An official from the Internal Revenue Service (IRS) recently highlighted the need, under the new partnership audit regime, for partnerships with foreign (i.e., non-US) partners to ensure that all Forms W-8 are accurate and on file.
Speaking at a recent Practicing Law Institute (PLI) conference in New York City, Clifford Warren, Senior Counsel to the IRS’ Associate Chief Counsel (Passthroughs and Special Industries), noted that with the advent of the new partnership audit regime, there will be a large focus on auditing partnerships. This focus on partnership audits brings about several documentation issues that many partnerships may be unaware of, despite their potential consequences. One particular documentation requirement with significant implications and potential risk for partnerships that is often over looked is the requirement to collect and maintain IRS Forms W-8 for foreign persons. As the IRS increases its focus on partnership audits, inspection of W-8 forms should be expected. Partnerships should therefore be armed with a documented process for collection, storage, and review of these forms.
As withholding agents, U.S. partnerships as well as non-U.S. partnerships that are owned 50 percent or more by U.S. persons, are generally required to collect IRS Forms W-8 from foreign partners in order to document their foreign (non-U.S.) status, their chapter three and chapter four status, and their entitlement to a reduced treaty rate of withholding. Payments and distributions made to foreign partners must generally be associated with a valid W-8 form that the partnership had on file on or before the date that any payment or distribution was made to the partner or the payment may be subject to U.S. tax withholding at a rate of up to 30 percent. Partnerships that fail to collect W-8s timely have potential exposure for significant assessments of additional taxes, penalties and interest that could be avoided simply by collecting a valid W-8 form upon onboarding the partner and before releasing any payments or distributions to him/her. Offshore partnerships owned 50 percent or more by U.S. persons that are also reporting foreign financial institutions under the U.S. Foreign Account Tax Compliance Act (FATCA) face an even greater risk in that they may also be held in default of their FFI agreements for failing to comply with FATCA’s due diligence requirements which could result in them being subject to 30 percent withholding on certain U.S. sourced payments received from other withholding agents.
For all of the aforementioned reasons, it is critical that partnerships implement processes now for the collection, review, and retention of W-8 forms. A leading industry practice is to collect the forms with subscription documents when partners/investors are on-boarded or admitted in order to minimize any potential risk of under withholding. Partnerships should also consider implementing standardized procedures throughout the organization for reviewing the forms upon receipt. Common errors that render the forms invalid include missing signatures, incomplete treaty claims, missing chapter three or chapter four statuses, and expired forms (i.e., those signed more than three years before the date of payment). Partnerships should be aware of these issues and should have a process for timely follow-up and curing of potential deficiencies.
New rules requiring that foreign tax identification numbers (FTIN) and dates of birth be included on certain Forms W-8 have been particularly challenging for partnerships since this information was not historically required and meant significant modifications to systems and processes throughout organizations. Moreover, since FATCA’s enactment, partnerships have even more information to collect from investors in order to satisfy due diligence requirements under this and other regulatory regimes. The new global Common Reporting Standard (CRS), for example, which has been adopted by over 113 jurisdictions, requires reporting financial institutions to collect self-certification forms from partners now in order to document their tax residency and CRS status. Failure to comply with CRS’ due diligence requirements by collecting a self-certification form from partners can result in significant penalties. Partnerships must therefore have processes for collecting IRS forms W-8 and CRS self-certifications that take into account their system and resource limitations while providing sufficient lead time and additional training for staff charged with collecting and reviewing these forms.
Besides payments to their partners, partnerships should also verify that other payments of U.S. sourced fixed, determinable, annual or periodical income potentially subject to chapter three or chapter four withholding which might be generated from other areas of the organization are also properly documented if required with valid IRS Form W-8. Certain vendor payments generated by partnership’s accounts payable department, for example, could be subject to scrutiny under exam and those that cannot be associated with a valid form W-8 that was on file on or before the date of payment to the vendor could be subject to additional taxes, penalties, and interest. Payments made to non-US persons that are generated by other areas of the organization, such as legal and treasury, may also be at issue so partnerships should be prepared.
Recognizably, obtaining a correct and complete Form W-8 is critical for any withholding agent, but given the new partnership audit regime and its emphasis on partnership audits, it is of the utmost importance now for partnerships with foreign partners. Under the new regime, if the IRS audits a partnership (that does not generate ECI) with foreign partners and ultimately assesses the highest liability, it will be up to the partnership to prove that the foreign partners are indeed foreign to avoid liability for withholding U.S. income tax, which means having the applicable Form W-8 for the respective foreign partners accurately completed and on file.
With the new partnership audits rules taking effect for audits of 2018 and later years, and with audits themselves likely to begin as early as 2019 or 2020, it is imperative that partnerships review the Forms W-8 that they currently have on file for partners to determine whether it’s reasonable to rely on them, and implement a process for collecting W-8 forms from new partners prior to their onboarding.
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