Reporting Treaty-Based Return Positions

By now, most tax practitioners should be comfortable with the reporting requirements for payments subject to U.S. withholding tax, especially after the waves created by Form W-8BEN, Certificate of Foreign Status or Beneficial Owner for United States Tax Withholding, when it was first released. With the extended tax season on the horizon, practitioners should not forget about another change added last year that may affect some taxpayers. In fact, what may appear to be a minor problem could ultimately be a major one on closer examination of the rules.

Disclosing Treaty-Based Return Positions

Generally, under Regs. Sec. 301.6114-1(a)(2)(i), a taxpayer would take a treaty-based return position if there were a difference between the tax liability that the taxpayer intended to report on its return and the tax liability that it would have reported if the relevant treaty provision did not exist. Accordingly, if the taxpayer takes such a position, it must disclose it on Form 8833, Treaty-Based Return Position Disclosure, accompanying its return.

Regs. Sec. 301.6114-1(b) provides a list of specific positions for which disclosure would be necessary--even if a taxpayer is not otherwise required to file a return. Regs. Sec. 301.6114-1(b)(4)(ii)(C) provides that, for post-2000 payments exceeding $500,000, a taxpayer would have to report a position taken under a tax treaty containing a limitation-on-benefits (LOB) provision, if the treaty exempts the tax (or reduces the tax rate) on fixed or determinable annual or periodic (FDAP) income subject to withholding under Secs. 1441 and 1442, received by a foreign person that is the income's beneficial owner and related to the payor within the meaning of Secs. 267(b) and 707(b).

Under Regs. Sec. 301.6114-1(b)(4)(ii)(D), a taxpayer would also have to explicitly disclose any post-2000 payments under a treaty that imposes any other conditions for the entitlement of treaty benefits, if the taxapayer takes the position that the payments meet these conditions. This requirement can apply when a treaty has a two-tier withholding rate on dividends (e.g., owners of 10% or more of the payor's stock obtain a 5% withholding rate, while all other owners are entitled to only a 15% rate). In addition, if read literally, this regulation may imply that, even in the absence of a two-tier withholding system, any provision that imposes conditions on treaty benefits will subject FDAP income to disclosure. One such provision is the interest article in many U.S. treaties, which provides that interest between related parties must be charged at arm's-length rates. Because most treaties contain conditional provisions, a majority of FDAP-income payments may require disclosure, whether or not related parties receive these payments and even if the payments do not exceed $500,000.

Waivers

Despite the disclosure requirements, the regulations also provide situations in which certain taxpayers do not have to disclose their treaty-based positions. For example, Regs. Sec. 301.6114-1(c)(2) generally provides that an individual who receives payments not exceeding $10,000 does not have to disclose a treaty-based position.

Notice 2001-43

Notice 2001-43 clarifies and corrects Regs. Sec. 301.6114-1(b) and (c). Although the notice addressed more than treaty-based disclosures, a key impetus for its release was to provide guidance on conforming the withholding tax and disclosure regulations.

The notice also states that the IRS intends to amend the regulations to waive disclosure requirements for payments not exceeding $10,000, received by taxpayers other than individuals or states that rely on a treaty that imposes additional conditions other than an LOB article. For example, the disclosure requirements would continue to apply to FDAP income exceeding $10,000 if the income is subject to a two-tier withholding rate system. In this situation, all taxpayers who receive more than $10,000 of FDAP income from related or unrelated parties and rely on a treaty with a two-tiered withholding structure (usually applicable to dividends) or any other condition, should disclose their position in their U.S. income tax return. Thus, in reviewing 2001 intercompany transactions, practitioners should note that a disclosure obligation might exist for clients that receive FDAP income, even if it does not exceed $500,000, from related (as well as unrelated) parties.

To comply with these disclosure requirements, affected taxpayers should file an appropriate U.S. return and attach Form 8833. However, to file such returns, they must obtain a taxpayer identification number. In addition, taxpayers receiving FDAP income must have a W-8BEN on file with the payor, and the withholding agent must properly report all payments on Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding (see Tax Clinic, "New Forms and Transitional Rules for Withholding Tax," TTA, May 2000, p. 323).

A foreign taxpayer should determine the total amount of FDAP income received after 2000, because the taxpayer may have to file a U.S. income tax return with Form 8833 attached. Under Sec. 6712(a), the failure to make this disclosure may subject a taxpayer to a $1,000 penalty ($10,000 for C corporations).

From John F. Santa Maria, CPA, and Daniel W. Markiewicz, MBA, New York, NY