The United States levies withholding tax on dividend payments that are classified as FDAP income. FDAP stands for Fixed, Determinable, Annual, and Periodic. In essence, FDAP refers to income that is not “effectively connected income” (also known as “ECI”), which means it is not income that is derived from a US trade or business. In other words FDAP is passive income.  

Dividends paid by US companies on stock that is held as portfolio (i.e. passive) investment generally qualify as FDAP and are in principle subject to the 30% withholding tax that is applied to FDAP income. Investors that are eligible for reduced (tax treaty) rates may be able to reduce this dividend withholding tax at source (“relief at source”, also referred to as “RAS”)

The United States has implemented a system that requires beneficiaries to classify themselves as recipient of FDAP income. Institutions involved in the distribution of this income need to identify the beneficiary and request them to complete a tax form. This is also known as self-certification. Investors who are eligible for a reduced withholding tax rate can apply for a reduction in the tax form and submit this form to their intermediary.

The intermediary will pass on the forms to the next financial institution in the payment chain, all the way to the party responsible for paying the FDAP and withholding the dividend tax (i.e. tax on FDAP). 

To prevent billions of tax forms from being sent around the globe from institution to institution, many financial institutions operate as so-called “qualified intermediaries” (QI). After they have collected the self-certification forms from the beneficiaries (their clients), they group beneficiaries with the same tax rates (benefits) and establish so-called rate pools. This allows them to exchange information with other intermediaries on an aggregated basis rather than form by form.

Possible Relief Methods - Relief at source

Because of the QI-system, a United States listed company paying (FDAP) dividends to its portfolio shareholders, will learn from the US financial intermediary supporting its dividend distribution, how much dividend to pay to investors in the different rate pools and how much dividend tax withholding to apply and remit to the US tax administration (Internal Revenue Service, or “IRS”).

US companies rely on the network of qualified intermediaries that establish which beneficiaries at the end of the payment chain are (ultimately) eligible for relief from the dividend withholding tax.  

The self-certification in this system plays a pivotal role. It is therefore explicitly pointed out to the beneficiary that such a statement is signed under penalties of perjury.

Corrections can be made

It is not easy to operate such a large global network without incurring errors. Within the mechanism, there is room for certain corrections when an incorrect dividend withholding tax rate is applied at source. This correction mechanism is operated by the intermediaries, rather than a reclaim procedure for the excess dividend withholding tax with the Internal Revenue Service (IRS).

Still, if the correction mechanism cannot be applied, investors may be able to recover the excess dividend withholding tax. The procedure to recover the tax, in that case, may be more complicated.

Statute of limitations

The statute of limitations for the United States is 3 years from the end of the calendar year in which tax was withheld unless a double tax treaty applies.