United States: ECI And Withholding Considerations In Cross-Border Receivables Factoring

I. Introduction

The global supply chain financing market has grown exponentially in the last decade. It is not only banks that provide this type of financing to companies of all sizes, but recent years have seen non-bank financial institutions, specialized funds, and fintech platforms all become important players in the market. Not surprisingly, a significant portion of supply chain financing is cross-border. The financing provider, the seller of the accounts receivable, and the obligors under the financed receivables may be located in two or more different jurisdictions.

While the industry continues to grow, tax practitioners face a dearth of guidance on several thorny tax issues, particularly when it comes to the purchase of U.S. accounts receivable by a non-U.S. buyer.¹ These issues have also not been a popular topic among tax commentators, with very few, if any, articles being written since Frederick R. Chilton, Jr.'s 1985 article appeared in this journal.² It has been almost 40 years since that article, so returning to the issues now does not feel too soon ...

Unless otherwise noted, the factoring transaction contemplated in the discussion ahead is (i) a "Seller" delivers goods or services to a U.S. taxpayer "Customer," (ii) Seller sells the account receivable on a nonrecourse basis to "Factor,"³ a nonU.S. taxpayer, for an immediate payment of funds that is less than the amount owed by Customer under the account receivable, and (iii) Customer settles the account receivable with a payment that is received by Factor. This article will usually refer to the amount received by the Factor over the purchase price paid for the account receivable as factoring income or discount.

Actual facts of course vary and transactions observed in the market present an array of special features and nuances. For instance, sometimes there are other fees paid to the Factor, sometimes certain layers of recourse are accepted by the Seller, etc.⁴ There are also other forms of supply chain financing including, importantly, so-called reverse factoring.⁵ In addition, transactions involving a Seller or Customer in a foreign jurisdiction may raise unique tax issues under applicable local law.⁶ That said, this article will focus on certain U.S. tax issues involved in the plain vanilla accounts receivable purchase transaction outlined above, more specifically, the effectively connected income and withholding tax consequences.

Generally, a non-U.S. person is subject to (i) U.S. federal income tax on a net basis (with possible additional branch profits tax) for income that is effectively connected with a U.S. trade or business ("ECI") and (ii) "chapter 3" withholding of tax under Code Secs. 1441 and 1442 at a 30% rate on U.S. source fixed, determinable, annual, or periodic income ("FDAPI") that is not ECI ("NRA Withholding"). Both of these results can be altered (and alleviated in various degrees) by a relevant income tax treaty between the United States and the country of residence of the recipient of the income. As explained above, our focus here is generally limited to navigating the considerations of ECI and NRA Withholding in the contemplated factoring transaction and we do not intend to provide a comprehensive analysis of all relevant tax considerations. Specifically, this article will not discuss income tax treaties in great detail, chapter 4 Foreign Account Tax Compliance Act ("FATCA") withholding, backup withholding, the treatment of factoring transactions under Code Sec. 163(j), or state and local tax considerations (which may include, among others, nexus for the Factor and bad debt deductions on factored accounts receivable for sales tax purposes).⁷ This article will also not cover any of the topics unique to intercompany factoring arrangements, such as transfer pricing, applicability of the base erosion and anti-abuse tax, or issues specific to factoring by a controlled foreign corporation, including Subpart F and Code Sec. 956 considerations.

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Footnotes

1. As explained below, the focus of this article is on commercial transactions between unrelated parties. The purchase of accounts receivable from a U.S. person by its related controlled foreign corporation has already drawn the attention of Congress. The Tax Reform Act of 1984 introduced Code Secs. 864(d) and 956(b)(3) addressing related-party factoring, but we will not address these provisions here. See also Internal Revenue Service Factoring of Receivables Audit Techniques Guide, LMSB-04-0606-004 (Jun. 2006).

2. Frederick R. Chilton, Jr., International Factoring, 11 Int'l Tax J. 139 (1985). See also Julie A. Roin and David Rosenbloom, Bringing foreign profits to the U.S. by factoring: how to use this technique, 58 J. Tax'n 164 (1983).

3. The Seller will typically represent to the Factor that the receivables sold are for goods that have already been delivered or services that have already been provided to the Customer.

4. See T.D. 9160, 2004-2 CB 785 (Oct. 22, 2004) (preamble to Treasury regulations under Code Sec. 6050P describing various unrelated-party factoring arrangements).

5. Unlike traditional factoring, in reverse factoring the program is initiated by the customer in order to help its suppliers finance their accounts receivable against the customer through early payment by the factor.

6. Merely as an illustration of non-U.S. tax issues that may arise in factoring transactions: (i) upon the purchase of accounts receivable from a Mexican Seller by a non-Mexican Factor, the discount income is treated as interest for Mexican tax purposes and subject to withholding tax; (ii) payments made by a Canadian Customer to a non-Canadian Factor in respect of an account receivable arising from services performed within Canada may be subject to Canadian withholding tax. Also, for an overview of tax considerations in the United Kingdom, see Matthew Mortimer and Emma Noehrbass, The Taxation of Receivables Finance Transactions, Tax J., Apr. 23, 2021, p. 12.

7. See Charles Kearn and Michael J. Kerman, Sales Tax Considerations in Financing TransactionsDoes Substance over Form Govern?, 25 J. Multistate Tax Incentives 20 (2016).

Originally published by International Tax Journal .

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