William Byrnes' Tax, Wealth, and Risk Intelligence

Note: The following is an excerpt from Chapter 11 of the LexisNexis® Guide to FATCA Compliance* – The title is now shipping to customers world-wide.

Importance of the Income Source

In cross-border transactions, the U.S. tax system, as well as the tax systems of most other nations or jurisdictions, contains rules to determine and identify items of income (or expense) derived from U.S. sources or foreign sources-referred to from the U.S, perspective as U.S. source income or foreign source income. This is generally referred to as the source of income rules. The U.S. Internal Revenue Code (IRC) contains source of income rules.1 Tax treaties also provide and often clarify source of income rules. The source of income rules provide the basis for taxation, but the operating rules are contained elsewhere in the IRC.

The income category generally determines the source of income rules. These rules attempt to assign income to a U.S. or non-U.S. source on a statutory basis by looking at the perception of what is the predominate situs (location) of the economic activity that generates the income, and the source of legal protections that facilitate such income generation.

Certain categories of U.S. source income are subject to withholding “at source”-i.e. in the U.S.  Because the U.S. has no taxing authority or jurisdiction over foreign persons, the IRC finds one or more withholding agents who are required to withhold at source in the U.S.  Generally when transfers of these certain categories of income are made to persons outside the U.S., the withholding agent in the U.S. withholds a certain percentage of the funds and remits the funds to the Internal Revenue Service (IRS). The withholding rules are generally described under the Qualified Intermediary (QI) program.

FATCA Is In Addition to QI

The U.S. added the Foreign Account Tax Compliance Act (FATCA) as an additional layer over QI.2 FATCA consists of worldwide reporting and withholding rules designed to greatly reduce U.S. tax noncompliance for accounts and certain assets held offshore by U.S. taxpayers. FATCA’s withholding rules are discussed in this chapter.

GENERAL RULE FOR WITHHOLDABLE PAYMENTS 3

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1 Primarily IRC §§ 861, 862, 863, 865.

2 See Chapter 10.

3 See Chapter 12.