Sec. 1441 Voluntary Compliance Program

The IRS has launched a voluntary compliance program (VCP) under Sec. 1441 for withholding agents (such as financial institutions) that make payments of U.S.-source dividends, interest, rents, royalties and other fixed or determinable, annual or periodical (FDAP) income to foreign persons; see Rev. Proc. 2004-59.

The VCP responds to comments from financial institutions that wanted to disclose and resolve compliance issues associated with implementing final regulations under Secs. 1441–1464 and 6041–6050S. When these financial institutions started to implement the final regulations, they began identifying tax deficiencies and failures in their systems. These entities told the IRS that complying with the final regulations required ongoing documentation of account holders and major changes to existing systems and procedures.

The Sec. 1441 VCP is available for submissions made from Sept. 29, 2004–Dec. 31, 2005. It applies to tax withholding and reporting obligations under Secs. 1441–1443 and 1461, and to related tax withholding and reporting obligations under Secs. 3406 and 6041–6050N.

Background

Sec. 1441 requires any person who pays income subject to tax under Sec. 871(a) or 881(a), which includes FDAP income, to withhold tax on the gross amount paid. Generally, the tax is imposed on the gross amount at a 30% rate. However, the withholding rate may be reduced or eliminated pursuant to a tax treaty or a Code section, if the withholding agent obtains documentation from the foreign person. A withholding agent is required to determine the status of the persons to whom it makes payments by obtaining documentation from them and may withhold at a reduced rate on payments to foreign persons only if the foreign person has furnished the required documentation.

Eligibility

To be eligible for the VCP, a withholding agent must meet the definition in Regs. Sec. 1.1441-7(a)(1): any person, whether U.S. or foreign, that has the control, receipt, custody, disposal or payment of an item of income of a foreign person subject to withholding, and is not a “qualified intermediary,” a “withholding foreign partnership,” a “withholding foreign trust” or an “eligible organization” as defined in Section 2.01 of Rev. Proc. 2001-20. An “eligible organization” includes (1) a college or university described in Sec. 170(b)(1)(A)(ii), which is exempt from tax under Sec. 501(a) as an organization described in Sec. 501(c)(3); or (2) an organization described in Sec. 501(c)(3) and exempt from income tax under Sec. 501(a) that is affiliated with any such college or university.

A withholding agent is not eligible for the VCP if he or she is under examination for Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, as of Sept. 29, 2004, or comes under examination before submitting the information required for VCP participation. This program is also not available to any withholding agent that has a case pending in the Office of Appeals or is in litigation on certain issues involving tax, withholding or reporting obligations subject to the VCP.

The Program

The VCP applies only to tax and reporting obligations related to Forms 1042 and 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, and not Forms 945, Annual Return of Withheld Federal Income Tax, and 1099, except to the extent that (1) correcting a failure to document U.S. persons or (2) a misclassification of U.S. and foreign persons, requires the filing or correction of those forms.

The program allows withholding agents to voluntarily disclose failures to (1) withhold or pay the correct tax on income reported on Form 1042, (2) withhold or pay the backup withholding tax and (3) correctly report information under Secs. 1461 or 6041–6050N.

Submission procedures: To participate in the VCP, the withholding agent must submit a letter to the IRS; anonymous requests are not acceptable. The submission must contain certain information and documentation, including the following:

1. The withholding agent’s name, address and taxpayer identification number.

2. A description of the current procedures that the withholding agent uses to determine tax, withholding and reporting obligations for payments to foreign persons.

3. A description of the failures in the withholding agent’s tax, withholding and reporting procedures for payments to foreign persons, how and why the failures occurred and the years affected.

4. The number of persons affected by such failures and how it was determined.

5. A calculation of the total amount of taxes the withholding agent failed to withhold, pay and/or report, not including interest and penalties, for tax periods open for assessment or collection under Sec. 6501.

6. A detailed description of the corrective procedures the withholding agent has implemented or will implement to ensure that payments to foreign persons will be subject to the correct amount of withholding and that withheld amounts will be paid over and reported to the IRS on the proper forms in a timely manner.

7. A statement signed by the withholding agent or its authorized representative acknowledging and agreeing that thewithholding agent’s participation in the VCP will not constitute an audit of the withholding agent.

8. A statement that the withholding agent is an eligible withholding agent.

9. Copies of workpapers or schedules that clearly explain the withholding agent’s calculation of its correct tax liability for payments to foreign persons. The workpapers or schedules should also show to which specific tax returns and tax periods the liability relates.

10. Copies of the original Forms 1042 and 945 (if any) as filed that relate to the above calculations.

In general, withholding agents will be given 90 days to correct an inadequate or incomplete submission to the IRS. The Service will issue an acknowledgement letter to the withholding agent once it is satisfied that the agent has instituted policies and procedures to ensure the correct amounts of tax will be withheld, paid and reported. The acknowledgement letter will state that, based on the IRS’s review, the withholding agent is in substantial compliance with its tax withholding and reporting obligations for payments to foreign persons. The IRS will not assert penalties if the agent’s failure is due to reasonable cause. However, if a resolution cannot be reached, the IRS may consider the case for examination.

From Sharlene Sylvia, CPA, Washington, DC, and Adam Kantor, J.D., LL.M., New York, NY