Flow-Through Entities

 

Chapter 3 payees. The payees of payments (other than income effectively connected with a U.S. trade or business) made to a foreign flow-through entity are the owners or beneficiaries of the flow-through entity. This rule applies for purposes of Chapter 3 withholding and for Form 1099 reporting and backup withholding. Income that is, or is deemed to be, effectively connected with the conduct of a U.S. trade or business of a flow-through entity, is treated as paid to the entity.

All of the following are flow-through entities:

If the Chapter 3 payee is a disregarded entity or flow-through entity for U.S. tax purposes, but the payee is claiming treaty benefits, see Fiscally transparent entities claiming treaty benefits, below.

Chapter 4 payees. For purposes of Chapter 4, however, a foreign entity that is a flow-through entity is a payee with respect to a payment (other than income effectively connected with the conduct of a U.S. trade or business) if the flow-through entity is:

  • An FFI that is not a participating FFI or deemed-compliant FFI, or restricted distributor (an entity that operates as a distributor that holds debt or equity interests in a restricted fund as a nominee and meets the requirements described in Regulations section 1.1471-5(f)(4)) receiving the payment on behalf of its owners (in such a case, the entity is a nonparticipating FFI subject to withholding under Chapter 4); or
  • An excepted NFFE that is not acting as an agent or intermediary with respect to the payment.

If you make a withholdable payment to a flow-through entity that is not one of the types described above, you must treat the partner, beneficiary, or owner (as applicable) of the flow-through entity as the payee for Chapter 4 purposes (similar to the determination of the payee for Chapter 3 purposes) (looking through partners, beneficiaries, and owners that are themselves flow-through entities that are not one of the types described above).

Generally, you treat a payee as a flow-through entity if it provides you with a Form W-8IMY on which it claims such status. You may also be required to treat the entity as a flow-through entity under the presumption rules.

For purposes of Chapter 3, you must determine whether the owners or beneficiaries of a flow-through entity are U.S. or foreign persons, how much of the payment relates to each owner or beneficiary, and, if the owner or beneficiary is foreign, whether a reduced rate of Chapter 3 withholding applies. For purposes of Chapter 4, you must determine the Chapter 4 status of the owners or beneficiaries of a flow-through entity (subject to the exceptions described above), how much of the payment relates to each owner or beneficiary, and whether withholding under Chapter 4 applies. You make these determinations based on the documentation and other information (contained in a withholding statement) that is associated with the flow-through entity's Form W-8IMY. If you do not have all of the information that is required to reliably associate a payment with a specific payee, you must apply the presumption rules. Refer to Beneficial Owners and Documentation and Presumption Rules.

"Withholding Foreign Partnerships" and "Withholding Foreign Trusts" are not flow-through entities. See the discussion of these entities on the Revised Qualified Intermediary (QI) Agreement PDF, in Revenue Procedure 2017-15, and refer to Revenue Procedure 2017-21 PDF for guidance on entering into a withholding foreign partnership or trust agreement.

Foreign Partnerships

A foreign partnership is any partnership (including an entity classified as a partnership) that is not organized under the laws of any state of the United States or the District of Columbia or any partnership that is treated as foreign under the income tax regulations. If a foreign partnership is not a withholding foreign partnership, the payees of income are the partners of the partnership, provided the partners are not themselves a flow-through entities or a foreign intermediary. However, the payee is the partnership itself if the partnership is claiming treaty benefits on the basis that it is not fiscally transparent in the treaty jurisdiction and that it meets all the other requirements for claiming treaty benefits. If a partner is a foreign flow-through entity or a foreign intermediary, you apply the payee determination rules to that partner to determine the payees.

For purposes of Chapter 4, a foreign partnership is a payee of a withholdable payment if the partnership is a withholding foreign partnership that is not acting as an agent or intermediary with respect to the payment. If the partnership is not a withholding foreign partnership, the payees are the partners (looking through any partners that are flow-through entities that are not treated as payees under the Chapter 4 regulations).

Example 1. A nonwithholding foreign partnership has three partners: a nonresident alien individual; a foreign corporation, and a U.S. citizen. You make a payment of U.S. source interest to the partnership. Assume that the payment is subject to Chapter 3 withholding but is not a withholdable payment. The partnership gives you a Form W–8IMY, with which it associates Form W–8BEN from the nonresident alien, Form W-8BEN-E from the foreign corporation, and a Form W–9 from the U.S. citizen. The partnership also gives you a complete withholding statement that enables you to associate a part of the interest payment to each partner.

You must treat all three partners as the payees of their part the interest payment as if the payments were made directly to them. Report the payments to the nonresident alien and the foreign corporation on Forms 1042–S. Report the payment to the U.S. citizen on Form 1099–INT. You do not need to determine the Chapter 4 status of the partnership because the payment is not a withholdable payment.

Example 2. A nonwithholding foreign partnership has two partners: a foreign corporation, and a nonwithholding foreign partnership. The second partnership has two partners, both nonresident alien individuals. You make a payment of U.S. source interest to the first partnership. Assume that the payment is subject to Chapter 3 withholding but is not a withholdable payment. The first partnership gives you a valid Form W–8IMY with which it associates a Form W–8BEN-E from the foreign corporation and a Form W–8IMY  from the second partnership. In addition, Forms W–8BEN from the partners are associated with the Form W–8IMY from the second partnership. The Forms W–8IMY from the partnerships have complete withholding statements associated with them. Because you can reliably associate a portion of the interest payment with the Forms W–8BEN-E and W-8BEN provided by the foreign corporation and the nonresident alien individual partners as a result of the withholding statements, you must treat them as the payees of the interest. You do not need to determine the Chapter 4 status of the partnership because the payment is not a withholdable payment.

Example 3. You make a payment of U.S. source dividends to a withholding foreign partnership. Assume that the payment is subject to Chapter 3 withholding and is not a withholdable payment. The partnership has two partners, both foreign corporations. You can reliably associate the payment with a valid Form W–8IMY  from the partnership on which it represents that it is a withholding foreign partnership. You must treat the partnership as the payee of the dividends for purposes of both Chapter 3 and Chapter 4, and you must determine the Chapter 4 status of the partnership.

Foreign Simple and Grantor Trust

A trust is foreign unless it meets both of the following tests.

  • A court within the United States is able to exercise primary supervision over the administration of the trust.
  • One or more U.S. persons have the authority to control all substantial decisions of the trust.

Generally, a foreign simple trust is a foreign trust that is required to distribute all of its income annually. A foreign grantor trust is a foreign trust that is treated as a grantor trust under sections 671 through 679 of the Internal Revenue Code. The payees of a payment made to a foreign simple trust are the beneficiaries of the trust. The payees of a payment made to a foreign grantor trust are the owners of the trust.

However , the payee is the foreign simple or grantor trust itself if the trust is claiming treaty benefits on the basis that it is not fiscally transparent and that it meets all the other requirements for claiming treaty benefits. If the beneficiaries or owners are themselves flow-through entities or foreign intermediaries, you apply the payee determination rules to that beneficiary or owner to determine the payees.

Example 4. A foreign simple trust has three beneficiaries: two nonresident alien individuals and a U.S. citizen. You make a payment of interest to the foreign trust. Assume that the payment is subject to Chapter 3 withholding but is not a withholdable payment. The foreign trust gives you a Form W-8IMY with which it associates Forms W-8BEN from the nonresident aliens and a Form W-9 from the U.S. citizen. The trust also gives you a complete withholding statement that enables you to associate the interest payment with the forms provided by each beneficiary. You must treat all three beneficiaries as the payees of their part of the interest payment as if the payment were made directly to them. Report the payment to the nonresident aliens on Forms 1042-S. Report the payment to the U.S. citizen on Form 1099-INT. You do not need to establish the Chapter 4 status of the trust because the payment is not a withholdable payment.

Fiscally Transparent Entities Claiming Treaty Benefits

For purposes of claiming treaty benefits, if an entity is fiscally transparent for U.S. tax purposes (for example, a disregarded entity or flow-through entity for U.S. tax purposes) and the entity is or is treated as a resident of a treaty country, it will derive the item of income and may be eligible for treaty benefits. In such case, the entity is the payee for Chapter 3 purposes.  It does not need to be taxed on such item, but the item must be accounted for as the entity's income, not the interest holders' income, under the law of the treaty country whose treaty it is invoking. It also must meet any other requirements for claiming benefits, including a limitation on benefits article, if any, in the treaty. The entity should provide a Form W-8BEN-E in such circumstances. If, for Chapter 3 purposes, the payee is a foreign corporation or other non-flow-through entity for U.S. tax purposes, it is nonetheless not entitled to claim treaty benefits if the entity is fiscally transparent in its country of residence (that is, foreign reverse hybrid). Instead, any interest holder resident in that country will derive its allocable share of the items of income paid to the foreign reverse hybrid and may be eligible for benefits. If an interest holder is a resident of a third country, the interest holder may claim treaty benefits under its treaty with the United States, if any, only if the foreign reverse hybrid is fiscally transparent under the laws of the third country. If an interest holder is entitled to treaty benefits under its country of residence, the payee may provide a Form W-8IMY and attach Form W-8BEN or W-8BEN-E from any interest holder that claims treaty benefits on such income. The determination of whether an entity is fiscally transparent is made on an item of income basis (that is, the determination is made separately for interest, dividends, royalties, etc.). An interest holder in an entity makes the determination by applying the laws of the jurisdiction where the interest holder is organized, incorporated, or otherwise considered a resident. An entity is considered to be fiscally transparent with respect to the income to the extent the laws of that jurisdiction require the interest holder to separately take into account on a current basis the interest holder's share of the income, whether or not distributed to the interest holder, and the character and source of the income to the interest holder are determined as if the income was realized directly from the source that paid it to the entity. Subject to the standard of knowledge rules, you generally make the determination that an entity is fiscally transparent based on a Form W-8IMY provided by the entity.

For Chapter 3 purposes, the payees of a payment made to a fiscally transparent entity are the interest holders of the entity if the interest holders are claiming treaty benefits with respect to the payment.

For Chapter 4 purposes, if you are making a withholdable payment to a fiscally transparent entity, you must apply the rules of Chapter 4 to determine the payee and whether Chapter 4 withholding applies to the payment based on the payee’s Chapter 4 status. Thus, Chapter 4 withholding may apply to a withholdable payment made to a fiscally transparent entity based on the Chapter 4 status of the entity even when the interest holders in the entity would be eligible for reduced withholding under an income tax treaty with respect to the payment. Treaty benefits may be granted to the interest holder when the payment made is not subject to Chapter 4 withholding based on the Chapter 4 status of both the entity and the interest holder.

Example 5. Entity A is a business organization organized under the laws of country X that has an income tax treaty in effect with the United States. A has two interest holders, B and C. B is a corporation organized under the laws of country Y. C is a corporation organized under the laws of country Z. Both countries Y and Z have an income tax treaty in effect with the United States.

A receives royalty income from U.S. sources that is not effectively connected with the conduct of a trade or business in the United States and that is not a withholdable payment. The Chapter 4 status of A does not need to be determined because the payment is not a withholdable payment. For U.S. income tax purposes, A is treated as a partnership. Country X treats A as a partnership and requires the interest holders in A to separately take into account on a current basis their respective shares of the income paid to A even if the income is not distributed. The laws of country X provide that the character and source of the income to A's interest holders are determined as if the income was realized directly from the source that paid it to A. Accordingly, A is fiscally transparent in its jurisdiction, country X.

B and C are not fiscally transparent under the laws of their respective countries of incorporation. Country Y requires B to separately take into account on a current basis B's share of the income paid to A, and the character and source of the income to B is determined as if the income was realized directly from the source that paid it to A. Accordingly, A is fiscally transparent for that income under the laws of country Y, and B is treated as deriving its share of the U.S. source royalty income for purposes of the U.S.-Y income tax treaty. Country Z, on the other hand, treats A as a corporation and does not require C to take into account its share of A's income on a current basis whether or not distributed. Therefore, A is not treated as fiscally transparent under the laws of country Z. Accordingly, C is not treated as deriving its share of the U.S. source royalty income for purposes of the U.S.-Z income tax treaty.

References/Related Topics

Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.