Do You Have the Necessary Withholding Documentation?
October 08, 2014
Will You be Held Responsible for the Taxes Your Suppliers and Vendors Owe?
As part of the ongoing IRS offshore tax-avoidance and compliance efforts, the IRS has increased its focus on withholding compliance. Consequently, in our first posts to this blog, we’ll discuss various aspects of the withholding regimes under Chapter 3 and Chapter 4 of the Internal Revenue code. The Chapter 3 rules relate to withholding tax on non-resident individuals and foreign corporations. The Chapter 4 rules relate to the taxes to enforce reporting of certain foreign accounts.
The case study below, which we will refer to in our next few posts, is being used to illustrate how the Chapter 3 and Chapter 4 rules apply to all industries and not merely financial services.
Case Study: ABC Wire Harness International Inc.
John Smith is the tax director at ABC Wire Harness International Inc., a multinational based in the U.S. that designs and manufactures energy-efficient wire harnesses. ABC has subsidiaries in China, Luxembourg, and Mexico. ABC purchases materials from vendors overseas, it hires non-U.S. service providers to provide various services including employee training services in the U.S., and on September 1, 2014 ABC obtained financing from a group of European banks in the form of a note in the amount of $7.2M with interest payable once annually at a rate of 8%.
To date, John has not focused on the withholding and documentation rules under the Internal Revenue Code because he did not think they were critical to businesses similar to ABC. Recently, Jane, an EisnerAmper International Tax Services team member, mentioned that effective July 1, 2014 there are new withholding rules under the FATCA provisions and suggested that this might be an opportune time to review ABC’s existing withholding practices to see if ABC had any exposure under the new and old withholding rules. Since that conversation with Jane, John has seen articles about the new withholding rules and the increased focus of the IRS on withholding compliance. He recalls that the last time the IRS audited ABC, the first information document request related to Forms W-8 and W-9. He is concerned that perhaps the lack of attention to withholding rules may result in significant cost to ABC down the line.
John contacted Jane to get an understanding of what the exposure would be for failure to follow the proper withholding and documentation procedures. Jane explained the Internal Revenue Code holds U.S. taxpayers personally liable for withholding tax on any payments which cannot be reasonably associated with valid documentation. During their conversation, John and Jane agreed it was time to review the withholding practices of ABC and implement procedures that would ensure compliance with both the old withholding rules under Chapter 3 of the Internal Revenue Code and the new FATCA rules under Chapter 4 of the Internal Revenue Code. In John’s words, he “did not want ABC to be held responsible for the unpaid taxes of one of his vendors or service providers.”
In our next post we’ll discuss the steps John and Jane took to get ABC on track with respect to withholding compliance.