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. The IRS later revised the practice unit to remove the reference to USSGTI 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.