Mortgage interest withholding paid to a Japanese bank

Technical topics regarding tax preparation.
#1
RightOn  
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"Article 11 of the United States- Japan Income Tax Treaty allows the source state to impose a withholding tax of 10 percent if paid to a resident of the other Contracting State that beneficially owns the interest. However, Article 11(3) of the treaty eliminates source-state withholding tax on broad categories of interest. The most significant of these is the elimination of source-state withholding tax for interest earned by financial institutions. This provision in the treaty is due to the highly-leveraged nature of financial institutions, imposition of a withholding tax on interest received by such enterprises could result in taxation that actually exceeds the net income from the transaction. Article 11(3)(c) provides that interest falling within this exemption includes interest beneficially owned by a resident bank, an insurance company, a registered securities dealer, or a qualified deposit-taking entity. In addition, Article 11(3)(d) exempt interest earned by pension funds from source-state withholding tax."

https://sftaxcounsel.com/income-tax-tre ... 20interest.

If I have understood the above correctly, based on Article 11(3) of the tax treaty between US and Japan, mortgage interest paid by a US resident to a Japanese bank is not subject to tax withholding. Is my understanding correct?

And in case I am correct and no withholding is required, is the US taxpayer still required to file Form 1042 or Form 1042-S because of the interest paid to his Japanese lender bank?
 

#2
Nilodop  
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Seems correct.
The interest income will be eligible for the benefits of the Convention that would be granted if it were received directly by the partner or member; thus, if the partners or members of the U.S. LLC are all banks that are U.S. residents and satisfy all other conditions specified in the Convention, the interest income would be exempt from source-basis taxation in Japan under paragraph 3 of Article 11.
. https://www.irs.gov/pub/irs-trty/japante04.pdf, page 17.
 

#3
RightOn  
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Nilodop wrote:Seems correct.
The interest income will be eligible for the benefits of the Convention that would be granted if it were received directly by the partner or member; thus, if the partners or members of the U.S. LLC are all banks that are U.S. residents and satisfy all other conditions specified in the Convention, the interest income would be exempt from source-basis taxation in Japan under paragraph 3 of Article 11.
. https://www.irs.gov/pub/irs-trty/japante04.pdf, page 17.


Thank you Nilodop. My question is strictly about the requirement of withholding though, not the taxability. But based on this information and the other that I have read, looks like they all point to the direction that mortgage interest paid to a Japanese bank is not subject to withholding.

So does anyone know if withholding is not required, are Form 1042-S and Form 1042 still required to file?
 

#4
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I believe that the payor of US-source income to a foreign person has to withhold 30% tax unless the payor receives a W-8 from the recipient claiming treaty benefits. Reg. 1.1441-1(b)(1) (“A withholding agent must withhold 30 percent of any payment of an amount subject to withholding made to a payee that is a foreign person unless it can reliably associate the payment with documentation upon which it can rely to treat the payment as made to a payee that is a U.S. person or as made to a beneficial owner that is a foreign person entitled to a reduced rate of withholding.”).
 

#5
Nilodop  
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The 1441 regs. are such a joy to read. I think this is correct and would mean no withholding if the forms are obtained/filed. https://www.irs.gov/individuals/interna ... nresidents
The beneficial owner of the interest income may claim the benefit of the tax treaty article which deals with "Interest Income." The beneficial owner may claim the lesser tax treaty rate by filing Form W-8BEN with the withholding agent. The withholding agent will report the payment on Forms 1042 and 1042-S, even if the entire amount of income is exempt under a tax treaty.
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