Last week, the IRS stepped up its effort to enforce taxpayer compliance in the cross-border withholding arena, by identifying cross-border withholding as a Tier I issue (“U.S. Withholding Agents - § 1441: Reporting and Withholding on U.S. Source FDAP Income”). Tier I issues are issues of high strategic importance to the IRS’s Large and Midsize Business Division (“LMSB”). Previously identified Tier I issues had been relatively narrow in focus. The addition of such a broad-ranging issue is striking, but consistent with the IRS’s overall goal to close the international tax gap. Given that a withholding agent will suffer strict liability for withholding non-compliance, and that documentation and reporting failures can be readily identified in the course of an audit, this issue is an easy target for IRS exam teams.

Lori Nichols (Director, International Compliance Strategy and Policy) is the Issue Owner Executive for cross-border withholding. Ms. Nichols will be responsible for coordinating LMSB’s efforts in this area and, more significantly, will be vested with settlement discretion. Consequently, audit teams may be left with little control over the ultimate disposition of a withholding issue. Moreover, the mere identification of a Tier I issue by an exam team can taint the dynamic between the taxpayer and Exam with respect to other issues under audit.

The IRS has signaled its interest in cross-border withholding for some time. In 2004-2005, the IRS initiated a Voluntary Compliance Program on withholding, the initial deadline for which was extended upon taxpayer request. Rev. Proc. 2004-59; Rev. Proc. 2005-71. In 2008, the IRS aggressively pursued and prevailed against a taxpayer that reported cross-border payments on its corporate returns yet failed to withhold and report, and published new comprehensive audit procedures on withholding. New York GuangDong Finance Inc. v. Commissioner, T.C. Memo 2008-62; IRM 4.10.21. Later in 2008, the Senate Permanent Subcommittee on Investigations released two reports exposing systemic problems and compliance concerns involving cross-border withholding practices. Tax Haven Banks and U.S. Tax Compliance, Staff Report (July 17, 2008); Dividend Tax Abuse: How Offshore Entities Dodge Taxes, Staff Report (Sept. 11, 2008). Identification of cross-border withholding as a Tier I issue leaves no doubt as to the government’s intent to crack down on withholding failures.

Withholding issues often go unidentified by a taxpayer, until they are highlighted on audit. Strict liability for the withholding tax is established at the moment an agent makes an outbound payment that is unsupported by appropriate documentation (including documentation that was initially sufficient but has expired or become outdated). Worse, reporting and withholding failures often result in substantial penalties and can even result in personal liability for tax executives. Taxpayers should take steps to identify gaps in their withholding procedures and initiate corrective action now, before the IRS appears with IDRs in hand.

For further information, please contact any of the following lawyers:

Rocco Femia, rfemia@milchev.com, 202-626-5823

Marianna Dyson*

Michael Lloyd*

Kimberly Majure*

*Former Miller & Chevalier attorney

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