S. person), treated as

effectively connected with a U.S. trade or business under Sec. 1.1441-

4(a)(3), or paid by a non-U.S. payor or a non-U.S. middleman. If none

of these exceptions applies, and the payor does not hold a Form W-9,

then a payment is presumed under Sec. 1.6049-5(d)(2)(i) to be made to a

U.S. person that is not an exempt recipient, in which case backup

withholding would be required under section 3406.

The final regulations under Secs. 1.6041-1(d)(5) and 1.1461-

1(c)(2)(i)(C) adopt the suggestion that nonperiodic payments are

reportable only at the time that an actual payment is made. The final

regulations require reporting of net income rather than gross amounts

from notional principal contracts. Further, in response to comments,

the final regulations in Secs. 1.1441-4(a)(3) and 1.6041-1(d)(5)

specify that the reporting requirements apply only prospectively, i.e.,

to payments made after December 31, 1998.

2. Form 8233 Procedures

The current regulations prescribe a procedure by which a

withholding agent may grant a reduced rate under an income tax treaty

on payments to nonresident aliens for services rendered in the U.S.,

generally in connection with a sporting, cultural, scientific, or

artistic event. The procedure involves submitting a Form 8233 to the

IRS for review and approval as instructed under Sec. 1.1441-4(b)(2).

The regulations provide, in effect, that the withholding agent may not

grant an exemption from withholding until after a 10-day period

beginning with the date that the Form 8233, as reviewed and approved by

the withholding agent, is mailed by the withholding agent to the IRS.

The proposed regulations extend the 10-day period to 20 days.

Commentators objected to the 20-day period and asked for the

retention of the 10-day period. In addition, they suggested that,

instead of making the treaty exemption effective only after the

[[Page 53406]]

submission of Form 8233, the exemption should be retroactive to the

date of first payment covered by the certificate if the completed Form

8233 contains the nonresident alien's TIN, and if the withholding agent

is not subsequently notified by the IRS within the 20-day period that

the exemption is not valid. After further consideration, the comments

are adopted. The 10-day waiting period is continued and the approval of

the Form 8233 is made retroactive to the date of first payment covered

by the certificate. However, the final regulations clarify that the IRS

review process does not exonerate the withholding agent from liability

for underwithholding. In its review, the IRS simply insures that the

form contains all of the requested information, that the country of

residence stated on the form is a country with which the U.S. has an

income tax treaty, that the reduced rate that the withholding agent

plans to apply is the proper rate under the applicable treaty, and

that, based solely on information contained on the form, the reduced

rate appears applicable. The IRS approval of the form makes no

determination regarding whether the withholding agent's reliance on the

form is reasonable, based on facts that the withholding agent knows or

has reason to know at the time of the payment and that are not

disclosed to the IRS as part of the review process. In addition, the

final regulations allow the 90-day grace period to apply to payments

covered by a Form 8233, in order to allow time for foreign persons who

come to the United States for the first time and must complete a Form

8233 shortly after arrival to apply for and obtain an individual

taxpayer identifying number. See Sec. 1.1441-1(b)(3)(iv).

The final regulations modify the proposed rule under Sec. 1.1441-

1(b)(6) reducing the amount of certain compensation income by the

personal exemption under section 151. The proposed regulations allowed

a reduction for the full amount of the exemption. Commentators noted

that allowing a reduction for the full amount of the allowable personal

exemption may lead to inappropriate claims of multiple exemptions for

nonresident aliens who come to the U.S. frequently for short-term

events or assignments with different organizations. Commentators were

concerned that they would have no ability to keep track of prior claims

of the personal exemption. For this reason, the proration rule now

currently in effect, is continued in the final regulations.

3. Reimbursed Expenses

Commentators asked that the regulations provide an exemption from

withholding for reimbursed expenses paid to a nonresident alien

individual in relation to performance of services in the U.S. as an

independent contractor. A change to the regulations is not necessary,

however. If the payments are exempt from tax under the Code, they are

exempt from withholding under Sec. 1.1441-4(b)(1)(iv). If, on the other

hand, those payments are not exempt under the Code, then it would be

inappropriate to provide for an exemption from withholding under

section 1441.

F. Comments and Changes to Sec. 1.1441-5

In response to comments, many partnership provisions have been

consolidated in this section. A new paragraph (a) has been added to

describe the steps necessary to determine the status of the payee for

withholding purposes. The withholding procedures applicable to domestic

partnerships are stated in paragraph (b). The withholding procedures

applicable to foreign partnerships are stated in paragraph (c).

Paragraph (d) describes applicable presumptions in the absence of

documentation. Paragraph (e) is reserved for rules applicable to

estates and trusts. Paragraph (f) contains the effective date

provisions. Corresponding provisions have been added in Sec. 1.6049-

5(d)(4), dealing with payments of reportable amounts under chapter 61

of the Code to address reporting of payments of amounts that are not

subject to chapter 3 withholding.

Paragraph (c)(1) provides guidance for identifying the payee in the

case of a payment to a foreign partnership. As a general rule, a

payment to a foreign partnership is treated as a payment directly to

the partners, whether or not documentation has been provided for the

partners, with two exceptions: a payment to a ``withholding foreign

partnership'' and a payment to a foreign partnership that has furnished

a certificate upon which the withholding agent can rely to treat the

payment as effectively connected with the conduct of a U.S. trade or

business are treated as a payment to the foreign partnership and not to

the partners.

Paragraph (c)(2) restates the rule proposed under Sec. 1.1441-

1(e)(5), dealing with qualified intermediaries, for foreign

partnerships that are withholding foreign partnerships. In order to

avoid confusion, a withholding foreign partnership is no longer named a

qualified intermediary.

Paragraph (c)(3) deals with foreign partnerships that are not

withholding partnerships. Paragraph (c)(3)(iii) incorporates the

withholding certificate provisions that were in proposed Sec. 1.1441-

1(e)(3)(iii). Those rules parallel the rules applicable to non-QIs

under Sec. 1.1441-1(e)(3)(iii) of the final regulations. In particular,

the regulations require that a statement be attached to the withholding

certificate if necessary to provide information sufficient for the

withholding agent to determine each partner's distributive share of

income subject to withholding. The rules governing the statement are

stated in paragraph (c)(3)(iv) and parallel similar rules in

Sec. 1.1441-1(e)(3)(iv) of the final regulations applicable to non-QIs.

At the request of commentators, paragraph (c)(3)(iii) clarifies that a

foreign partnership receiving income that is effectively connected with

the conduct of a U.S. trade or business is not required to furnish

separate certificates for each of its partners. Instead, it may furnish

one single withholding certificate, even though the partnership is not

a withholding foreign partnership. See also paragraph (c)(1)(ii)(C).

This procedure is reasonable because, in such a case, the partnership

is subject to withholding procedures under section 1446.

Paragraph (d) describes the presumptions upon which a withholding

agent can rely when making payments to a partnership for which certain

documentation is lacking or unreliable. First, under paragraph (d)(2),

a recipient that is presumed to be a partnership (based on presumptions

set forth in Sec. 1.1441-1(b)(3)(ii)) is presumed to be a foreign

partnership if certain indicia of foreign status are present. If, based

on such a presumption, the withholding agent has determined that the

payment is made to a foreign partnership (presumably acting for the

account of its partners since intermediary status generally cannot be

presumed in the absence of valid documentation), uncertainties may

remain regarding the status of the partners, the allocation of a

payment among them, or whether all the partners have been accounted

for. Under the final regulations, a payment that cannot be reliably

associated with a withholding certificate from a partner is presumed

made to a foreign payee. As a result, the withholding agent is required

to withhold 30-percent from the payment, without a reduction. Also, any

part of a payment that it is not reliably allocated to a partner is

presumed allocable to the partner with

[[Page 53407]]

the highest withholding rate or the highest U.S. tax liability (as the

withholding agent can best estimate) if the withholding rates are

equal. Third, if the withholding agent does not have a reliable

certification that all the partners are accounted for, and, as a

result, the withholding agent cannot reliably determine the

distributive share of any one or more partners, then none of the

payment can be reliably associated with any one partner and the entire

payment is presumed made to a foreign payee.

These procedures parallel those applicable to foreign

intermediaries under Sec. 1.1441-1(b)(3)(v). They differ from the

presumptions stated in the proposed regulations under Sec. 1.1441-

1(f)(4)(ii) which provided that the amounts were paid to a U.S. payee

that is not an exempt recipient. Thus, the final regulations, by

presuming that the amounts are paid to a foreign payee, require that a

30-percent amount be withheld on amounts subject to withholding under

chapter 3 of the Code rather than a 31-percent amount under the backup

withholding provisions of section 3406. However, for amounts that are

not subject to chapter 3 withholding, Sec. 1.16049-5(d)(4) retains the

provisions in the proposed regulations that the payments are presumed

made to a non-exempt recipient U.S. payee. In such a case, 31-percent

backup withholding applies instead of 30-percent withholding.

The final regulations under Sec. 1.1441-5(d)(3)(iv) clarify that a

foreign partnership that is a withholding foreign partnership

determines who the payee is and the status of the payee, based on the

provisions of Sec. 1.1441-1(b)(2) and Sec. 1.1441-5 (c) and (d) in the

same manner as if it were making payments directly to the partners

other than in their capacity as partners. In the absence of

documentation regarding the partners, the partners are presumed to be

foreign persons rather than U.S. persons, including for amounts that

are not subject to chapter 3 withholding. A presumption of U.S. status

for amounts not subject to chapter 3 withholding would not be

meaningful because a foreign partnership is not a payor for purposes of

chapter 61 of the Code and backup withholding under section 3406 when

making payments to its partners. Therefore, payments made by a foreign

partnership to its partners are not reportable under chapter 61 and are

not subject to backup withholding. Instead, a foreign partnership must

file an annual return on Form 1065 and report each partner's

distributive share on Forms K-1, which forms are filed with the IRS

with a copy to each partner. Such filing requirements apply in all

cases in which the foreign partnership derives U.S. income,

irrespective of whether the tax liability has been satisfied by

withholding at source or whether all the partners are foreign. See

section 6031 and Secs. 1.6031-1(c) and 1.6031(b)-1T. However, in order

to reduce the burden on foreign partnerships that are not withholding

foreign partnerships, the IRS and Treasury are planning to issue

regulations under section 6031 that would eliminate the filing

requirement under section 6031 for foreign partnerships that are not

engaged in a U.S. trade or business, that furnish appropriate

documentation for each of their partners, and whose partners' U.S. tax

liability has been fully satisfied at source.

Commentators asked that foreign partnerships be allowed to certify

under penalties of perjury that all the partners are foreign and to use

the same sub-accounting procedures that qualified intermediaries may

use. In particular, where a partner is entitled to reduced withholding

under the regulations without providing a TIN, commentators argue that

there should not be a requirement that the partnership's intermediary

withholding certificate specify that partner's distributive share of

the item of income paid to the partnership. Also, they argue that there

should not be a requirement that a separate Form 1042-S be filed under

the partner's name. Instead, the partnership's intermediary withholding

certificate should indicate the aggregate distributive shares of all

members entitled to a single rate, and reporting should be done on the

aggregate amount under the partnership's account. These comments are

similar to those received for non-QIs and are not adopted for the same

reasons that they are rejected for non-QIs. It is important to retain

the distinction between foreign partnerships that qualify as

withholding agents (i.e., those that are withholding foreign

partnerships or are subject to section 1446) and those that are not

qualified to act as withholding agents. If a foreign partnership is not

a withholding foreign partnership, it should not be permitted to

certify the status of its partners on their behalf.

Commentators asked that a foreign entity holding a passive

investment for its own account be allowed to use the withholding

procedures applicable to foreign corporate entities, irrespective of

its actual classification for tax purposes. It is argued that, in many

cases, investments are structured using organizations that, under the

default classification rules of the check-the-box regulations would be

classified as partnerships. In order to avoid more onerous withholding

procedures, these entities would normally prefer a corporate

classification. It is argued that the need to make an election for this

purpose is an unnecessary step that should be eliminated. This comment

is not accepted because the election procedure to insure corporate

classification is simple and serves an important compliance role.

At the request of commentators, the final regulations in

Sec. 1.1441-7(a) clarify that, if a nominee holds an interest in a

domestic or foreign partnership on behalf of a partner and provides the

partnership with the information required under Sec. 1.6031(c)-1T(a)

with respect to the partner, the nominee is deemed to have satisfied

its obligations as a withholding agent under chapter 3 of the Code and

has no liability for underwithholding on the partner's distributive

share of the amounts to which the furnished information pertains. This

rule reflects the fact that a custodian holding a partnership interest

for an investor often lacks the information needed to determine which

withholding regime applies to income from the partnership. The

necessary information to correctly withhold on partnership income is

often only known to the partnership and is not easily accessible to the

custodian. On the other hand, the partnership, which is also a

withholding agent, or has withholding responsibilities, has the

information necessary to determine how withholding should apply. It is

also responsible for filing the partnership return and furnishing the

Forms K-1 to the partners.

Some commentators requested that a withholding agent should be

permitted to rely on a withholding certificate provided directly by a

partner, without a withholding certificate from the partnership. The

commentators argue that this reliance rule would permit partners to

claim a reduced rate of withholding even though the partnership refuses

to cooperate and to submit the proper documentation. This suggestion is

not accepted because it would, in effect, read the partnership

withholding certification rules out of the regulations. It may also

become a source of confusion for withholding agents who would not

always know how reliable the partner's information is. The IRS and

Treasury believe that the partnership withholding certificate provides

important information to the withholding agent, such as each partner's

distributive share of the payment. In addition, in the absence of a

partnership withholding certificate,

[[Page 53408]]

the withholding agent would lack information required to be stated on

the Form 1042-S (e.g., the partnership's EIN) and compliance may be

weakened as a result.

G. Comments and Changes to Sec. 1.1441-6

1. Address Rule

Comments were received asking reconsideration of the proposal to

eliminate the address rule for dividends. The IRS and Treasury believe,

however, that there is no longer a justification for the address rule

as in effect under current law. When the payment is made directly to a

foreign beneficial owner, there is no justification for not requiring a

Form W-8 from the owner in the same manner that is required for

payments on debt obligations. In the case of payments of dividends to

foreign intermediaries, the proposed and final regulations provide for

new intermediary procedures that are more adapted to the monitoring of

abusive claims of treaty benefits than is the address rule. For these

reasons, the address rule is not reinstated.

2. Reliance on Withholding Certificate

In response to comments, Sec. 1.1441-6(b)(1) clarifies, by cross-

reference to Sec. 1.1441-1(e)(4)(viii) dealing with reliance on

withholding certificates, that a withholding agent may rely on

information and certifications in a certificate without having to

inquire into the truthfulness thereof, absent actual knowledge or

reason to know otherwise. Therefore, absent actual knowledge or reason

to know that such claims are false, a withholding agent may rely on

claims on a Form W-8 of beneficial ownership and residence by a person

claiming benefits under a tax treaty. Under these principles, a

withholding agent may rely on representations from a foreign person

regarding the application of foreign tax laws or certifications

regarding the circumstances of the recipient or of the transaction. In

particular, a withholding agent may rely on the recipient's

representation made by furnishing a beneficial owner withholding

certificate that it is a beneficial owner of the income. If the address

on a withholding certificate comports with a claim of residence in a

particular country, a withholding agent may also rely on such address

as indicative of residence, even though the determination of residence

for tax treaty purposes may be far more complex than establishing an

address in the treaty country and is likely to involve the application

of foreign tax laws, particularly in the case of a person other than an

individual. However, if the withholding agent knows that the

representations on a Form W-8 are inconsistent with foreign laws or

with the recipient's or the transaction's circumstances, then the

withholding agent must question the basis for the representations.

3. Requirement of a TIN

Commentators have suggested that the final regulations require a

TIN only for related party transactions subject to treaty rate

withholding. This would eliminate the need to provide a specific list

of payments exempt from a TIN requirement. This suggestion is not

adopted because the IRS and Treasury believe that the TIN requirement

is useful in monitoring claims of reduced rates under tax treaties for

all transactions. Because the procedures for obtaining a TIN are

simple, the TIN requirement for non-market based transactions is not

viewed as overly burdensome relative to the compliance benefits.

Section 1.1441-1(e)(4)(vii) enumerates the instances in which a TIN

must be furnished on a withholding certificate. Under the proposed

rules, a TIN is required to obtain the benefit of reduced withholding

under an income tax treaty, unless the payment consists of dividends

paid on publicly traded stocks. Commentators have requested that the

exemption from having to furnish a TIN be extended to other securities,

including pre-1984 bonds and other debt obligations, payments on any

mutual fund investment (e.g., an open-end mutual fund), interests in

publicly-traded grantor trusts generating royalty income, interest- and

dividend-equivalent payments on the loan of exempted publicly traded

stocks or securities, income from repurchase agreements involving

exempted publicly traded stocks or securities, dividends on non-

publicly traded stocks, interest on syndicated or bank loans, income

from publicly-traded grantor trusts, contingent interest, and amounts

paid on private placements of stocks or securities.

In response to these comments, the final regulation are amended to

expand the categories of income for which a TIN is not required to be

furnished. Under the final regulations, the categories are dividends

and interest on publicly traded securities, dividends on redeemable

securities issued by an investment company registered under the

Investment Company Act of 1940 (15 U.S.C. 80a-1), income related to

loans of publicly traded securities, and dividends, interest, or

royalties from units of beneficial interest in a publicly offered and

registered unit investment trusts. See Sec. 1.1441-6(b)(2)(ii). The

covered securities extend to foreign securities as well as U.S.

securities. Also, in response to comments that the regulations should

provide a reliable source to determine whether or not a stock (or other

security) is publicly traded, the regulations clarify that section

1092(d) and Sec. 1.1092(d)-1 apply to determine whether a stock or

security is publicly traded for this purpose. An exception is not made

for other securities because the IRS and Treasury believe that the TIN

exemptions should be limited to income arising from securities that are

publicly traded and should not extend to securities held and transacted

as part of a private business relationship. Also, an exception is not

made for sale-repurchase transactions (repos) because repos completed

within a 6-month period give rise to income that is treated as short-

term OID for tax purposes. Such income, if earned by a foreign person,

is exempt from chapter 3 withholding. Because the type of repo

transaction that would be equivalent to the type of TIN-exempted market

transactions would generally be of substantially shorter duration, the

IRS and Treasury believe that it is not appropriate to provide an

exemption for more than 6-month repo transactions.

Comments suggested that requiring TINs on intermediary certificates

is an undue compliance burden when reporting is not done to the

intermediary's account, especially if the Form W-8 of any underlying

beneficial owner is not required to bear a TIN. Commentators argue that

any IRS compliance concerns can be met without the requirement for a

TIN from a non-qualified intermediary since U.S. withholding agents

would, in any event, supply the identification and address of the

beneficial owners to the IRS on Form 1042-S. The final regulations

eliminate the need for a TIN on a non-qualified intermediary

certificate and on a certificate from a foreign partnership that is not

a withholding foreign partnership. However, a TIN continues to be

required in the case of a qualified intermediary certificate or in the

case of a certificate from a foreign partnership.

Some commentators asked that the TIN requirement be made optional.

They argue that this would provide a reasonable accommodation to

foreign investors who only occasionally or rarely enter into financial

transactions involving U.S. securities. This comment is not adopted;

instead, the final regulations broaden the types of transactions exempt

from the requirement to provide a TIN. This change should alleviate the

concern

[[Page 53409]]

expressed by these commentators. Also, commentators asked that the

final regulations provide an exemption for intermediaries with a small

number of foreign accounts (500 or less).

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