Energy Blog

Drilling down on energy tax audits: IRS focuses on royalty payments made in the oil & gas industry

Fresh off the heels of the annual Tax Withholding and Information Reporting Conference in NYC, the oil and gas industry should have one takeaway: be ready for focused audits. The IRS made its intentions clear that audits will occur in this vertical with a focus on royalty payments made by U.S. oil and gas companies, specifically when paid to foreign persons.

Historically, IRS audits of 1441 compliance stemmed from Information Document Requests (IDRs) issued when an annual Form 1120 audit was underway, and would be focused on any payments made to foreign persons. The IRS recently determined that focused audits on targeted areas of compliance within specific industries would be more impactful, and have started training regional teams accordingly.  It’s only a matter of time that auditors will start putting that training to work. Oil and gas companies should start preparing for “when” not “if” a focused audit will occur.

The monetary impact for companies will be 30% of any U.S. sourced royalty income paid to undocumented foreign recipients, plus penalties and interest, and up to $520 per information return (Form 1042-S) filed incorrectly or not filed at all.  If the IRS decides that there was intentional disregard with respect to the regulations in this area, penalties quickly grow steeper. There is no question that the negative financial impact of non-compliance is severe, however, non-compliance is 100% avoidable.

Industry experience has typically shown that 1441 compliance is conducted across multiple departments and is extremely manual.  Simply collecting Forms W-9 or W-8 is not sufficient for compliance. Companies must ensure that they are collecting the proper tax Forms (i.e. W-9 or W-8), in addition to validating those forms to determine the proper withholding rate, applicable withholding on payments, and timely filing of accurate annual information returns.

U.S. oil and gas companies can take precautionary steps to limit potential tax liability by automating these complex and burdensome compliance obligations. Instead of investing the time and money required to train and keep personnel current on these constantly evolving tax regulations, utilizing software can ensure that your company is identifying royalty payments within scope, electronically collecting and validating the necessary tax forms, as well as providing applicable withholding rates and Form 1042-S/1099 reporting codes. Without automated software, oil and gas companies run the risk that withholding is not being done correctly. We have seen this to be the case with our current clients and the recently updated tax regulations surrounding valid treaty claims. The new W-8BEN-E requires not only the paragraph, but also the subparagraph for all royalty payments. Without this granular detail, a treaty claim would not be valid, and under audit, the IRS would expect 30% withholding of any U.S. sourced royalty payment. While a seemingly simple change, it can have a large monetary impact under audit.  

Learn more about how IHS Markit can help automate these extensive compliance obligations. If you are already under audit, please contact our team of subject matter experts for information on our extensive audit preparation and defense experience

Cyrus Daftary is the CEO of IHS Markit CTI Tax Solutions. 

Posted 2 August 2017

About The Author

Mr. Daftary joined IHS Markit with the CTI acquisition in 2014 and is currently the CEO of our Tax Solutions business, based in Andover. He has particularly extensive experience with the United States withholding and reporting rules for US and non-US persons (QI and FATCA), as well as the Common Reporting Standard (CRS). Mr. Daftary advises a number of global financial institutions and multi-national corporations about how to manage and monitor their compliance obligations. Prior to IHS Markit, Mr. Daftary was a Partner at Burt, Staples & Maner, LLP, and PricewaterhouseCoopers. He also served as a member and Chairman of the IRS Electronic Tax Administration Advisory Committee (ETAAC).Mr. Daftary is co-author of three editions of the E-Business Legal Handbook, and has taught courses on cyber-law, Internet taxation and e-commerce as an adjunct professor at Suffolk University School of Law, Northeastern University’s Master of Taxation program and Suffolk University’s Frank Sawyer School of Business.