23 April 2019

Minimizing (or eliminating) US tax on US source income and legacies for non-US charities


American donors may qualify for a US charitable estate tax deduction even if assets are left to a non-US charity provided that the charity has purposes which are charitable in the US. As a result, many non-US charities are finding themselves receiving legacies from US estates. To the surprise of these charities, however, the executor may look for evidence that the charity meets the US estate tax requirements, and then threaten to impose a 30% withholding tax unless the charity certifies that it is eligible for a reduced rate of income tax withholding under the US Internal Revenue Code (‘the Code’) or a relevant tax treaty. Of course, a legacy should not be subject to income tax, and this is strictly not the correct procedure but since the tests are similar it provides a convenient way to satisfy the broader test for qualification as a charity for estate tax purposes.

A non-US charity can evidence that it is the equivalent of a US charity if it obtains US tax-exempt status by applying to the IRS for a determination letter or by obtaining a legal opinion certifying that the charity’s purposes are those which are considered charitable in the US. Both options will reduce or eliminate any US tax, however obtaining US tax-exempt status by receiving a determination letter from the IRS can be a time consuming and costly process, and may subject the non-US charity to annual IRS reporting requirements.

A less timely and more straightforward approach is for the non-US charity to obtain an opinion from a qualified practitioner confirming that the charity’s purposes are those which are considered charitable in the US. A non-US charity may obtain an opinion after a qualified practitioner conducts a review of the charity’s governing documents, financial accounts and activities for the last four tax years. The charity will then be asked to complete an affidavit setting out sufficient facts concerning its operations and its sources of support. The affidavit will also confirm that the charity’s activities are consistent with purposes which are considered charitable in the US, namely that the organisation is organised and operated exclusively for charitable purposes, that none of its earnings may inure to any private shareholder or individual, that it does not attempt to influence legislation as a substantial part of its activities and it does not participate in any campaign activity for or against political candidates.

Based on this review and the charity’s affidavit, a qualified practitioner will be able to issue an opinion letter confirming that the charity is the equivalent of a US public charity or a US private foundation. The letter must be provided to the withholding agent and attached to a Form W8EXP, Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding and Reporting.

The W-8EXP can be used for withholding on multiple types of US investments and for a charity with an investment portfolio there should be an immediate increase in investment return based on the reduction in withholding. It can also be used in practice as a certification method for the receipt of legacies. It should also be useful in satisfying potential donors that a legacy to the charity will in fact qualify the estate for an estate tax deduction.

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