The withholding tax rate on income originating from the U.S. for non-Americans is 30%. The Portfolio Interest Exemption (PIE) mechanism exempts interest payments made by a U.S. resident (individual or corporation) to a foreign lender from withholding tax. This exemption is outlined in 26 CFR Section 871(h) of the IRS.
Between Israel and the U.S., there exists a tax treaty that provides exemptions from tax in certain cases. It is important to note that the exemption discussed here is not dependent on the treaty and is unilateral. The U.S. grants the exemption as part of its tax policy.
To qualify for the tax exemption in the U.S., the following conditions must be met:
- Debt Instrument: The debt must be issued through a registered debt instrument paying a fixed interest rate. The debt is considered registered if it is recorded by the issuer or an agent on their behalf, or it is registered in a formal system through which interest can only be transferred and which tracks the interest beneficiary.
- Declaration of Foreign Status: The U.S. interest payer must receive a declaration from the debt holder stating that they are not a U.S. resident (IRS Form W-8). This declaration is subject to penalties for perjury.
- Ownership Restrictions: The debt holder must not directly or indirectly own 10% or more of the shares in the corporation or partnership paying the interest in the U.S.
- Lender Restrictions: The lender must not be involved in managing the transaction related to the loan for which the tax exemption is requested in the U.S.
- Bank and Controlled Foreign Corporation Exclusion: The exemption will not be granted if the lender is a bank or a controlled foreign corporation (a foreign corporation with more than 50% of its shares owned by U.S. persons).
- The IRS regulation specifies which types of interest are eligible for the exemption and which are not , to prevent tax avoidance by classifying various payments as interest. If all these conditions are met, the debt will be eligible for the exemption, and no tax will be incurred in the U.S. on this interest. The IRS reserves the right to deny exemption requests from countries that do not participate in information exchange with the U.S.
This mechanism provides non-American investors with an additional alternative for entering the American economy by offering loans. Before undertaking such a move, if not properly planned, it may result in losses. It is recommended to conduct meticulous tax planning with the help of expert accountants and lawyers specializing in international taxation to avoid a situation where losses accumulate.
