Revenue procedure 2004-59 sets out procedures for a temporary voluntary compliance program for tax, withholding, and reporting obligations applicable to withholding agents in connection with payments to foreign persons. This program is in part a response to the many financial institutions that approached the IRS to disclose and resolve issues arising from their effort to comply with their US tax withholding and reporting obligations under final regs effective after 2000. The IRS will review each submission and, if it is acceptable, provide the agent with written acknowledgment that its compliance procedures and policies are acceptable; penalties are not imposed on underpayments due to reasonable cause. Applications for the program will be accepted through December 31, 2005.

The primary objective of the program is to increase voluntary US withholding tax compliance by withholding agents making payments of US-source dividends, interest, rents, royalties, and other fixed or determinable annual or periodical (FDAP) income to foreign persons. Generally, FDAP income paid to a foreign person is subject to tax under Code section 871(a) or 881(a). Code section 1441 requires that any person who pays to a foreign person income that is subject to tax under section 871(a) or 881(a) must deduct and withhold 30 percent tax from the gross amount paid; the rate of tax, however, may be reduced or eliminated under the Code or an applicable treaty. A withholding agent must determine the status of the person to whom it makes payments by obtaining documentation from the person and may withhold at a reduced rate on payments to foreign persons only if the foreign person has furnished the required documentation (form W-8BEN). For instance, under the US-Canada treaty, payments of US-source dividends to a Canadian are generally subject to a 15 percent withholding tax, a rate that is reduced to 5 percent if the dividend is paid to a Canadian company that owns at least 10 percent of the voting stock of the US payer.

The program generally applies to tax and reporting obligations that relate to forms 1042 and 1042-S. Every US and foreign withholding agent must file form 1042-S to report US-source income paid to foreign persons; every US and foreign withholding agent required to file a form 1042-S must also file an annual return on form 1042. The program does not provide substantive determinations about a payment, such as the amount, timing, character, or source of the payment, or about whether or to what extent it was an amount subject to withholding.

To participate in the program, the withholding agent must (1) identify the areas in which it is not in compliance with tax, withholding, and reporting obligations on payments to foreign persons; (2) pay, as determined by the IRS, any tax, interest, and penalties due to satisfy its outstanding tax, withholding, and reporting obligations; and (3) institute corrective procedures that will ensure compliance in the future. The IRS will not impose penalties for identified underpayments or deficiencies that are due to reasonable cause.

Generally, a withholding agent is eligible for the program if it is a withholding agent defined in regulation section 1.1441-7(a)(1) that is not a “qualified intermediary,” a “withholding foreign partnership,” a “withholding foreign trust,” or an “eligible organization” as defined in section 2.01 of Revenue procedure 2001-20. A withholding agent may not participate in the program if it is currently under examination with respect to form 1042, if it comes under examination before submitting the information required by the program, or if it has a case pending in Appeals or in litigation on issues involving such tax, withholding, and reporting obligations. An examination is considered to commence on the date the withholding agent receives IRS notification of an impending examination or referral therefor.

In processing the submissions, the IRS will generally allow reduced withholding rates in the computation of any adjustments to taxes and withholding of taxes on payments to foreign persons if the withholding agent has properly documented the foreign persons and the documentation was related to the time of payment. Interest on the withholding agent’s underpayments is due from the last date prescribed for payment of the taxes to the date that payment is received. The IRS recently announced that it issued new Chief Counsel Advice under which it states that it will not charge interest on remediated accounts maintained under the program. Under a remediated account, a US withholding agent obtains a form W-8BEN with a statement that establishes that the account holder qualifies for either a treaty withholding rate or the portfolio interest exemption. Thus, a withholding agent participating in the program is not subject to an interest charge for taxes that it failed to withhold on the due date for filing its form 1042 if documentation (such as a form W-8BEN) received later establishes that the amount of tax actually withheld on the date was correct.

The withholding agent must also demonstrate to the IRS’s satisfaction that it has implemented or plans to implement the corrective procedures described in the agent’s submission to ensure that payments to foreign persons are subject to the correct amount of withholding and that withheld amounts are paid over and reported to the IRS on the proper forms in a timely manner. The IRS will review the corrective procedures to be sure that they are reasonably likely to ensure future compliance. The IRS reserves the right to require modifications or additions to the procedures before it will issue an acknowledgment letter that the withholding agent is at the time in substantial compliance with its tax, withholding, and reporting obligations with respect to the payments to foreign persons. If a resolution cannot be reached, the IRS may consider the case for examination.

Because of the complexity of these withholding obligations, many withholding agents may not have procedures in place to fully comply with these tax, reporting, and withholding obligations. However, the program may offer many withholding agents the opportunity to come into compliance with their tax withholding obligations and to implement corrective procedures to ensure compliance.