FOREIGN COMPANIES that invest in the United States through joint ventures are chafing at US withholding taxes.

FOREIGN COMPANIES that invest in the United States through joint ventures are chafing at US withholding taxes.

September 01, 2006

FOREIGN COMPANIES that invest in the United States through joint ventures are chafing at US withholding taxes.

The United States requires partnerships with foreign partners to withhold US income taxes from the share of each such partner’s partnership income that is effectively connected with a US business. A partner’s share of income may have nothing to do with the cash it is distributed by the partnership. Suppose a partnership earns $100 and uses $90 to repay principal on a loan. The withholding is on each partner’s share of the $100.

The withholding taxes are at a 35% rate for foreign partners who are individuals, but can reach as high as 54% for foreign partners who are corporations. The higher rate for corporations is due to additional withholding for “branch profits” taxes.

Any partner who has suffered from overwithholding can get a refund by filing a US tax return. Many choose not to do so.

Meanwhile, US tax withholding is not required on interest that a US borrower pays on “portfolio debt.” That is debt that is held by someone — like a private equity fund — that is not in the regular business of lending like a bank would be. However, someone who receives portfolio interest cannot avoid withholding if he or she owns 10% or more of the US borrower.

The US Treasury is working on guidance to address whether this requirement that an interest recipient not own 10% or more of the borrower is applied at the partner or partnership level in cases where the offshore lender is considered a partnership for US tax purposes. The guidance is expected by year end.

Keith Martin