Q. (cont.) We have a vendor that is insistent that they have “effectively connected income” (ECI), but no physical U.S. location from which they are generating that ECI income; and they maintain that a Form W-8ECI is the appropriate form for them to provide (with no U.S. address). Is that feasible?
I think the confusion is between effectively connected income and U.S.-source income. I cannot find guidance on this on the IRS website—does effectively connected income always mean that you must have a physical place of business in the U.S.? If so, I can tell this vendor to provide me the address for that location. If not, is the line for the U.S. address on the Form W-8ECI not mandatory for tax treaty benefits?
NOTE: The vendor is a trucking transportation vendor domiciled in Canada that delivers product to our U.S. locations.
A. Unfortunately, it's often difficult to find clear wording on the IRS site to answer these questions. But I agree it sounds as though they’re confusing ECI with U.S.-source income.
Here’s a key: do they have a U.S. address and do they file a U.S. tax return?
If, instead, they’re located in Canada but their trucks carry freight across the border so that the trucks are “operating” in the U.S., i.e., part of their services are performed in the U.S., then they’re earning U.S. source income, but it’s not effectively connected income.
See The Who, What and Why of W-8.
They probably need to be giving you a W-8BEN-E and claiming the Tax Treaty exemption there.
Q. Makes sense—so would “effectively connected income” be income only earned from a U.S. location that a foreign vendor might have?
Where I get confused and wish the IRS would clarify a little more is highlighted below. I wish the IRS stated that it has to be income generated from a physical place of business in the U.S., because “conduct of a trade or business” to me could mean just U.S. source income as well.
Form W-8ECI (Effectively Connected Income)
Who: Entity doing business in the U.S. claiming that income is effectively connected with the conduct of a trade or business
What: Entity will have physical place of business in the U.S. and will file U.S. income tax return and pay U.S. tax
Why: a) Documentation of non-U.S. status; b) No withholding required on this type of ECI—must have a US TIN; c) ECI is exempt from FATCA.
A. I’m not sure on this one, but they may be correct after all. What’s unclear to me is the difference between “doing business in the U.S.” vs. having U.S.-source income (because services were provided in the U.S.).
The key seems to be that the entity must file a U.S. tax return and pay U.S. taxes. Also, there MUST be a U.S. tax ID Number.
I found the following from Marianne Couch at Cokala:
What Is “Effectively Connected Income” or “ECI”?
• Usually all non-passive income from U.S. sources when the party is engaged in the conduct of a trade or business in the U.S. (but can include passive income like royalties if trade or business related)
• ECI is income that is effectively connected with a U.S. trade or business (“ECI”)
—Involves business activity in the U.S., e.g., construction, transportation, engineering, consulting, retail store owner
—Subject to much the same rules as U.S. taxpayers
* Taxed at marginal rates just like a U.S. taxpayer
* Requires filing U.S. tax returns, i.e., 1040NR, 1120F
So it does not have to be a parent/subsidiary kind of thing; it could be the business itself, as in a Canadian company but doing business in the U.S. And note that the above specifically identifies the transportation industry—sounds like your situation; except that I had been under the impression that “doing business in the U.S.” meant a presence here in the form of an office/building/location.
In another place in Marianne’s presentation, she offered an example of a Canadian company providing consulting services and performing those services in the customer’s U.S. office; if they provide a W-8ECI with a U.S. TIN and all other info on the W-8 is correct, then the correct choice (it was posed as a multiple choice question) is to report payment on the 1042-S but do not withhold.
See the IRS's article on EFI.
I would 1) verify that the TIN is a U.S. TIN, and 2) ask them if they file a U.S. tax return and pay taxes in the U.S. If so, then the W-8ECI is appropriate. You still have to report payments on a 1042-S, but you do not have to withhold on the payment. This much is clear: the ECI exemption from withholding is based on the filing and paying of taxes in the U.S.
Q. I might have found something in your link you provided that calls out the physical place of business in the U.S. we're looking for here. Let me know if you agree.
See the "Transportation Income" section that states:
Transportation income (defined in chapter 2) is effectively connected if you meet both of the following conditions.
1. You had a fixed place of business in the United States involved in earning the income.
2. At least 90% of your U.S. source transportation income is attributable to regularly scheduled transportation.
My interpretation of this is if you meet both conditions and thus have effectively connected income, than you would have a "fixed place of business in the U.S."— thus a U.S. address to provide on line 6 of the ECI form. If you do not meet both conditions, your income would not be considered "effectively connected" and then a Form W-8BEN-E would be the appropriate form.
A. I agree. It says you have to meet both conditions.
So for your Canadian shipper, seems we’re back to U.S.-source but not effectively connected income, and therefore W-8BEN-E, unless they come through with a fixed place (address) of business in the U.S.