International tax and withholding considerations for US companies and their directors

To staff their board of directors with the best and most diverse talent, multinational companies commonly elect boards with international representation. It is also common for companies to convene periodic board meetings outside the United States. This may be done, for example, to provide board members with an opportunity to visit local operations or mark an expansion into a new market.

US companies that do either − or both − of these things must be mindful of any resulting US or foreign tax implications.

US federal income tax considerations

Director fees paid to a US taxpayer are generally not considered salary or wages. Instead, such fees are deemed ordinary income that is subject to both US federal income tax (at graduated rates) and self-employment income tax. Because US citizens and tax residents are subject to US federal income tax on a worldwide basis, it is irrelevant where they perform director services.

US federal withholding tax considerations

Under US law, directors’ fees a US company pays to a nonresident alien director who performs director services while in the United States are considered US source income that is subject to US federal withholding tax of 30 percent.

When the same director performs director services for a US company outside of the United States (such as when a meeting is convened outside of the United States or he participates by conference call from outside the country), the portion of fees paid for services performed outside of the United States are not subject to US federal withholding tax.

If a portion of the director’s fees paid to the nonresident alien relates to preparatory services performed outside the United States, the amount of compensation attributed to such preparatory activities is considered foreign source income that is not subject to US federal withholding tax.

US federal income tax reporting requirements

US resident directors who receive directors’ fees from US or foreign companies must report such fees on their individual income tax returns and pay income and self-employment tax on them.

Directors’ fees earned by a nonresident alien while present in the United States are considered US source income that is “effectively connected with the US trade or business.” Therefore, such fees are subject to US income tax at the same graduated income tax rates that apply to US residents.

As a result, a nonresident alien director generally must report the US portion of directors’ fees received on Form 1040NR by June 15 of the year after the calendar year in which the fees were received. The June 15 deadline can be delayed if a timely and valid extension is filed.

To the extent that a US company withholds US tax from fees it pays to a nonresident alien director, it must remit the withholding tax and provide its nonresident alien director with Internal Revenue Service Form 1042-S.

US state and local tax implications

Depending on where in the United States a board of directors meeting is held, directors’ fees may also be subject to state and local income and withholding taxes.

United Kingdom tax considerations

Assume that a US company pays directors’ fees to a tax resident of the United Kingdom. Because such directors are considered employees under UK tax law, the directors’ fees are subject to UK income taxation.

In general, UK tax rules allow UK tax residents to claim a credit against their UK tax liability for any foreign taxes suffered on income that is also taxable in the UK. In some circumstances, a UK tax resident can elect to have the foreign tax deducted from the taxable amount in the UK as an alternative to getting a credit for the foreign tax suffered.

Brazilian tax considerations

If a US company pays directors’ fees to a Brazilian tax resident, the fees are subject to Brazilian income tax but are not subject to Brazilian withholding. As is the case in the United Kingdom, a Brazilian director who suffers tax on the directors’ fees may claim a credit against his Brazilian income tax liability.

Applicability of tax treaties

In certain situations, double tax treaties may mitigate a US company’s obligation under domestic or foreign law to withhold tax from the fees it pays to its nonresident alien directors.

In determining whether a nonresident director may avail himself of the benefits of a double tax treaty and potentially eliminate the need for a US company to withhold tax on the his behalf, key factors include the director’s tax residency and where the services were provided.

The US Model Income Tax Treaty generally provides that the country where services are provided may tax the directors’ fees paid. However, treaties between other countries (not including the United States) may provide for different tax treatment.

Tax residency of the directors

To identify and apply the appropriate tax rules and potentially applicable tax treaty to each corporate director, a company must ascertain each director’s tax residency. Companies should obtain this information soon after a director is elected to its board. US companies can obtain such information by having each director complete a Form W-9 (if a US citizen or tax resident) or a Form W-8BEN (if a foreign individual).

Moreover, a company’s agreement with a director should permit the company to request − and require the director to provide − any additional information that is needed to enable the company to fulfill its tax compliance requirements. A director agreement should also require a director to inform the company in the event that his tax residency changes. It is important for companies to remember that an individual’s nationality is not always the same as his tax residency.

For example, a Brazilian citizen may be a tax resident of Portugal. Incorrectly assuming that a director’s tax residency is the same as his nationality may result in the misapplication of tax rules or treaties.

Location of board of director meetings

A US company must be mindful of the potential tax implications of holding its board of directors meetings outside the United States. Assume that a US company with a board of directors comprised entirely of US tax residents convenes a board meeting in Mexico to celebrate the opening of a new distribution facility.

In that case, the company should consider the Mexican tax implications associated with holding the meeting in Mexico and whether the US-Mexico Double Tax Treaty mitigates such implications. It must also be mindful of whether it will need to withhold and remit tax to Mexican tax authorities on the basis that the fees were earned in Mexico.

If one (or more) of the directors is a Spanish tax resident, the US company should also consider any potential Spanish tax implications (including ones arising from the Mexico-Spain Double Tax Treaty) in addition to the relevant Mexican tax implications.

To potentially avoid some of the complexities that arise when a US company with a multinational board holds meetings outside of United States, the company may consider holding its meetings in jurisdictions that do not impose income tax or withholding tax obligations on nonresident companies or nonresident (or even resident) directors.

Maintaining a compliance program

A US company that has a multinational board or periodically holds its board of director meetings outside of the United States should maintain a robust program to ensure compliance with all relevant tax laws. If the board is made up of a diverse group of directors or the company frequently holds board meetings outside of the United States, the volume of work for each meeting or payment of fees can be significant.

There are a number of steps and procedures that a company may implement to promote tax compliance with respect to the payment of director’s fees.

Sourcing and tracking time and travel

If a director is a nonresident, countries will typically require withholding only when a directors’ fee is attributable to that country. This requires a review of the “sourcing rules.”

For example, if a Brazilian tax resident director spends four hours outside the United States preparing for a board meeting and 12 hours attending board meetings in the United States, the United States will consider 75 percent of the director’s fees paid to be United States source income that is subject to US withholding tax.

In comparison, some countries require withholding on the entire amount of director’s fees paid, regardless of sourcing. In some cases, and depending on where the director is a tax resident, a foreign tax credit may be allowable to the extent of source-country tax on foreign source income.

Because of the prominent role that sourcing rules play in determining whether director’s fees are subject to withholding tax, companies should require directors to track their time serving on the board and engaging in board-related activities. Companies should also consider implementing a system that tracks where board services are provided.

Such travel-tracking systems should allow the company to track a director’s travel in real time so it can identify whether the director is close to triggering a tax liability in a particular jurisdiction. Such information can assist a company in calculating any withholding obligations.

Some companies offer professional tax advisory services to directors so they can understand their filing and reporting obligations and otherwise comply with all relevant tax laws. Other companies provide tax preparation services to ensure that all income, withholding and taxes are appropriately reported and credited.

Taxation of the company

In addition to complying with withholding obligations, US companies must consider the potential tax implications to the company itself. For example, a US (or foreign) company may be considered to have a taxable presence in some jurisdictions to the extent that such company holds a board within their borders. This is often referred to as the “mind and management” concept.

As a result, to the extent that a US company periodically holds board meetings outside of the United States or in some cases, where a majority of the board participate in board meetings outside of the United States, it should consider jurisdictions that either do not levy a corporate income tax or that do not apply a “mind and management” standard.

Conclusion

US companies and their directors must ensure that they are compliant with all relevant tax laws relating to their receipt or payment of director’s fees. Failure to properly withhold, report or otherwise remit taxes on director’s fees may result in interest and financial penalties to the US company or to the director.

Moreover, companies face reputational risk to the extent that the US company or its directors are noncompliant with relevant tax laws. To mitigate the risk of noncompliance, companies and their directors must be informed of applicable tax compliance requirements.