Impact of Tax Cuts and Jobs Act: Part V – Certain Changes Affecting Cross-Border Withholding and Sourcing

Thursday, November 2, the House Ways and Means Committee released the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”), a bill that, if enacted, would represent the most substantial overhaul of the U.S. tax code in decades.  We are releasing a series of posts to highlight the provisions of the Bill affecting the topics pertinent to our readers, where each post will cover a different area of importance.  Part I of this series covered potential changes to employer-provided benefits, Part II addressed entertainment expenses and other fringe benefits, Part III discussed changes to employee retirement plans, and Part IV covered changes to the Code section 162(m) deduction limitation for executive compensation.  In this Part V, we will discuss the Bill’s potential impact on two cross-border tax issues.

Reduced FIRPTA Withholding Rates.  Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), gain or loss on the disposition of U.S. real property interests by a nonresident alien individual or foreign corporation is subject to U.S. income tax as though the taxpayer were engaged in a trade or business in the United State and such gain or loss were effectively connected with such trade or business.  Section 1445 applies a withholding mechanism to ensure the payment of any tax due.  When a domestic partnership, trust, or estate disposes of a U.S. real property interest, section 1445 requires that it (or the trustee or executor, in the case of a trust or estate, respectively) withhold 35 percent of the gain realized that is allocable to a foreign person (or allocable to a portion of a trust treated as owned by a foreign person).  Similarly, when a foreign corporation distributes a U.S. real property interest to its shareholders, it must withhold at a rate of 35 percent.  The same withholding rate applies to distributions that are treated as gains or losses from the disposition of a U.S. real property interest allocable to foreign persons from certain domestic entities (such as real estate investment trusts and registered investment companies that would be considered U.S. real property holding corporations if their shares were not publicly traded).  Section 3001 of the Bill, which reduces corporate tax rates in general, includes a corresponding reduction of the FIRPTA tax withholding rate, modifying paragraphs 1445(e)(1), 1445(e)(2), and 1445(e)(6) to require withholding at a 20 percent rate.  The reductions would take effect for tax years beginning after 2017.

Modification to Sourcing Rule for Sales of Inventory Property.  Currently, up to 50 percent of income from the sale of inventory property produced entirely within the United States and sold outside the United States (or vice-versa) can be treated as foreign-source income for purposes of calculating foreign tax credits.  Section 4102 of the Bill would require sales of inventory property to be sourced solely based on the location of production activity with respect to the inventory.  This change would be effective for tax years beginning after 2017.

Temporary FATCA Coordination Regulations Bring U.S. Source Gross Transportation Income Saga to a Close

On Friday, December 30, 2016, the IRS and Treasury Department released over 600 pages of new final, temporary and proposed regulations under Chapter 4 (FATCA), Chapter 3, and Chapter 61 (see earlier coverage).  The four packages finalize the temporary regulations issued in 2014 and make additional changes based on comments received by the IRS.  One issue addressed by the temporary FATCA coordination regulations issues under Chapter 3 addresses the outstanding question of whether withholding agents must document the foreign payees of U.S. source gross transportation income (USSGTI) and withhold under Chapter 3.  The temporary regulations amend the regulations under Section 1441 to specifically exempt USSGTI from amounts subject to withholding.

Although it informally suggested that withholding agents were not required to document or withhold 30% on payments of USSGTI, the IRS has been reluctant to issue formal guidance.  To this end, IRS Publication 515 provides that such amounts are not subject to Chapter 3 withholding under Section 1441 or 1442.  However, Sections 1441 and 1442 generally require withholding agents to withhold 30% on payments subject to the tax imposed by Sections 871 and 881 (i.e., FDAP income).  However, payments of gross transportation income that is U.S. source because the transportation begin or ends (not both) in the United States are subject to a 4% excise tax under Section 887 that is self-imposed by the payee, unless an exception applies.  Section 887(c) provides that the 30% gross tax applicable to most U.S. source income of foreign persons (other than income effectively connected with a U.S. trade or business) does not apply to transportation income.

The issue that has arisen is that neither Section 1441 or 1442 explicitly reference Sections 871 and 881 as a basis for the withholding.  However, it seems illogical to require 30% withholding on U.S. source gross transportation income given that such income is only subject to the 4% excise tax.  Despite the guidance in Publication 515, examiners have asserted on audit that such payments are subject to withholding under Chapter 3.  Nevertheless, withholding agents have generally been successful in rebutting such assertions and avoiding audit assessments.

The IRS created confusion regarding this issue earlier in 2016 when it asserted in a practice unit that USSGTI did not constitute FDAP income and was therefore not subject to withholding under Chapter 3 (see earlier coverage).  The IRS later revised the practice unit to remove the reference to USSGTI (see earlier coverage) after taxpayers questioned whether such payments are FDAP income.  The preamble to the temporary regulations now clarify that although USSGTI is FDAP income, it is nonetheless not subject to Chapter 3 withholding because the tax imposed under Section 871 or 881 does not apply.  The temporary regulations now thankfully bring this saga to a close six years after the IRS Information Reporting Program Advisory Committee made its original request for the IRS to clarify this problem for withholding agents in 2010.  A discussion of this issue can be found in IRPAC’s 2013 annual report.

Print Out IRS FAQs and Other Informal Guidance While You Have the Chance

July 26, 2016 by  
Filed under Chapter 3, IRS

When you find favorable informal guidance posted on the IRS website, print it out and save it.  A few years ago, a Treasury official from the Office of Tax Policy rebuked someone who proposed addressing a technical issue through IRS FAQs, conveying that the Treasury frowns on issuing such informal guidance.  At the time, we wondered whether the official had recently visited the IRS website and understood how much informal guidance the IRS provides to taxpayers and practitioners in this manner.

The U.S. tax system is complicated, and significant guidance is necessary to foster compliance.  Yet, the IRS and Treasury does not publish adequate formal guidance (e.g., regulations, revenue rulings, notices, etc.) each year to keep up, so the IRS fills the gaps through FAQs and other informal guidance on its website.  The problem is multifaceted, from the IRS brain drain due to the loss of retiring seasoned technicians, to difficulty recruiting qualified personnel at IRS Chief Counsel related to inadequate Congressional funding and compensation that is no longer reasonably competitive with the private sector, to a logjam of draft guidance at the Treasury Office of Tax Policy.  The IRS seems to feel that the issuance of informal guidance on its website is better than nothing, and it is probably right.

The knock on FAQs and its ilk is twofold.  First, taxpayers probably cannot rely on it because it is informal, unreviewed, and occasionally wrong.  Second, it has a way of disappearing from the website without a trace.  This happened recently with respect to slides made public by the LB&I International Practice Service Concept Unit, which were issued last month and revised this month.  We wrote about how the original slides addressed “transportation income” in an earlier post.

The original slides included a reference to “transportation income” with a parenthetical indicating that such income was “not FDAP.”  FDAP stands for fixed or determinable annual or periodical income.  This struck us as odd, because we felt that transportation income likely was FDAP income, but practitioners have been asking the IRS to issue formal guidance to clarify withholding rules regarding transportation income for years, without success.  (If you are interested, see the IRPAC briefing books on the IRS website to see a discussion of the requests for guidance from 2010 through 2013.)  Thus, any discussion from the IRS to address Chapter 3 withholding related to U.S. source gross transportation income is of great interest to those of us who have been requesting it. Publication 515, for the record, indicates Chapter 3 withholding is not required on U.S. source gross transportation income.  Taxpayers paradoxically should not really rely on statements of law included in IRS publications either.

Alas, someone must have told the responsible LB&I unit that transportation income is FDAP, so when the slides were updated, the statement about transportation income not being FDAP income was removed.  The older version of the practice unit has been replaced with the updated version, so the statement can no longer be found on the IRS website.  Unfortunately, the latest hope for a trump card on U.S. source transportation income disappeared like so many FAQs on other issues before it – into the ether.  The before and after slides are shown below.

Original Practice Unit [Click Image to Enlarge]


Updated Practice Unit [Click Image to Enlarge]