U.S. Withholding Agents Take Note: CCA 201428007

With FATCA having been officially implemented for the most part this past July 2014, withholding agents will want to be especially vigilant in their duties and obligations regarding the solicitation and receipt of the appropriate Form W-8 from foreign persons. They will also want to be up on the rules that entitle them to rely on these certifications for both Chapter 3 and Chapter 4 withholding.

Apropos of the last point, the IRS recently issued CCA 201428007 which addresses the extent to which a withholding agent may rely on a Form W-8 furnished by a foreign beneficial owner.

The facts of the CCA involved a foreign beneficial owner who had furnished to the withholding agent Form W-8 ECI claiming that the income in question was income effectively connected with a U.S. trade or business and included in the recipient’s gross income under §871(b)(2) and, therefore, not subject to withholding under §1441(c)(1).

In the original instance, under Reg. §1.1441-4(a)(2), a withholding agent is entitled to rely on a foreign beneficial owner’s claim of exemption, provided that, prior to payment of the income to the foreign beneficial owner, the withholding agent can reliably associate the payment with a properly executed Form W-8 ECI. For this rule to apply, the Form W-8 ECI must be properly completed and include all of the required information called for on the form, including a representation under penalties of perjury that the income is effectively connected and includable in the recipient’s gross income for the taxable year.

However, this rule is turned off if the withholding agent has actual knowledge or reason to know otherwise. Under Reg. §1.1441-4(a)(2) and §1.1441-7(b)(1) (now Reg. §1.1441-7T(b)(1)), a withholding agent must withhold at the full 30% rate if the agent has actual knowledge or reason to know that a claim of reduced withholding is unreliable or incorrect. Further, if the withholding agent receives notification from the IRS that a claim of a reduced withholding rate is incorrect, the agent has actual knowledge beginning on the date that is 30 calendar days after the date the notice is given.

Under the facts contained in the CCA, in the course of a withholding tax audit the IRS determined that one of the foreign beneficial owners who had been submitting Forms W-8 ECI had not filed U.S. income tax returns for the audit years in issue or for any subsequent year. The withholding agent apparently maintained that it was entitled to continue to rely on the beneficial owner’s certification on Form W-8 ECI, evidently because the form was complete and appropriately signed, i.e., everything was apparently in order on the four corners of the document.

Thus, the issue presented was whether the IRS could provide notice to the withholding agent that the beneficial owner’s claim was incorrect based on the IRS’s determination that U.S. tax returns had not been filed by the beneficial owner (thus giving rise to actual knowledge on the part of the withholding agent) or whether the withholding agent’s ability to rely on the Form W-8 ECI certificate is limited to the information provided by the beneficial owner on the Form W-8 ECI itself. Another way of framing the question is whether the IRS’ authority to require withholding in this situation is limited to when it has sufficient facts to prove that the information provided by the beneficial owner on the Form W-8 ECI is incorrect.

Not surprisingly, the IRS flatly determined that there is no such limitation. First, it pointed to the fact that the statute, regulations, and Form W-8 ECI all reference effectively connected income as income that is included in the beneficial owner’s gross income for the taxable year. Thus, the exemption claim of the owner incorporates the owner’s representation that tax returns are being filed.

Second, the IRS pointed out that the Form W-8 ECI has a notation on the top of the form to the effect that a person submitting Form W-8 ECI to claim an exemption for effectively connected income must file a tax return to include the effectively connected income.

On this basis, the IRS concluded that it properly determined that the exemption claim was, in fact, incorrect and that the IRS validly served notice on the withholding agent, who then had actual knowledge that he could no longer rely on the certification given in the foreign taxpayer’s withholding certificate. It’s hard to imagine coming up with a different conclusion.

Interestingly, the IRS stated that it expressed no opinion as to whether the notification proposed to be sent by the auditor to the withholding agent raised any confidentiality and/or disclosure issues under §6103. That’s an issue for another day.

This commentary also will appear in the January 2014 issue of the  Tax Management International Journal.  For more information, in the Tax Management Portfolios, see Tello, 915 T.M., Payments Directed Outside the United States — Withholding and Reporting Provisions Under Chapters 3 and 4,  and in Tax Practice Series, see ¶7170, U.S. International Withholding and Reporting Requirements and FATCA.