In this video, I discuss inbound investment and specifically the Foreign Account Tax Compliance Act FATCA.
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Foreign Account Tax Compliance Act FATCA was established to prevent tax evasion involving offshore financial accounts and investments by U.S. taxpayers. It requires foreign financial institutions (FFIs) and certain non-financial foreign entities (NFFEs) to report information about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest. Failure to comply with these reporting obligations results in a 30% withholding tax on certain U.S.-source payments made to these institutions and entities. Notably, FATCA's withholding tax is not aimed directly at individual foreign investors (nonresident aliens) but at the foreign financial institutions and entities that handle their investments. Exemptions under FATCA include payments to nonresident aliens, foreign governments, international organizations, and certain types of retirement funds, among others.
FDAP Income
The FDAP system pertains to the taxation of investment-type income such as dividends, interest, royalties, and certain types of compensation for services provided. This income is subject to tax on its total amount, without the allowance for deductions, at a default rate of 30%. The rationale behind withholding at the source is to facilitate the collection of taxes from foreign persons, who might otherwise be beyond the reach of the Internal Revenue Service (IRS) for tax collection purposes. The responsibility for withholding the correct amount of tax and remitting it to the IRS lies with the U.S. payer of the income to the foreign recipient.
When individuals or entities from outside the United States invest within the country, this is known as an inbound investment. The U.S. imposes taxes on these foreign investors for the income they generate within its borders, termed as U.S.-source income. A "foreign person" in this context can be:
Individuals who are nonresident aliens, meaning they do not meet the residency or citizenship criteria to be considered U.S. persons.
Corporations that are established and operate outside of the U.S.
Partnerships formed under the laws of foreign countries.
Trusts and estates that are governed by foreign law.
Any other individual or entity that does not qualify as a U.S. person under U.S. tax laws.
The income that foreign persons earn in the U.S. is categorized into two types: business income and nonbusiness income. Business income arises from the active engagement in trade or business activities within the U.S., while nonbusiness income typically includes passive earnings such as interest, dividends, and royalties from U.S. sources.
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