For the first time since 2011, we now have updated US income tax treaties – four of them to be exact. And now is the time to review them for withholding tax rate changes since the US Treasury has announced the entry-into-force dates of each of the four new treaty protocols.
In other news: the IRS has released its 2019 update to Publication 1187 (Specifications for Electronic Filing of Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding). Also, we have a new draft Schedule Q for Qualified Derivatives Dealers.
1. Countdown Begins for Effective Dates on Withholding Tax Provisions in New Tax Treaty Protocols
This past summer, the US Senate ratified four long-pending tax treaty protocols that had been negotiated with Japan, Luxembourg, Spain and Switzerland. After the exchange of notes/ratification instruments, the US Treasury has now announced the dates that each of the four treaty protocols has or will enter into force.
There is generally a delay between the exchange of notes and sometimes the entry-into-force date and the effective date when withholding tax provision changes in the treaty take effect. This is to allow withholding agents the opportunity to update their withholding tax systems or procedures. Now that the entry-into-force dates are known, we begin the countdown to the effective dates for the changes to the withholding at source provisions.
The effective dates for withholding tax changes differ by treaty. The changes to the Japan treaty, for example, should be effective November 1, 2019 based on the entry-into-force date, and Spain tax treaty changes for withholding tax occur later – November 27, 2019.
Withholding agents will need to review the new tax treaty protocols to determine their impact to their withholding systems based on income payments they make. Among the changes to note are that the withholding rate for interest for both the Japan and Spain tax treaty updates will generally be reduced from 10% to 0%. In the Spain tax protocol, royalties are also reduced to a 0% withholding rate. Each of the Spain, Japan and Switzerland tax protocols also provide for certain specific changes to the dividend articles of the treaties (impacting for example certain dividend payments between parent-subsidiaries or payments to an individual retirement arrangement). Changes to the Luxembourg tax treaty seem more confined to exchange of information protocol between the respective tax authorities.
2. 2019 Publication 1187 on Form 1042-S Specifications
The IRS has released the Pub 1187 containing Form 1042-S electronic filing specifications for the 2019 tax year. 2019 changes are noted on pages 7 and 8 of the publication, including a note on an extended due date in certain cases relating to withholding that occurs due a change in the “lag method” rules. For withholding agents reporting on Forms 1042-S and Forms 1099, Pub 1187 is the Form 1042-S counterpart to Pub 1220 (issued earlier this month and containing the electronic specifications for the Form 1099 series, among other information reporting forms).
3. IRS Issues Draft Schedule Q for Qualified Derivatives Dealers
Qualified Derivatives Dealers or QDDs (generally non-US financial institutions entering into derivative trades with underlying US equity) should be aware that the IRS has issued new draft Schedule Qs. The Schedule Qs (intended for the 2019 Form 1042 and 2019 Form 1120-F) are to be attached to Form 1042 and Form 1120-F and allows the QDD to report the break-out of its QDD Tax Liability determined in accordance with its agreement with the IRS.
QDDs generally obtain exemption from withholding tax on receipt of dividend equivalent payments subject to section 871(m) (as well as actual dividends, at least through 2020). In exchange, the QDD agrees with the IRS to withhold on dividend equivalents it in turn pays out to its counterparties. Under its agreement with the IRS, the QDD is also responsible for reporting and paying certain residual QDD tax liability amounts. These liability amounts are currently reflected in a statement that the QDD attaches to Form 1042 and Form 1120-F. The new draft Schedule Q would replace that statement.
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