Overview of US Taxation of Non-US Persons
To better understand the rationale behind these withholding regimes, it may help to first review how non-US persons are subject to US federal income tax on their US-source income. In general, the US tax treatment depends on whether the income is categorized as capital gains, passive income (e.g., interest, dividends, royalties), or “ECI” (including “FIRPTA” gains).
Capital Gains
Non-US persons generally are not subject to US federal income tax on US-source capital gains attributable to the sale of investment securities, provided that the gains are not FIRPTA gains or otherwise considered ECI, as described below. The receipt by a non-US person of such US-source capital gains income does not trigger a US tax filing obligation.
Passive Income
Non-US persons generally are subject to a gross 30% withholding tax on US-source dividends, certain types of interest, and other “fixed or determinable, annual or periodical” (FDAP) income. This 30% withholding tax does not apply to “portfolio interest,” which generally includes interest on debt instruments in registered form, provided that the non-US lender owns less than 10% of the US borrower. Income tax treaties frequently reduce the withholding rate on dividends to 15% (or less) and eliminate the withholding on non-portfolio interest. The receipt by a non-US person of US-source FDAP income does not trigger a US tax filing obligation, provided that the appropriate taxes are withheld.
ECI and FIRPTA
A non-US person that is engaged (or is deemed to be engaged) in trade or business in the United States will be subject to US federal income tax on any income that is effectively connected with that trade or business, even if the income otherwise would not have been subject to US federal income tax or would have been considered FDAP income. Such taxable income commonly is referred to as effectively connected income, or ECI. The tax is levied on the net ECI at the same graduatedrates that normally apply to US persons: up to 37% for individuals and 21% for corporations. While ECI generally is not subject to withholding, a US partnership that realizes ECI is required to withhold tax against any such ECI that is allocated to its non-US partners, even if not distributed. Importantly, a nonUS person that realizes ECI will be required to file a US federal income tax return annually. For this reason, non-US investors generally want to avoid all ECI.
Read this article in full
Bird Tax Law Newsletter – January 2025 – ECI and FIRPTA Withholding Considerations for LP Secondaries
About Bird Tax Law
Chris has been practicing tax law for over 15 years, with much of that time at AM Law 100 firms. His practice encompasses investment funds, M&A and executive compensation. As part of his investment fund practice, Chris advises non-US fund sponsors and investors on the US tax aspects of fund formations and secondary transactions.