It is a hackneyed cliché that the world is getting smaller, but this shift is true for business as technology allows even small entities the ability to compete and utilize talent on a global scale. In the past few months we have seen many of our clients begin to expand their operations to international sites or begin to use foreign contractors to outsource work. What once was only available and only an issue to large multinational firms has now come into the radar of small and medium businesses.
One of the most common ways that a business begins to operate in the global marketplace is through the use of outsourced contractors, often in foreign countries. These vendors often will market their skills on different online marketplaces and offer alternatives and a new talent pool to businesses that until recently was unavailable. The most common question many of these businesses ask relates to how these vendors are treated for tax purposes.
Most businesses are now aware that if an outside contractor is hired in the U.S., the business is required to provide them with a Form 1099 reporting all payments made to the vendor for the year; but what about reporting payments to vendors outside the US? Are there any withholdings requirements? Does the business need to file a return in that country now?
These are all common questions from clients. The answers are relatively simple in a general sense, but it is best to talk with a tax advisor regarding the specifics of any cross-border transactions, as different transaction types and tax treaties can make a huge difference in how these transactions are treated.
For starters, generally speaking each time a foreign vendor is utilized, a best practice is to give them a Form W-8 BEN (for individuals) or W-8 BEN-E (non-individuals). This is the foreign equivalent of a W-9 and confirms the information of the vendor and that they are indeed working overseas, which eliminates much confusion and burden on the business.
Once this Form is received, it should be kept in the vendor file. Since this form confirms that they are overseas, no additional reporting is required (since the income is not US Source Income). US Source payments to Foreign Individuals are reported on the Form 1042 series and can have either Chapter 3 or Chapter 4 withholding due, depending on factors such as who the money is paid to, the resident country and what the payment is for.
Lastly, there is a question of filing requirements in Foreign Countries. Generally speaking, permanent establishment is needed to have the requirement to file in Foreign Countries – in this case, the use of an independent contractor will almost never lead to permanent establishment. However, should the use of the contractor lead into an employee relationship, this very well may establish permanent establishment and needs to be further vetted with a tax advisor.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.