Withholding and reporting requirement for payments to foreign partnerships.

• Author: Halphen, Christine

Persons who make income payments to foreign partnerships face new compliance and penalty risks in connection with the withholding and reporting of US. tax. Under new regulations effective for payments made after 1998, special withholding and reporting rules apply to payments to foreign partnerships under Sec. 1441, 1442 or 1443. These rules should be considered in conjunction with other recent developments: the legislative changes that eliminate the "10 commandments" and, thus, make it easier for foreign partnerships to come ashore; the temporary regulations under Sec. 894 that change the way payments to hybrid entities can benefit from reduced rates under income tax treaties; and the legislative changes to reporting by foreign partnerships and the expected regulatory changes in this area. Foreign partnerships should consider whether to become a "withholding foreign partnership" by entering into an agreement with the IRS to assume full responsibility for withholding.

Foreign partnerships are subject to 30% nonresident alien (NRA) tax on most items of income they receive from sources within the U.S. that are not effectively connected with the conduct of a trade or business in the U.S. (non-ECI). This includes payments of interest, dividends, royalties, compensation and other fixed or determinable annual or periodical (FDAP) income. The 30% NRA withholding rate on U.S.-source FDAP payments to foreign partnerships may be reduced under the Code or an income tax treaty. Withholding is generally required at a 30% rate, however, unless the withholding agent holds certain documentation that it can reliably associate with the payment and on which it can rely to reduce the rate of withholding. For payments of U.S.-source FDAP to a foreign partnership, the documentation on which the withholding agent can rely to reduce the 30% withholding rate includes a Form W-8, Certificate of Foreign Status, from the partnership with the partnership's employer identification number, certifying that it is a withholding foreign partnership. A foreign partnership can certify that it is a withholding foreign partnership only if it has entered into a withholding agreement with the Service.

For FDAP payments to a withholding foreign partnership, the withholding agent pays the amount without any withholding and reports the payments on Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, in the name of the partnership. The withholding foreign...