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July 28 — The rest of the world is investing substantially in the U.S. but the taxes being collected are minimal, a fact that might change as Congress debates several tax overhaul proposals, an analyst told Bloomberg BNA in response to newly released IRS data.
Withholding agents use Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, to report U.S. income payments to nonresident aliens, as well as the appropriate withholding tax to the Internal Revenue Service. Based on an IRS Statistics of Income Bulletin posted July 27, U.S.-source income paid to foreign persons—as reported on Form 1042-S—totaled $697.6 billion for calendar year 2013, the most recent year for which data is available.
That amount represents an increase of 3.7 percent from 2012 and an even higher increase—22.7 percent—from 2011. While the data also shows that withholding taxes on this income rose by 31.2 percent from $10.8 billion in 2012 to $14.2 billion in 2013, the amount of tax withheld is still low compared to the total amount of U.S.-source income.
In 2012, there was a similar increase, yet almost 90 percent of all such income paid to foreign persons was exempt from withholding tax, according to an IRS analysis of that year. That information was not available in the 2013 data.
The numbers illustrate that “the U.S. is paying a fair amount of income to foreigners; the rest of the world invests in the U.S. pretty substantially,” said Steve Rosenthal, a senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute. But “I was struck by how few taxes we collect,” he told Bloomberg BNA July 28.
One reason for the low taxes is current policy, he said. “We have a lot of portfolio interest rules and reduction in withholding because of treaties, especially on interest, but also on capital more generally,” he said. In addition, dividends are usually subject to reduced taxation because of the U.S.'s desire to attract foreign capital, he said.
However, foreign investors may be asked to pay more tax on U.S.-source income in the future, “depending on where the U.S. tax system goes,” Rosenthal said. There are a variety of tax overhaul proposals currently under consideration.
House Republicans have advocated for a shift from taxing income to taxing consumption, an idea included in their tax overhaul blueprint unveiled June 24 (123 DTR G-6, 6/27/16).
Of the U.S.-source income paid to foreign persons in 2013, interest made up the largest percentage at 42.1 percent. Dividends—23.3 percent—and notional principal contract income—13.3 percent—accounted for the next largest shares, according to the IRS data.
The 2013 data doesn't include a breakdown of how much tax was withheld for each type of income within the total amount; however, the 2012 analysis does include such information.
With respect to notional principal contracts specifically, the 2012 analysis shows that while a significant portion of U.S.-source income was derived from NPCs, none of that income was subject to withholding.
A notional principal contract is one involving two parties who agree contractually to pay each other amounts at specified times, based on the underlying notional amount. Generally income from NPCs is sourced to the recipient, not to the payer, which could explain the zero percent withholding tax in 2012, Rosenthal said.
Two years prior in 2010, Congress enacted tax code Section 871(m) in the Hiring Incentives to Restore Employment Act. Section 871(m) imposes a withholding tax on dividend equivalent payments, Rosenthal said.
However, the 2012 data on NPCs doesn't reflect those changes.
“You won’t see most of the 2010 changes in the data from 2012 because initially 871(m), the new withholding regime for dividend equivalent payments, applied only in the narrowest of contexts against what are known as cross in/cross out trades,” Rosenthal said. In these transactions a foreigner could enter into a swap with a U.S. bank to sidestep withholding taxes.
“That abuse was shut down immediately, but the broader set of dividend equivalent payments on NPCs, those are not going to be shut down” for a while, Rosenthal said.
The IRS issued final, temporary and proposed regulations (T.D. 9734, REG-127895-14) on Section 871(m) in September 2015 (181 DTR G-2, 9/18/15).
The rules generally apply to transactions issued on or after Jan. 1, 2017. Rosenthal said he expects the impact of the Section 871(m) regulations to be reflected in later datasets as those changes begin to take effect.
To contact the reporter on this story: Allyson Versprille in Washington at email@example.com
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IRS data from 2013 Forms 1042-S is at https://www.irs.gov/uac/soi-tax-stats-foreign-recipients-of-u-s-income-statistics.
IRS's analysis, Foreign Recipients of U.S. Income, 2012, is at https://www.irs.gov/pub/irs-soi/soi-a-init-id1602.pdf.
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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