The tax rules for non-U.S. residents are complicated enough regularly, but they only get more intense when you apply them to foreign athletes and entertainers. In today’s podcast, we explore the rules with Patrick McCormick of the law firm Culhane Meadows.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
The rules for taxation of non-U.S. residents are difficult enough on a standard basis, but how are those rules affected when the individual in question is a foreign athlete or entertainer? To go over this question, we have with us one of our foremost experts on international tax questions, Patrick McCormick of the law firm, Culhane Meadows.
As background, how are non-residents taxed generally by the United States?
[McCormick] What you're really looking at is where nexus exists for the United States to impose tax on a non-resident. The United States domiciled taxpayers, whether by virtue of their residency, their citizenship, their place of incorporation, whatever the case may be, are, generally speaking, going to be taxable by the United States on a worldwide basis on their worldwide income with foreign tax credits, generally utilized from the United States perspective for U.S. domicile taxpayers to alleviate the burdens of double taxation.
In the context of non-United States taxpayers, non-residents, whether those non-residents be individuals or, say, a corporation or a non-grantor trust, any non-resident taxpayer is only going to be subject to United States tax, statutorily on a fixed or determinable annual or periodic income, or income effectively connected with the United States trade or business. Income tax treaties come into play, and this is where income tax treaties are applicable to non-residents, which United States operations, which United States sourced income, what you typically look at in the multinational sphere is under an income tax treaty.
The general relief is being provided to non-residents who have income generated outside their jurisdiction of residence to alleviate the burdens of double taxation in that non-resident's jurisdictions. Within their resident's jurisdiction, they're typically utilizing foreign tax credits. Under income tax treaties, the fixed or determinable annual or periodic income standard stays fairly uniform with the primary impact under treaties being modifications of the applicable rates at that income, and statutorily taxed at a 30% rate by the United States gross-based tax. Subject to withholding, income tax for these can lower the effective rate rather significantly.
They can either eliminate tax on certain items, like royalties, or ones that are often subject to a 0% tax in the source jurisdiction. Under an income tax treaty, the effectively connected with the United States trade or business standard is modified too for general business profits income properly attributable to a permanent establishment maintained in the United States. More pertinently is in the context of independent personal services. Like independent personal services, articles within the treaties, which are specifically designed to cover non-resident individual activities in a jurisdiction, that's not their jurisdiction of residence.
How are those rules that you described there modified for non-resident entertainers?
[McCormick] There are both treaty modifications that generally come into play in pertinent parts for non-resident entertainers in specific treaty provisions that are applicable designed just for them under income tax treaties where you typically see, where you most often see them leave available to non-resident entertainers and performers. They're either in those personal services articles that I mentioned previously, or in what's usually titled an entertainers and sportsmen article within the income tax treaties. It's one specifically designed for artists and entertainers, ultimately is what they're looking at.
You're really looking under pretty well developed, surprisingly well developed, I would say, given the niche nature of the area, qualification for the entertainers and sportsmen article for relief under that article is really limited to individuals who are performing entertainment services within that jurisdiction. Things like support staff, things like, there's a case that comes to mind or it's a service ruling, regarding a model who was displaying goods within the United States, who is a non-resident and was determined to not be eligible for the treaty benefit.
What you really look at under an entertainers and sportsmen article, and to contextualize under United States statutory default rules unmodified binding of tax treaties, a non-resident is going to be taxable on any personal services performed by her within the United States at any time. There's a small de minimis exception that comes into play when less than 90 days are spent in the United States and less than $3,000 is earned in the United States, which is a low, low threshold. Otherwise, if you're not meeting that de minimis exception, you are subject to tax automatically by the United States on income generated from the United States personal services. When you were looking in the context of an income tax treaty, the entertainers and sportsmen article will typically have a higher, and often a fairly significantly higher, threshold amount that comes into play for entertainers' and sportsmen's activities within their non-resident jurisdiction to be subject to tax.
So if you're looking at a non-U.S. taxpayer who's coming into the United States and performing entertainment services, athletic performances as well, you have that non-resident, if she's a qualified resident, all the jurisdiction, it has a treaty with the United States. She's eligible for relief, both under that entertainers and sportsmen article, as well as the general articles, regarding things like personal services, business profits, royalties are again something here where you have royalty income that's generated within the United States.
If those activities generated any income or source outside the United States, statutorily, you're getting a great carve-out from the United States tax, where there's more of a connection whether in some level of availment of the United States market, beyond a passive place of sales. Then, it can be very advantageous, should you resonate all the treaty party jurisdictions. Certain countries, Canada is one that comes to mind generally for royalties and how she'd be subject to tax, or for general business profits context. There needs to be 183 days of physical presence within Canada, within that jurisdiction, if you're looking at the reverse scenario here. So if you're looking at a Canadian with a US royalty income, she'd need 183 days in the United States for that income to subject to U.S. tax.
Aside from those rules there, are there special considerations for non-resident entertainers when compared to other non-residents?
[McCormick] One of the big things that comes into play and something that can be when you're talking to, specifically for the entertainer, the artist, she's, say, engaging in her first United States tour, where she's commencing the United States operations. Very often, just like in the context of non-residents making investments in the United States, you want to test the waters before they get involved in too much detail. They'll make a small investment in the United States, see how it goes for a couple years, then invest more if it's going well.
Very similarly, non-resident touring artists, touring entertainers, performing athletes obviously as well, will spend certain amounts of small time within the United States to test the waters. As the case may be, say you're a European soccer club that does exhibitions in the United States during the summer, you're going to have questions as a result of that like, look, your performance services within the United States and the soccer context.
When you're talking about these billion dollar soccer clubs, it's not necessarily as much of a consideration, but if you're talking about, say, a band that's performing in the United States on a limited scale, they're doing a tour of, say, six to eight cities in the United States, all of that income statutorily is subject to withholding under the FDIC provision unless they can essentially document if they're going to be engaged in the U.S. trader business and, as a result, maintain a U.S. tax return filing requirement. All of the income that's being paid out is automatically subject to withholding for non-residents. What that often means, what the non-resident has to do, even if she can benefit from an income tax treaty, even if on filing the tax return, if she's subject to a lower rate of tax, there are timing considerations that come into play as to, “Hey, listen, I don't want to be out of pocket of these funds for 12 months, 18 months.”
If I'm out of pocket, I'm already operating on a bit of a tight budget. That delay in getting the funds back means it's really disadvantageous to have the United States really sit on those funds. One thing that is an option to keep in mind is what's called a central withholding agreement. These are labeled CWAs. It can be a barrier. They are basically advanced agreements that you can enter into with the Internal Revenue Service to provide that, over the course of a tour, over the course of a non-resident's trip to the United States for performance activities like entertainers and sportsmen, general services that are being provided artists and entertainers as well, there's a notice out there by the service that specifically designates who is or is not eligible for a CWA. You can essentially put that agreement together with this service prior to the tour starting, not be subject to any withholding by the United States, with the agreement basically being “Look, at the end of the tour, we'll figure out what the tax amount is directly with the service and we'll remit data.”
Now, the issue with CWAs that can make them a bit suboptimal is the amount of documentation that's required prior to entering into a CWA. You really need to give a sophisticated budget to the service to outline, “Hey, here are the items that we're anticipating in terms of profit expenses.” Very often, that process is arduous and not, again, for smaller entertainers, for non-conglomerates, say, who are regularly conducting multinational activities. If you're looking at that small entertainer that needs to put together the books and records, depending on the circumstances can make the CWA not make a lot of sense.
You talked about CWAs there, so perhaps that's one of them, but are there other methods these individuals and groups can use to mitigate withholding?
[McCormick] What you're looking at in terms of withholding mitigation really comes down to documentation that you can provide to the United States withholding agent. Essentially, they'll read withholding forms on the American side under that provision. The last United States person with control over an income item that's payable to a non-resident is required to withhold a 30% tax on that payment to the non-resident unless she receives documentation that provides a contrary rate as a non-resident to avoid withholding. Getting proper documentation to the reporting agent is critical. You can do it through, say, if you're engaged in a U.S. trade or business by virtue of your U.S. activities, you can file a W-8 ECI. You can claim any treaty benefits that you want to claim on a form W-8 BEN. There are multiple possibilities that are out there.
I was speaking a bit ago today with a client, not in the entertainers and sportsmen context, but in the general non-resident context, of looking at our options to avoid withholding requirements. Really, that's where you're looking, though, is in the context of the general forms W-8, supplying those forms to payors, claiming any exemptions from withholdings that are available. Whether it's by virtue of being in a trade or business, whether it's by virtue of residing in a treaty jurisdiction, you really want to because withholding agents are extremely capitalist.
They should be, given the fact that they maintain several liabilities for any withholding failures on the tax penalties and interest, which accrued based on the failure to withhold, given that it's very often on the withholding agent's side, there's very much an erring on the side of caution, on the side of over-withholding. I think it's needed in order to make sure there isn't any liability incurred on the American side as a result, having clean documentation, that you can get this properly filled out, these withholding agents really can be advantageous to avoid those timing issues that I mentioned before.
Income tax treaties: do they come into play in this area at all?
[McCormick] They very much do. What you're looking at here really is in the context of the provisions, like I mentioned before, on entertainers and sportsmen. Once you get past that though, say for non-residents, she doesn't qualify as "entertainers and sportsmen," which is going to be, even in the context of U.S. artists and entertainers services, if it's touring, believe that their support staff's touring as well. The majority of those present in the United States are not going to qualify for the entertainers and sportsmen provision. That's when you have the intertwining of the personal services articles. As the case may be, sometimes in more updated treaties, the business profits article I mentioned before the U.S.-Canada treaty, the U.S.-Canada treaty is one that's more recently been updated. I believe it was the mid-2000s when it was passed and since been updated.
That specifically takes out the independent personal services provision of that treaty, and full, independent personal services into the business profits. Now that's where you get the provision about things like royalties that I mentioned before. In lieu of an updated treaty, if a treaty does have an explicit, independent personal services article, that's very often where you're looking at for non-residents involved in performance and entertainment services within the United States and what independent personal services provisions typically say in there keeps them advantageous, if they're available.
It's really that the non-resident doesn't have a fixed base available to her within the United States, and she's not spending more than 183 days in the United States in a given year. She's not going to be subject to United States tax on that being held in the case of independent personal services. If those independent personal services are performed in the United States, what you're generally looking for is a fixed place of business. If that non-resident is a resident of a jurisdiction that has an income tax treaty with the United States.
Talking about the tax issues here, it makes me think, are there non-tax considerations that come in and intertwine with the tax issues to complicate them at all?
[McCormick] One of the things that comes to mind is that one of the big reasons I've been talking about this so much is because I just finished up an updated chapter of a treatise with the American Immigration Law Association. That's one that's going to be published, I believe, in June 2020, maybe a little bit after that, the third edition, I believe it is, that my new chapter will be in. Immigration is one of the areas where there's significant intertwining. Obviously, on the attorney side, the need for accountants is paramount. Really multinational advisors in this area is something where you've got to have somebody in the non-resident's home jurisdiction as well at minimum to run things by to make sure that the U.S. plan isn't going to blow up in her face in her home jurisdiction.