BBB Act on “Portfolio Interest Exemption”

The Build Back Better Act (“BBB Act”), most recently passed by House of Representatives, contains proposed legislative changes and narrower definition of “portfolio interest exemption.”

“Portfolio interest exemption” and capital gain (except FIRPTA , and capital gain on sale and exchange of US partnership interest, Code §864(c)(8)) are two main exceptions to withholding tax on nonresident alien individuals and foreign corporations’ U.S.-source income.

Portfolio interest received by nonresident alien individuals and foreign corporations on bonds and similar portfolio investments is exempted from US withholding tax regime. Code §871(h). To qualify for the exemption, an obligation that is in registered form qualifies for the portfolio interest exemption provided that the US person who would otherwise be required to deduct and withhold tax from such interest has received a statement (usually on IRS Form W-8BEN) that the beneficial owner is not a United States person. “Portfolio interest” does not include interest received by 10-percent shareholder (i.e. any person who owns 10 percent of corporate combined voting power, or owns 10% or more of the capital or profits interest in a partnership.)

The portfolio interest exemption (Code §871(h) “Repeal of Tax on Interest of Nonresident Alien Individual Received from Certain Portfolio Debt Investment” and Code §881(c) “Repeal of Tax on Interest of Foreign Corporation Received from Certain Portfolio Debt Investment“) does not apply to 10-percent shareholders, who instead are subject to withholding on interest at a 30% rate (unless an income tax treaty on double taxation provides otherwise). Under current law, a 10-percent shareholder is defined as a holder of at least 10% of the debtor corporation’s voting power.

The BBB Act would now expand the exception to the definition of “portfolio interest” to include a holder of at least 10% of the value of the debtor corporation’s stock, to narrow the scope and applicability of this already precious exemption​,​ by amending Section 871(h)(3)(B)(i) to read as follows:

“in the case of an obligation issued by a corporation–
(I) any person who owns 10 percent or more of the total combined​ ​voting power of all classes of stock of​ ​such corporation entitled to vote, or
(II) any person who owns 10​ ​percent or more of the total value of​ ​the stock of such corporation[…]”

Should it pass​ the Senate ​​and ​​become part of US international tax law, foreign shareholders of a US corporations will be again subject to withholding tax by ​merely ​holding “low​-vote” or non-voting stocks.

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