Absent the application of a tax treaty or other applicable exclusion, foreign taxpayers who receive interest from U.S. payors unrelated to a U.S. trade or business are subject to a 30% withholding tax. However, if Internal Revenue Code requirements are followed to qualify the obligations under which the interest is paid as "portfolio interest obligations," the foreign receipient is not subject to U.S. income tax.
One limitation on the ability to use these rules is that the foreign recipient cannot be a 10% or more shareholder of a U.S. corporate payor, or a 10% or more partner of a U.S. partnership payor. While related party rules exist, neither the Code nor the legislative history specifically addresses how the 10-percent shareholder test is to apply when interest is paid to a partnership that has foreign partners. That is, neither the Code nor the legislative history explicitly provides whether the 10-percent shareholder test should be applied at the foreign partner level, the partnership level, or both levels. Different results may obtain whether one is testing if a partnership itself owns the disqualified 10% or more ownership interest, or whether the affected foreign partner itself owns that disqualified interest.
Pursuant to proposed regulations, the IRS and the Treasury Department have concluded that the 10-percent shareholder test should apply at the foreign partner level to the nonresident alien individual or foreign corporation that is the beneficial owner of the income. Accordingly, the proposed regulations provide that when interest is paid to a partnership, the persons who receive the interest for purposes of applying the 10-percent shareholder test are the nonresident alien individual partners and the foreign corporations that are partners in the partnership. The 10-percent shareholder test is then applied by determining each such person's ownership interest in the obligor.
When interest is paid to a simple trust or a grantor trust, an issue also arises as to whether the 10-percent shareholder test should be applied at the trust or beneficiary or owner level. Similar to the foregoing provisions for partnerships, the proposed regulations provide that when interest is paid to a simple trust or grantor trust and such interest is distributed to or included in the gross income of a nonresident alien individual or foreign corporation that is a beneficiary or owner of such trust, as the case may be, the withholding agent is to apply the rules of the proposed regulations with respect to determining whether a 10-percent shareholder has received interest, at the beneficiary or owner level.
Preamble to Prop Reg 06/13/2006 ; Prop Reg § 1.871-14 , Prop Reg § 1.881-2.
One limitation on the ability to use these rules is that the foreign recipient cannot be a 10% or more shareholder of a U.S. corporate payor, or a 10% or more partner of a U.S. partnership payor. While related party rules exist, neither the Code nor the legislative history specifically addresses how the 10-percent shareholder test is to apply when interest is paid to a partnership that has foreign partners. That is, neither the Code nor the legislative history explicitly provides whether the 10-percent shareholder test should be applied at the foreign partner level, the partnership level, or both levels. Different results may obtain whether one is testing if a partnership itself owns the disqualified 10% or more ownership interest, or whether the affected foreign partner itself owns that disqualified interest.
Pursuant to proposed regulations, the IRS and the Treasury Department have concluded that the 10-percent shareholder test should apply at the foreign partner level to the nonresident alien individual or foreign corporation that is the beneficial owner of the income. Accordingly, the proposed regulations provide that when interest is paid to a partnership, the persons who receive the interest for purposes of applying the 10-percent shareholder test are the nonresident alien individual partners and the foreign corporations that are partners in the partnership. The 10-percent shareholder test is then applied by determining each such person's ownership interest in the obligor.
When interest is paid to a simple trust or a grantor trust, an issue also arises as to whether the 10-percent shareholder test should be applied at the trust or beneficiary or owner level. Similar to the foregoing provisions for partnerships, the proposed regulations provide that when interest is paid to a simple trust or grantor trust and such interest is distributed to or included in the gross income of a nonresident alien individual or foreign corporation that is a beneficiary or owner of such trust, as the case may be, the withholding agent is to apply the rules of the proposed regulations with respect to determining whether a 10-percent shareholder has received interest, at the beneficiary or owner level.
Preamble to Prop Reg 06/13/2006 ; Prop Reg § 1.871-14 , Prop Reg § 1.881-2.
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