What chapter 4 does
Chapter 4 of the Code (sections 1471 to 1474, known as FATCA) requires a withholding agent to withhold 30% on a withholdable payment made to a foreign financial institution (FFI) that has not agreed to report its U.S. account holders, or to a passive non-financial foreign entity (NFFE) that does not disclose its substantial U.S. owners. It runs alongside chapter 3: the same payment can be within both, and the 1042-S reports the payee's status under each.
Effectively connected income certified on a W-8ECI is not a withholdable payment either (chapter 4 exemption code 14).
Withholdable payments, and the payments that are not
A withholdable payment is, in general, a payment of U.S.-source fixed or determinable annual or periodical (FDAP) income. The regulations also reach gross proceeds from sales of securities, but proposed regulations issued in December 2018, which taxpayers may rely on, eliminate withholding on gross proceeds. The categories that matter for an ordinary business:
- Excluded nonfinancial payments are not withholdable (Treas. Reg. 1.1473-1(a)(4)(iii)): payments for services, including wages; the use of tangible property, such as office and equipment leases; software licenses; transportation and freight; gambling winnings; awards, prizes and scholarships; and interest on accounts payable for goods or services. Publication 515 also treats royalties as nonfinancial payments.
- Effectively connected income is not withholdable when the payee certifies it on a W-8ECI.
- Grandfathered obligations, such as debt outstanding on July 1, 2014 and not significantly modified since, are outside chapter 4.
- What is left for most businesses: interest on loans from foreign lenders or shareholders, dividends to foreign shareholders, and similar financial income.
The payee's chapter 4 status
An entity reports its chapter 4 status in Part I, line 5 of the W-8BEN-E. For a withholdable payment, the status decides whether you withhold.
| Status on the W-8BEN-E | Chapter 4 withholding on a withholdable payment | 1042-S chapter 4 status code |
|---|---|---|
| Active NFFE: less than 50% of gross income is passive and less than 50% of assets produce passive income | None (exemption code 15) | 22 |
| Publicly traded NFFE or affiliate | None | 21 |
| Passive NFFE that identifies its substantial U.S. owners (or certifies it has none) | None, but you report the owners | 19 (owners identified) or 20 (none) |
| Participating FFI or registered deemed-compliant FFI, with a GIIN you verified | None | 05 to 09 by type |
| Nonparticipating FFI, or a passive NFFE that does not identify its owners | 30% | 15 (nonparticipating FFI) |
| No valid W-8BEN-E | Apply the chapter 4 presumption rules; an undocumented foreign entity is generally treated as a nonparticipating FFI or passive NFFE, and withheld on | 29 (unknown recipient) |
A substantial U.S. owner is generally a specified U.S. person holding more than 10% of the entity's stock (by vote or value), profits or capital interests, or treated as owning part of a grantor trust.
Checking a GIIN
A participating FFI, a registered deemed-compliant FFI and several other statuses must give you a Global Intermediary Identification Number (GIIN) on the W-8BEN-E, and you must verify it against the IRS FFI list, published monthly. You have reason to know the claim is unreliable if the payee's name (or a name reasonably similar to the one on file) and GIIN do not appear on the most recently published list within 90 days of the date the claim is made. A form that shows "Applied for" in the GIIN box must be followed by the GIIN within 90 days.
How chapter 4 and chapter 3 meet
- When chapter 4 withholding applies, it satisfies chapter 3 for the same payment: the tax is 30% once, not twice. The 1042-S shows chapter indicator 4, the chapter 4 rate 30.00, and chapter 3 exemption code 12 (payee subjected to chapter 4 withholding).
- When chapter 4 does not apply, chapter 3 still does. A dividend to an active NFFE in Germany is not a FATCA case, but it is withheld on at the treaty rate under chapter 3.
- A treaty never reduces chapter 4 withholding. A nonparticipating FFI in a treaty country is withheld on at 30% and claims any treaty refund from the IRS.
Reporting it
Form 1042-S carries both statuses: the recipient's chapter 3 status (box 13f) and chapter 4 status (box 13g), the chapter 4 exemption code (box 4a) and rate (box 4b). The 1042-S code finder lists every code. A withholding agent that pays a withholdable payment to a passive NFFE reporting substantial U.S. owners also reports those owners to the IRS on Form 8966. Chapter 4 tax is deposited and reconciled on Form 1042 with chapter 3 tax.
Questions people ask
We only pay foreign contractors and licensors. Do we need to think about FATCA?
Very little. Payments for services and royalties are excluded nonfinancial payments, so chapter 4 withholding does not apply. You still collect a W-8BEN-E (which asks for chapter 4 status anyway) and still apply chapter 3, and the 1042-S shows chapter 4 exemption code 16.
Our foreign parent lends us money. Does FATCA apply to the interest?
Yes, interest is a withholdable payment. If the parent is an active NFFE (most operating companies are), there is no chapter 4 withholding; chapter 3 applies at 30% or the treaty rate. Note that interest to a related lender is generally not portfolio interest.
Does FATCA apply to payments to foreign individuals?
Chapter 4 withholding does not apply to individuals. The payment can still be subject to chapter 3.
What is a sponsored entity or an owner-documented FFI?
Statuses for investment vehicles and small financial entities. Ordinary vendors rarely claim them; when one does, the W-8BEN-E instructions list what else you need (the sponsor's GIIN, or the owner reporting statement).