Cross-border guarantee fees subject to U.S. withholding tax.

• Author: Hoge, Richard

In general, a guarantee fee is consideration that a debtor pays to a guarantor for the latter's assurance to pay the former's obligation to the creditor. The Code does not provide specific rules detailing the character or source of guarantee fees. Thus, taxpayers and the IRS have been forced to use sourcing rules that apply to analogous types of income to determine the proper treatment of such fees, as exemplified in Field Service Advice (FSA) 200147033.

In FSA 200147003, the IRS dismissed a taxpayer's contention that guarantee fees that a U.S. subsidiary paid to its foreign parent were foreign-source, personal-services income exempt from U.S. tax. Instead, it concluded that such fees should be sourced as if they were interest, even though they were not actually interest. The IRS treated the guarantee fees like other U.S.-source fixed or determinable annual or periodical (FDAP) income, subject to 30% U.S. withholding tax. The FSA also analyzed the effect of the applicable treaty (the FSA did not specify a treaty jurisdiction) and determined that the treaty's interest article did not apply. (The FSA did not specifically address whether the fees would be exempt from tax under an "other income" treaty article; apparently, no such article existed under the treaty discussed in the FSA.) The FSA did, however, hold out the possibility that the guarantee fees could be exempt from withholding tax if additional facts established that the fees were industrial or commercial profits under the treaty.

Under the FSA's facts, third-party lenders made loans to several U.S. subsidiaries (related lenders) of a foreign parent. The related lenders then made loans to another (presumably U.S.) subsidiary of the foreign parent, under various loan agreements. The foreign parent formed a new U.S. subsidiary (taxpayer). For business reasons, the taxpayer assumed the subsidiary's debt obligations under the loan agreements. To assure the third-party lenders that the taxpayer would satisfy its debts, the taxpayer and foreign parent entered into a guarantee agreement, under which the foreign parent agreed to unconditionally guarantee the taxpayer's performance under the loan agreements for a specified guarantee fee.

At issue in the FSA was the character and source of the guarantee fees paid by the taxpayer to the foreign parent, and whether the treaty interest-and-business-profits articles applied to such fees. The taxpayer characterized the guarantee fees as...