IT contract with US client: Is my Ltd an active or passive NFFE? (W-8BEN-E form)

[TRON]

Should I choose the "Active NFFE" or the "Passive NFFE" (Non-Financial Foreign Entity) option on the W-8BEN-E form?

An NFFE is passive if more than 50% of its income is passive or more than 50% of its assets are held for the production of passive income. Most IT contractors in the UK (including me) take a lot of money out from their Ltds as dividends that counts as "passive income" (AFAIK after reading some complicated US tax laws...). It's very confusing that I haven't found any online advice/example recommending the "Passive NFFE" option on the form. Literally all examples I've seen (websites and youtube) used the "Active NFFE" box. I asked the client too and they recommended the Active NFFE option but they are fine with the Passive NFFE option too.

Deciding whether an NFFE is active involves complicated calculations (quarterly). For this reason some companies use the "Passive NFFE" option even if they are active just to avoid the calculations: When an Active NFFE Can Be a Passive NFFE - International Tax Blog

Is there a downside to ticking the "Passive NFFE" box (instead of the "Active NFFE") on the W-8BEN-E form?

[WordIsBond]

Assuming your company is owned by you and/or your spouse/partner, it is a closely held company for US tax purposes. If you are materially participating in the company, which I'm sure you are from your question, I believe income from the company in whatever form (salary or dividend or capital gains) constitutes active income, not passive income.

[TRON]

Assuming your company is owned by you and/or your spouse/partner, it is a closely held company for US tax purposes.

Thanks for your reply. After searching for "closely held company" I found this page: Entities 5 | Internal Revenue Service

Based on those descriptions I feel to be much closer to the "personal service corporation" than the "closely held corporation".

I mentioned in my original post that deciding whether my company is active or passive requires an accountant playing with numbers (quarterly in worst case). This is why I asked whether it's OK to choose "passive NFFE" just to avoid complications with accounting (as it is explained in the article linked in my first post). My current accountant isn't familiar with foreign tax law and changing an accountant just for this contract would be an absolute PITA and probably an overkill.

I might be wrong with my assumptions - this is why I asked the question.

[Maslins]

Not an area I'm 100% confident on...but I think when considering the income you're considering the wrong entity. I think it's the Ltd Co that's relevant in terms of what its income is, not you personally. Therefore assuming your Ltd Co gets most of its income from contracting work/similar (as opposed to interest/rent/dividends received from investments), then tick the "active NFFE" box.

[TRON]

I think it's the Ltd Co that's relevant in terms of what its income is, not you personally.

The definition of "Active NFFE" (copy-pasted from the W-8BEN-E form):

• The entity identified in Part I is a foreign entity that is not a financial institution;
• Less than 50% of such entity's gross income for the preceding calendar year is passive income; and
• Less than 50% of the assets held by such entity are assets that produce or are held for the production of passive income (calculated as a weighted average of the percentage of passive assets measured quarterly) (see instructions for the definition of passive income).

The instructions for the W-8BEN-E form mention that the definition of passive income and the exceptions can be found at 1.1472-1(c) (1)(iv)(A) and 1.1472-1(c)(1)(iv) (B) but that's where I gave up after reading it a few times. Dividends (or at least certain types of dividends) are also counted as passive income but I don't know whether I'm an exception or not. (I get most of my money from my Ltd as dividends.)

Additional info:

• W-8BEN-E form: https://www.irs.gov/pub/irs-pdf/fw8bene.pdf
• how to complete the form: https://www.irs.gov/pub/irs-pdf/iw8bene.pdf
• headache generator: 26 CFR SS 1.1472-1 - Withholding on NFFEs. | CFR | US Law | LII / Legal Information Institute

EDIT:

Even if my Ltd is an "Active NFFE": do I really want to hire an accountant who's familiar with US tax rules to check my account quarterly? That's why I'm curious about the pros and cons of the "Passive NFFE" option.

[BlasterBates]

The definition of "Active NFFE" (copy-pasted from the W-8BEN-E form):

• The entity identified in Part I is a foreign entity that is not a financial institution;
• Less than 50% of such entity's gross income for the preceding calendar year is passive income; and
• Less than 50% of the assets held by such entity are assets that produce or are held for the production of passive income (calculated as a weighted average of the percentage of passive assets measured quarterly) (see instructions for the definition of passive income).

The instructions for the W-8BEN-E form mention that the definition of passive income and the exceptions can be found at 1.1472-1(c) (1)(iv)(A) and 1.1472-1(c)(1)(iv) (B) but that's where I gave up after reading it a few times. Dividends (or at least certain types of dividends) are also counted as passive income but I don't know whether I'm an exception or not. (I get most of my money from my Ltd as dividends.)

Additional info:

• W-8BEN-E form: https://www.irs.gov/pub/irs-pdf/fw8bene.pdf
• how to complete the form: https://www.irs.gov/pub/irs-pdf/iw8bene.pdf
• headache generator: 26 CFR SS 1.1472-1 - Withholding on NFFEs. | CFR | US Law | LII / Legal Information Institute

EDIT:

Even if my Ltd is an "Active NFFE": do I really want to hire an accountant who's familiar with US tax rules to check my account quarterly? That's why I'm curious about the pros and cons of the "Passive NFFE" option.

The dividends income they mention is what the Ltd company earns not what you personally earn from the Ltd. Your company is quite clearly an Active NFFE, it is not an investment company earning from passive investments. If the US client doesn't care how your registered it probably doesn't matter as it is essentially their problem.

[Maslins]

TRON - re-read my earlier post.

You and your Ltd Co are two separate legal entities. You personally are not working for the US client. Your Ltd Co is doing work for the US client. Therefore what personal income you have is irrelevant.

I think you need to get more into the mindset that as a contractor you are running a business. Your business has clients, you don't. This form is about your business (ie Ltd Co), not about you.

[TRON]

Less than 50% of the assets held by such entity are assets that produce or are held for the production of passive income

This part is quite confusing. I'm not sure whether it refers strictly to the income of the Ltd or any income "produced" for its employees.

Even if my Ltd is an Active NFFE: ticking the Passive NFFE box might be a simpler solution in my situation for the reasons mentioned in the article linked in my original post. I was just curious about any potential downsides the Passive NFFE option might have.

[jayn200]

Income derived from selling services is active income not passive income.

Passive income is essentially investment income. If you kept your earnings from. Your contracting services in the company and used them to invest/trade in something or you bought BTLs with them then that would be considered passive.

I gotta imagine most companies here would be active as most people are trying to leave open the option of an ER exit.

[TRON]

I decided to go with the "Passive NFFE" option because in my situation (my Ltd doesn't have SUSOs) it's less work (because of the reasons mentioned in the article I linked in my first post).