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Treaty Benefits

Definition:

The concept of withholding tax on payments to nonresident alien individuals and foreign corporations applies to U.S. source FDAP income that is not effectively connected with a trade or business in the U.S. This is because FDAP income that is effectively connected with a U.S. trade or business of the foreign person is taxed as part of the net income of the U.S. trade or business. “The U.S. taxes nonresident alien individuals and foreign corporations on their U.S. source income under either a withholding on a gross income basis or a net taxation basis if engaged in a trade or business within the U.S. The U.S. imposes either a statutory rate of 30% for withholding or the U.S. graduated rates for taxpayers engaged in a trade or business within the U.S. Treaties can reduce the rate of withholding tax and modify U.S. tax law with regards to taxation on a net basis.

Generally, withholding agents are required to withhold at the statutory rate of 30% and must deposit any tax withheld and file Form 1042 and Form 1042-S with the IRS. If a withholding agent fails to withhold the correct amount of tax or file the respective returns it is liable for the tax, interest, and penalties with regards to the payments.

Furthermore, withholding agents who cannot reliably associate a payment with documentation on the date of the payment are liable under IRC § 1461 for the tax required to be withheld under the Code. In these instances a withholding agent may be liable for as much as 30% of the gross income paid to the payee or beneficial owner. Therefore, it is important that IRS agents understand when the Service can accept a claim for treaty benefits. In cases where the withholding agent, payee or beneficial owner have provided late documentation, the Service may consider accepting the late documentation and allow claims for treaty benefits. However, when documentation is provided after a payment is made the reliability of the documentation may be questionable. As such, examiners may require additional proof if it is determined that the delays in obtaining the withholding certificate affect its reliability.” See Page 3, 22, 26  See Page 14