Qualifying for Portfolio Interest and Other Withholding Exceptions

Profitable US enterprises are often funded with a significant amount of debt, which provides them with a relatively cheap and tax-deductible form of capital. Concurrently, lenders benefit by holding a more secure claim to the issuer’s assets than its equity holders. Instruments qualifying under the portfolio interest exception allow foreign debt holders to earn interest income free of US income or withholding tax. But as more financing transactions are conducted across national borders, portfolio debt instruments have come under increased scrutiny because of the potential they create for tax evasion.

Evidence of massive offshore tax evasion schemes has resulted in the promulgation of anti–tax evasion measures, most particularly the Foreign Account Tax Compliance Act (FATCA). In this new regulatory environment, entities making qualifying payments to foreign payees that don’t meet FATCA’s documentation standards must withhold a 30 percent tax on those payments unless they meet certain exceptions. As a result, borrowers shouldn’t simply assume that presumed portfolio debt is free of US tax consequences, because it’s the payer of such interest—the borrower—that’s liable for any failure to withhold.

So how do US enterprises take advantage of the benefits of portfolio interest while navigating the applicable withholding regulations?

Adequate documentation is the key. This white paper discusses the tightening documentation requirements payers must meet to demonstrate that their US-source interest payments qualify for an exception to the withholding tax. More specifically, it covers:

  • What documentation is now required by the FDAP and FATCA regulations
  • How to document your payments and payees to avoid secondary liability for unwithheld tax
  • Next steps to help you benefit from the portfolio interest exception
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