Do you have a business that uses foreign vendors to provide personal services?

Many US businesses use foreign companies or individuals to provide website development, SEO, customer service, accounting, IT support and many other services.

US businesses need to know that foreign individuals or entities are subject to U. S. tax at 30% on income they receive from U. S. sources when personal services are provided.  Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, and the performing arts.  This would seem to indicate that US businesses need to withhold 30% on all payments sent to foreign companies and individuals for these types of services.

But wait….

In many situations the US Company will not have to withhold tax as long as:

• The foreign vendor completes a Form W8 “Certificate of Foreign Status” before the form is completed and signed,
• The personal services were wholly performed outside of the US, or
• A Tax Treaty exists between the US and the country in which the foreign entity or individual resides.

As you can imagine the foreign company or individual is going to be surprised and upset when you tell them that you are holding back 30% of their  payments until they have completed , signed an returned the W8 Form.  This will usually be the Form W-8BEN. The completed Form W-8 is not sent to the IRS.

It is also important that all foreign individuals and vendors be required to complete the Form W-8 irrespective of what the payment is for or where the services were performed, not just those foreign vendors for services performed in the US.

The US Company must also carefully review where the services are performed.  The IRS considers many services as performed in the US if the recipient of the services is located in the US.  As examples, the IRS has decided that the following are subject to this policy for example:

a.       Website hosting performed in France where the website’s visitors are located in the US.

b.      Telephone and a web-based conferencing service provided by a Canadian vendor where the users are located in the US.

If the personal services are performed in the United States, the income paid is from U.S. and withholding tax will have to be assessed.

The place where the services are performed determines the source of the income, regardless of where the contract was made, the place of payment, or the residence of the payer. If the services are wholly performed outside of the US then the income is not sourced from the US and no withholding tax will be taken.

If the income is for personal services performed partly in the United States and partly outside the United States, you must make an accurate allocation of income for services performed in the United States based on the facts and circumstances. In most cases, you make this allocation on a time basis.

The US company paying for the service needs to take great care in determining where the services are performed.

There are significant penalties if the US Company does not have the complete form on file.  The US Company must fulfill the IRS instruction to verify that their payments are properly documented when made to a foreign company or individual.

The US Company may be liable to pay the withholding tax if the completed and signed Form W-8 is not on file or the proper withholding tax has not been withheld.