How to Avoid Payment Delays When Conducting Business Overseas
June 22, 2017
For U.S.-based companies familiar with doing business overseas, payment delays are no surprise. Such a lapse typically occurs if a company engaging in international transactions doesn’t have a treaty residency certificate. In this scenario, the company’s foreign customer will likely withhold at the maximum rate under local law.
Overall, foreign countries impose withholding taxes on payments made to non-residents of that country. That withholding tax, however, can be reduced or even eliminated when income tax treaties are in place between the two countries in question. It seems simple enough: U.S. business owners should know whether income tax treaties exist between the U.S. and the country where they are conducting business, and they should make sure the appropriate paperwork has been filed with the IRS. Unfortunately, American businesses are often unaware of the tax withholding laws until they’re ready to be paid, which inevitably leads to deep income cuts and long delays.
Understanding When Income Tax Withholding Applies
Often, a U.S.-based business gets a contract with an overseas customer, finishes the work and sends an invoice, at which point their client says, “We don’t have your income tax treaty paperwork.” In this situation, the U.S. company has to decide whether they should ask their customer to withhold taxes at the highest rate, or take the time to file and get approval for the proper paperwork in order to reduce or eliminate the income tax withholding.
While filing the form is fairly straightforward, the IRS can take quite some time to act on your filing and provide you with the proper documents to get a discount. The instructions to Form 8802 state that you should apply at least 45 days before you need the certification, but experience has shown that this process usually takes significantly longer. By understanding the treaty status and filling out the necessary paperwork ahead of time, you will keep your payment schedule on track.
If you’re simply selling products overseas, income tax withholding may not apply to the payments customers make to your company. But all payments such as interest, dividends, rents and royalties are subject to income tax withholding. For instance, if you own a U.S.-based software company and you license your software in India, withholding will apply. In some countries, the rate of withholding for foreign entities can be as high as 35 percent. However, because the United States has many income tax treaties in place that can reduce this rate — sometimes to zero — American companies that file the proper paperwork can qualify for withholding at a much lower rate.
Preparing the Right Forms
The U.S. has active income tax treaties with almost 70 different countries. If you’re expecting interest, dividend, rent or royalty income from a customer in one of those countries, it’s crucial you file the right paperwork with the IRS to avoid payment delays and reduced payments.
To request income tax treaty benefits — which could potentially save your company thousands of dollars — you may need to file IRS Form 8802. This form is an application for an IRS Form 6166, which certifies you are a U.S. resident, allowing you to benefit from the lower income tax withholding rates when conducting business internationally. You should complete Form 8802 as soon as possible. After all, it can take longer than the designated 45 days for the IRS to issue a certificate of residency, which can lead to significant delays in receiving payments from foreign sources.
Conducting business overseas comes with its own unique set of financial challenges. Don’t wait until your work is complete: Take immediate action to ensure you have the necessary tax treaty paperwork in place and payments are not delayed.
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About the Author
Robert is an international tax partner with more than 27 years of experience providing international tax solutions to publicly and privately-held corporations on an array of international tax matters, such as foreign tax credit management and utilization, structuring foreign and domestic operations, international mergers and acquisitions, and export tax incentives. He also has many years of experience serving foreign-owned U.S. businesses.