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By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
In CCA 201343020, the IRS Chief Counsel's Office had occasion to
deal with basic characterization, sourcing, and withholding issues
in the context of a multilevel marketing arrangement. The CCA
addresses, in particular, payments to foreign distributors by a
U.S. manufacturing corporation that sells products to both U.S. and
foreign distributors under a multilevel marketing
arrangement. The distributors can be individuals or
corporations and typically act as independent contractors (and not
as employees). In a multilevel marketing arrangement, a distributor
realizes income from two types of activities: (1) the purchase and
sale of product; and (2) the successful recruiting, training, and
supporting of other distributors, referred to as "lower-tier
distributors," with payment from the U.S. manufacturing corporation
being based on the amount of purchases of product by the lower-tier
distributors. The lower-tier distributors, in turn, may sponsor
other distributors, thereby creating a sponsorship chain.
The Chief Counsel's Office first analyzed the character of the
income earned, focusing, in particular, on the second category of
income, i.e., earnings of a distributor based on the sales of
lower-tier distributors. It concluded that the earnings represented
compensation from personal services rendered in recruiting,
training, and supporting lower-tier distributors in the sponsorship
chain. The Chief Counsel's Office relied on an earlier case1 which held that
even if earnings are measured by the amount of sales, "it is the
situs of the activity or property which constitutes the source of
the compensation paid and not the situs of the sales by which it is
measured that is of critical importance."
Thus, reasoned the Chief Counsel's Office, since the foreign
distributor does not take title to, or otherwise have beneficial
ownership of, the products, the payments do not derive from sale of
the products to the distributor but, rather, from activities
performed by the distributor, e.g., recruiting, training, and
supporting the lower-tier distributor. It does not matter that the
compensation is measured by the amount of the product sales by the
taxpayer to the lower-tier distributor. It does not matter that
only minimal activities are performed by the distributor. Finally,
it does not matter that some of the compensation may be contingent
The Chief Counsel's Office also concluded that, to the extent
such activities are performed in the United States, the foreign
distributor would be considered engaged in the conduct of a U.S.
trade or business within the meaning of §864(b). Further, the
foreign distributor would be subject to tax on U.S.-source services
income and, if services are performed both inside and outside the
United States, the services income would need to be apportioned on
a time basis under §861. In essence, the location of the services
rendered is what would govern rather than the location of the
activity of the lower-tier distributor.
In terms of withholding, the Chief Counsel's Office reviewed the
basic rules, highlighting a major difference between payments for
services rendered by an individual versus payments for services
rendered by a corporation, a rule which is often overlooked.
Section 1441 generally requires 30% withholding on
non-effectively-connected, U.S.-source, fixed or determinable
annual or periodical (FDAP) payments to foreign persons, including
payments for services rendered in the United States. In the case of
a foreign corporation, withholding may be avoided upon the proper
submission by the foreign corporation to the U.S. payor of a Form
W-8 ECI, attesting to the fact that the corporate recipient is
foreign and that it intends to file a tax return reporting the
income as income effectively connected with its U.S. trade or
However, the rule is different for individual service providers.
If the individual service provider is an employee subject to wage
withholding, then an exception from the 30% withholding will obtain
(at the cost of wage withholding, of course). On the other hand, if
the individual is an independent contractor on which wage
withholding is not applicable (as is typically the case of
distributors in a multilevel marketing arrangement), then the 30%
Treaties, however, may alter these rules. For example, in the
case of individual service providers, a treaty may eliminate the
30% withholding requirement. This would be the case under an
"independent personal services" article of a treaty, or under the
"permanent establishment/business profits" article of a treaty,
either of which would exempt the income, provided the individual is
not present in the United States for a certain period of time or
provided the individual does not have a fixed place of business or
permanent establishment in the United States, and provided that the
individual submits to the payor a valid Form 8233.
In the case of payments to a corporate distributor for services
rendered in the United States, if the corporate distributor has no
permanent establishment in the United States, the services income
would be excepted provided the corporate distributor submits to the
payor a valid Form W-8 BEN.
Multilevel marketing arrangements have been around for a while,
attracting praise and criticism for their recruitment methods and
purported profitability. Only fairly recently have multilevel
marketing arrangements morphed into multinational operations with
distributors around the globe. CCA 201343020 presents (or reminds
us of) significant issues about income characterization, sourcing,
and withholding. Foreign distributors should be aware of the
documentary mechanisms potentially available to avoid the 30%
withholding tax - and possibly U.S. tax altogether.
This commentary also will appear in the January 2014 issue
of the Tax Management International Journal.
For more information, in the Tax Management Portfolios,
see Blessing and Lubkin, 905 T.M., Source of Income Rules,
Tello, 915 T.M., Payments Directed Outside the United
States - Withholding and Reporting Provisions Under Chapters 3 and
4, Nauheim and Scott, 938 T.M., U.S. Income Tax Treaties -
Income Not Attributable to a Permanent Establishment and
in Tax Practice Series, see ¶7110, U.S. International Taxation,
¶7120, Foreign Persons - Gross Basis Taxation, ¶7160, U.S. Income
Tax Treaties, and ¶7170, U.S. International Withholding and
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