In a previous blog we discussed a situation where tax was required to be withheld on profits allocated to LLC investor-members who were nonresident aliens. Today we will look at a situation where a company borrowed money from a foreign parent corporation. Although this story is based on a real-life situation, the names and details have been changed.
Grapes-R-Us Inc. is an agribusiness incorporated and operating in New York State. It is owned by a larger US corporation which is a subsidiary of the Dutch corporation Wijn Holding. Grapes-R-Us has various liabilities on its books, including a loan from Wijn. Although it had not been able to make any principal payments, Grape-R-Us had been making regular interest payments to Wijn for the last five years. The loan from Wijn bears a reasonable rate of interest rate and has a solid business purpose.
During preparation of the Grapes-R-Us corporate tax returns, the CPA noticed that there were payments being remitted to a foreign entity. After discussions with the client, the CPA learned that the payments were interest, which is a type of Fixed, Determinable, Annual or Periodic income (commonly referred to as FDAP). Payments of US source FDAP to foreign persons (which includes foreign entities as well as foreign individuals) are generally subject to income tax withholding by the US payer at a rate of 30%. Although there are certain exceptions to the withholding rules, none applied in this situation.
For the last five years Grapes-R-Us had failed to withhold taxes, make timely tax deposits, or file the appropriate withholding tax and information returns.
The first step was to file the past returns and remit the withholding tax to the IRS. Although the IRS initially assessed deposit, late filing, and late payment penalties, the penalties were eventually abated after protesting the penalties and providing the IRS with an adequate explanation for the past noncompliance. In addition, Grapes-R-Us was able to recoup from Wijn the taxes that should have been withheld from the interest payments to Wijn.
We cannot guarantee that all situations will end as well as this one, but an important takeaway from this story is that there is a greater chance of avoiding penalties if, once an error is discovered, immediate action is taken to correct the situation. It helps strengthen the case that no intentional disregard of the US tax laws was ever intended. If the IRS discovers an error and believes that the taxpayer was aware of the problem but took no remedial action, there is a high probability that penalties will be imposed. One thing is for certain: when it comes to international matters, the penalties for non-compliance with US rules can be large and painful.
Contact us to learn more about how we can help you identify and address US tax withholding and filing requirements.