A foreign entity may be treated as fiscally transparent if a reduced rate of withholding is being claimed under an income tax treaty. The persons that hold an interest in the foreign entity determine whether the entity is fiscally transparent based on each item of income. The interest holders make this determination based on the laws of the jurisdiction in which they are organized or incorporated, or where they are considered residents.
An entity is considered fiscally transparent if the interest holders are required to separately take into account their share of the entity’s income on a current basis, whether or not the income has been distributed. Also, the character and source of the income must be determined as if the income had been realized by the interest holders directly from the source.
You as the payer of the income should be able to determine whether the entity you are paying is fiscally transparent based on the Form W-8IMY it gives you. If the entity is fiscally transparent, then for purposes of withholding tax, the payees are the interest holders of the entity.
Foreign Intermediaries
An intermediary is a broker, custodian, nominee, or any other person that acts as an agent in receiving income for another person. Generally, when you make payments to an intermediary, for tax withholding purposes you are making payments to the account holders or customers and not to the intermediary itself. You would apply the rules for NRA withholding and 1099 reporting as if the payments were made directly to the final account holders or customers.
A foreign intermediary is considered either a qualified intermediary or a nonqualified intermediary for U.S. income tax withholding purposes. This determination can be made based on the information provided in the intermediary’s Form W-8IMY. Also, based on this same form and its associated information and documentation, you should be able to determine whether the account holders or customers are foreign or U.S. persons, and if they are foreign, whether they qualify for reduced withholding or an exemption from withholding.
If you make a payment to a nonqualified intermediary, the payments are treated as having been made to the account holders or customers, for U.S. withholding tax purposes, and you will have to withhold and report the tax. You would report the amounts paid to any foreign account holders or customers on Form 1042-S and the amounts paid to U.S. account holders or customers on the appropriate Form 1099.
A qualified intermediary is one that has entered into an agreement with the IRS to act as the primary withholding agent and that is entitled to use simplified withholding and reporting procedures. Foreign financial institutions and foreign branches of U.S. financial institutions are the intermediaries that can generally qualify for this status. If you make a payment to one of these qualified intermediaries that has assumed primary responsibility for NRA and backup withholding and 1099 reporting, you do not need to withhold or report tax on the payment. The intermediary’s Form W-8IMY should indicate whether it has assumed primary responsibility.