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Heads, IRS Wins, Tails, You Lose

02/03/2016


The IRS has shifted enforcement but still maintains full downside protection on Foreign Account Compliance Tax Act (FATCA) withholding. Withholding agents are entrusted to act as Trustees over monies that are the property of the government (also known as ‘fisc’).

Unfortunately for government purses and for the taxpayer with the substantive tax liability, withholdings are not always done correctly and remittances may not be made on a timely basis (or at all). In the U.S., withholding agents responsible for Fixed, Determined, Annual and Periodical income (FDAP) withholding are typically domestic actors, although there is a system of “qualified intermediaries” that allow some of the burden of tax collection to be shifted to non-U.S. persons if they meet very strict requirements (these are typically major foreign financial institutions).

With the advent of FATCA, there is now an entirely new 30% withholding tax potentially eligible against non-participating foreign financial institutions, certain foreign entities with a lack of disclosure and recalcitrant account holders. With a sweeping withholding regime, the universe of potential withholding agents has also been expanded significantly.

There are processes in the U.S. for non-resident taxpayers to credit amounts withheld against domestic taxes otherwise payable, if amounts are withheld in error or the withholdings exceed the substantive tax liability to obtain a refund. Typically, the process for chapter 3 withholding , which was adopted under chapter 4 (FATCA), involves the payee providing the IRS with its 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding ) form, which shows the amounts which were withheld with respect to payments received. The IRS is then able to match the withholdings reflected on the 1042-S with amounts deposited by the payors. In theory however, given the withholding agent is an agent of the fisc, entrusted with its property, the payee has made a payment of tax when such amounts are withheld, not when they are remitted to the government.

Culminating in Notice 2015-10 (April 28, 2015), the Department of the Treasury has concluded that given the new FATCA reality in which a family trust can be a “financial institution” and a broad range of foreign people well beyond “qualified intermediaries” can be withholding agents, remittance to IRS is equally important to withholding to ensure the integrity of the system.

Both the Department of the Treasury and the IRS will amend the regulations to permit a tax credit or refund in respect to FDAP or FATCA withholding only “to the extent that the withholding agent has deposited (or otherwise paid to the Treasury Department) the amount withheld.”

This gives rise to a number of practical and equitable questions. For instance, what if a withholding agent withholds on multiple payees during a period and remits only a portion of the amounts withheld - with respect to which payee(s) do the remittances relate? Treasury is proposing to allocate remittances on a pro rata basis based on amount of payments received subject to withholding. Of course a taxpayer claiming a refund or credit will have no way of knowing whether or how much withholding was actually remitted to the government by the withholding agent.

For more information on how you could be affected by FATCA, contact Bradley Thompson, Leader of MNP’s International Tax Services group in Montreal at 514.861.9274 or [email protected].