For those who attended our last training session of 2023 on “Year End Payroll and Income Reporting for Recipients”, we discussed the year end reporting requirements but also some tips on how to be better prepared and tips on things to look out for. And as we emphasized in the training, it is never too early to begin preparing for year-end tax compliance reporting!
And as is our usual practice, we start off the initial training session of 2024 with a review of certain issues that we encountered in the previous year end reporting.
We encountered two areas of interest that are likely to occur again in our client base in the future:
- Original Issue Discount related to convertible notes issued with warrant coverage,
- Payment of interest to foreign persons, including nonresident aliens, foreign corporations, foreign partnerships, foreign trusts, foreign estates, foreign governments, and international organizations.
First, Original Issue Discount. Our clients often use convertible notes as an element in their financing plans. Such notes contain conversion features that allow the noteholders to participate in future equity financings, an attractive feature for such investors.
According to IRS Publication 1212, “Guide to Original Issue Discount (OID) Instruments”,
Original Issue Discount is a form of interest. It is the excess of a debt instrument’s stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). Zero coupon bonds and debt instruments that pay no stated interest until maturity are examples of debt instruments that have OID.
Original issue discount is interest income to the noteholder, so there would be reporting and / or possible withholding obligations. For GAAP accounting, a free-standing warrant would be accounted for by determining its fair value, recording it as a debt discount on the issuer’s books, and amortizing that amount to interest expense.
On the tax side, when encountering warrants issued in connection with convertible note financings, we consult the client’s tax adviser for the proper tax reporting analysis including possibly the issuance of Form 1099-OID.
Payment of interest to non-U. S. persons. This situation can also arise in debt financing arrangements of our clients. One or more of the noteholders could be a foreign person such as a nonresident alien individual, a foreign corporation, a foreign partnership, etc.
Why is this important? According to IRS publication “Withholding of Tax on Nonresident Aliens and Foreign Entities”:
In most cases, a foreign person is subject to U.S. tax on its U.S. source income. Most types of U.S. source income received by a foreign person are subject to U.S. tax of 30%. A reduced rate, including exemption, may apply if there is a tax treaty between the foreign person’s country of residence and the United States. The tax is generally withheld from the payment made to the foreign person.
And further, a withholding agent is the person responsible for withholding on payments made to a foreign person. A withholding agent may apply a reduced rate of withholding (including an exemption from withholding) if it can reliably associate the payment with documentation from a beneficial owner that is a foreign person entitled to a reduced rate of withholding.
Issue awareness from our training, a thorough knowledge of our client’s financial situation and regular communication with client tax advisers are the keys to assisting our client to successfully navigate these complex compliance challenges.
For our next article, we will discuss Beneficial Ownership Information Reporting Requirements that were to begin in 2024 for many of our clients and some recent developments that are of interest to companies subject to this reporting requirement. More to come on that topic in our future articles.