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Royalty Payment to a Nonresident Alien

A royalty is income derived from the use of the taxpayer's property. A royalty payment must relate to the use of a valuable right. According to the IRS, tax must be withheld on the payment of royalties from sources in the United States. However, certain types of royalties are given reduced rates or exemptions under some tax treaties. Accordingly, these different types of royalties are treated as separate categories for withholding purposes.

The royalty article applies to both individuals and entities. To be a royalty, a payment must relate to the use of a valuable right. Payments for the use of trademarks, trade names, service marks, or copyrights whether or not payment is based on the use made of such property, are ordinarily classified as royalties for federal tax purposes.

A right to use the intellectual property right of another person would be classified as a royalty. Tax rules apply to where the property is used. (Example: A press receives payment for permission to use part of a published book in their own work. Press keeps part of the payment and the author keeps part. If the author is an NRA and the source is the US -- tax at 30%.)

If payment is for the right to use a product (film, play, etc.), the ownership rights of which remains with the individual in a foreign country, then the payment is a royalty. The source of the income for a royalty is where the property is used. (i.e., if a play is produced in the US, the income is US-sourced.) Royalties paid to an NRA are subject to 30% withholding, unless a tax treaty applies. Payment of royalties would be reported on a 1042-S.

Royalty Categories:

  • Industrial Royalties -- includes royalties for the use of, or the right to use, patents, trademarks, secret processes and formulas, goodwill, franchises, "know-how," and similar rights. It also may include rents for the use or lease of personal property.
  • Motion Picture or Television Copyright Royalties -- royalties paid for the use of motion picture and television copyrights.
  • Other Royalties -- royalties paid for the use of copyrights on books, periodicals, articles, etc., except motion picture and television copyrights. (Income code 12)
  • If UR is paying for all rights to the picture, it is a sale and not subject to NRA withholding and reporting.
  • If UR is paying for the right to use a picture that belongs to the artist, the payment is a royalty. If the use is in the US, it is US source income and subject to 30% NRA withholding and reporting.

Film Rentals:

  • If UR rents a film from a foreign company (even if nonprofit), the payment is treated the same as a royalty payment -- sourced in the US and taxed at 30%.
  • The only exception would be if the owner of the copyright in the film provides a Form W-8BEN with a US EIN and a claim for a lower treaty rate based on the Royalties article.

Equipment Rentals:

  • Result in royalty income subject to 30% withholding and 1042-S reporting
  • Some treaties provide a treaty benefit for equipment royalties

Software Royalties:

  • Generally, a payment for use of a software product or database results in the payment of rent for lease of the product/database or royalty for use of the intellectual property. When the property is used in the United States, the source of income is considered to be U.S. source income subject to 30% withholding and reporting on Form 1042-S unless an exception applies. The possible exceptions are:
    • the terms of the software agreement are essentially a sale of all substantial rights to use the product (such as purchased boxed software under a shrink-wrap license)
    • the location of the server providing the software service is outside the United States, in which case the source of income may be foreign (the IRS has issued no guidance in these matters)
    • the payment is exempt from tax or subject to a reduced rate of tax under an income tax treaty and the payee has submitted a Form W-8BEN (TIN required) with the treaty claim
  • The IRS has issued regulations regarding cross-border computer agreements that provide a framework for analyzing the terms and conditions of the agreement in order to determine how the transaction (or its elements) are taxed. (The regulations are available on the Windstar Users Website under Resources.)
  • To be an outright purchase, the agreement must give UR all substantial rights in the product. (Example: Purchase of a Data Set -- can the user take the data set and use it or change it for their own purpose or is it a lease of the data because the data is being used as is.)
    • Foreign Vendor and Foreign Server: Foreign sourced income.
    • Foreign Vendor and US Server: Lease of property in the US and subject to tax.

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Payroll & International Taxation
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