Foreign Tax-Exempt Organizations
Many foreign
tax-exempt organizations have been providing services in the performing
arts in the United States for decades. The U.S. payers have only recently
begun informing the organizations that, absent a Code exception or treaty
exemption, the payments for these performances are subject to 30 percent
withholding tax. (In some cases there may be state tax withholding as
well). The payer must report both the income and tax to the organization
and the IRS on Form 1042-S, Foreign Person’s U.S. Source Income
Subject to Withholding. Payers must also submit a Form 1042 tax
return reporting gross income, taxes withheld, and tax
deposits.
In 2001, the IRS
introduced procedures for foreign tax-exempt organizations to follow to
obtain an exemption from the withholding tax. The procedures depend on
whether or not the foreign organization is a resident of a country that
has an income tax treaty with the United States.
- An organization
that satisfies the U.S. definition of a tax-exempt organization may use
Form W-8EXP, Certificate of Foreign Government or Other Foreign
Organization for United States Tax Withholding , to claim an
exemption from withholding tax as a tax-exempt organization that meets
U.S. rules for tax exemption.
- An organization
resident in a country that has an applicable income tax treaty with the
United States may use Form W-8BEN, Certificate of Foreign Status of
Beneficial Owner for United States Tax Withholding , to certify to
facts supporting an exemption from withholding tax under the tax treaty
provision.
In both cases, the
foreign tax-exempt organization must record a U.S. employer identification
number (EIN) on the form. Foreign organizations can apply for an EIN on
Form SS-4, available on the IRS website at
http://www.irs.gov/pub/irs-pdf/fss4.pdf. Entities with a foreign address
cannot currently apply for an EIN online.
Form W-8EXP
A foreign organization
is not exempt from U.S. withholding tax based on its foreign tax-exempt
status because many foreign countries have more liberal tax-exempt rules
than the United States. However, a foreign organization that is tax exempt
under section 501(c)(3) of the Internal Revenue Code (the “Code”) (or that
would be exempt under that section if the organization applied for
tax-exempt status) is not subject to a withholding tax on amounts that are
consistent with such tax-exempt status.
A foreign organization
claiming tax exemption under U.S. rules must provide the payer a Form
W-8EXP prior to payment. The submitter of Form W-8EXP must check:
- Box 12a: Certifying
that the IRS has issued a determination letter and the date of such
letter, or
- Box 12b: Indicating
that a letter from an attorney in the United States attesting that the
organization would likely obtain tax-exempt status from the IRS if it
applied to the IRS for such status is attached.
In addition, such a
foreign tax-exempt entity must attach an affidavit stating that it is not
a private foundation and so indicate in Box 12c or indicate that it is a
private foundation in Box 12d. (The 4 percent excise tax on private
foundations is not overridden by a tax treaty exemption because excise
taxes are not covered by income tax treaties.)
U.S. income of a
foreign tax-exempt organization making such a claim is reported under
Recipient Code 07 and Exemption Code 02 on a Form 1042-S. No U.S. tax
return is required.
Form W-8ECI
If the organization’s
income is unrelated business income under section 512 of the Code (and
therefore not tax exempt) such income may be exempt from withholding if
the income is effectively connected with the conduct of a trade or
business in the United States. For exemption from the withholding tax as
effectively connected income, the organization must provide the payer a
Form W-8ECI, Certificate of Foreign Person’s Claim That Income Is
Effectively Connected With the Conduct of a Trade or Business in the
United States, prior to payment. Form W-8ECI must include a U.S. EIN.
Effectively connected income is reported under Exemption Code 01 on a Form
1042-S. The foreign organization must submit a Form 1120F income tax
return.
Form W-8BEN
A foreign organization
that is resident in a country that has an income tax treaty in effect with
the United States may choose to make a claim of exemption from tax under
an applicable tax treaty provision. (The 4 percent excise tax on private
foundations is not overridden by a tax treaty exemption because excise
taxes are not covered by income tax treaties.) To make a claim under the
tax treaty, the organization must meet the conditions for exemption and
submit the claim to the payer on Form W-8BEN. The Form W-8BEN
must contain a U.S. EIN in order for any type of treaty claim to be
honored. The specific claim depends on the provisions available for tax
exemption under the tax treaty.
Exempt
Business Profits
Net income from
services performed in the United States by employees or contractors of a
foreign organization, regardless of the organization’s foreign
tax-exempt status, is considered business profits for U.S. income tax
purposes. Generally under the Business Profits Article of tax treaties,
the business profits of an organization that is a resident of the treaty
country are not subject to tax in the United States unless the
organization has a permanent establishment (PE) in the United States and
the profits are attributable to that PE.
The Permanent
Establishment Article typically finds a PE if the organization has
either an office or other fixed place of business in the United States,
or a dependent agent in the United States that habitually negotiates
contracts on behalf of the organization. Some PE articles also find a PE
if the organization has employees or contractors performing non-sales
services in the United States for a specified period of time. See, for
example, Article 5(2)(1) of the treaty with India.
Tax treaty-exempt
business profits are reported under Exemption Code 04 on Form 1042-S. No
U.S. income tax return is required of the foreign organization. However,
a protective Form 1120F may be submitted with the tax treaty claim to
preserve deductions and credits should the organization’s income later
be determined to be attributable to a U.S. PE.
Special
Provisions for Exempt Organizations
The tax treaties
with Canada, Germany, Mexico, and the Netherlands include special
provisions for organizations that are tax-exempt under the laws of the
respective countries. For example, Paragraph 1 of Article XXI (Exempt
Organizations) of the tax treaty with Canada provides that income
derived by a religious, scientific, literary, educational or charitable
organization shall be exempt from tax in the United States if the
organization is resident in Canada but only to the extent that the
income is exempt from tax in Canada. (The new protocol with Canada
disallows the exemption to the extent that the income is from a trust,
company, organization, or other arrangement carrying on a U.S. trade or
business or from a related person.) A similar provision can be found in
Article 27(1) of the treaty with Germany, Article 22(1) of the tax
treaty with Mexico, and Article 36(1) of the treaty with the
Netherlands.
Under such tax
treaty provisions, it is the tax-exempt rules of the respective treaty
country that determine whether the income is exempt from tax. Therefore,
a tax-exempt organization resident in one of these four treaty countries
is not required to follow the more costly Form W-8EXP alternative. An
organization making a claim under such a tax treaty provision makes the
claim on Form W-8BEN. To support the validity of the claim, the
organization should include evidence of its tax-exempt status in the
respective treaty country. For example, Canadian tax-exempt
organizations could attach a copy of their Canadian registration letter.
For practical reasons, an English-language translation should accompany
foreign-language documentation of tax-exempt status in Germany, the
Netherlands, or Mexico.
Tax treaty-exempt
income is reported under Exemption Code 04 on Form 1042-S. No U.S.
income tax return is required for the tax-exempt claim based on these
provisions.
About The Author
Paula N. Singer, Esq. chairman of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer, Newton, MA, has over 25 years of experience providing advice and compliance services to employers on cross-border employment matters. For more information, visit www.windstar.com. For additional information, call 1-800-259-6398 or email: info@windstar.com.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.
Copyright © 1999-2007 American Immigration LLC, ILW.COM
|
Add to del.icio.us