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Monday, October 30, 2006


Non-U.S. persons who receive interest income or dividends from U.S. payors are typically subject to a 30% tax. The person paying the interest or dividends to the foreign person (the "withholding agent") is obligated to withhold this tax from the interest or dividend payment, and pay it over to the IRS. If the withholding agent does not withhold the tax, the IRS can nonetheless hold the withholding agent responsible for the tax if the payee does not pay it.

There are exceptions to the withholding tax, such as the portfolio interest exception which exempts interest paid on certain qualified obligations from U.S. tax, and tax treaties which may reduce or eliminate the tax. Generally, the withholding agent must receive certain documentation, like a Form W-8, from the payee before the withholding agent is released from its obligation to withhold.

What happens if a withholding agent doesn't receive the proper documentation before it makes its payment, but it turns out that no tax was due? In what many perceive to be an unfair rule, a withholding agent who doesn't withhold will still be liable for interest on the tax not withheld, even though no tax is due. Treas. Reg. § 1.1441-1(b)(7)(iii).

Well, that used to be the case. In Notice 2006-99, 2006-46 IRB, the IRS has advised that it will be amending the Regulations to avoid the interest charge against the withholding agent if it turns out the payee owed no tax. The Regulations will also clarify that no penalties will be imposed against the withholding agent in that circumstance. The Regulations will be retroactive to January 1, 2001.

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