US IRS Form W-8ECI or what does "effectively connected income" mean? My brain hurts

I’m reading the instructions to the “Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States” aka Form W-8ECI (irs.gov/pub/irs-pdf/iw8eci.pdf) and I do not understand what this part means

So, what is “[color=#BF0000]effectively connected income[/color]”?
What does “[color=#BF0000]effectively connected with the conduct of a trade or business in the US[/color]” mean?

It says, “If you receive [color=#BF0000]effectively connected income[/color] from sources in the United States, you must provide Form W-8ECI to … Claim that the income is [color=#BF0000]effectively connected[/color] with conduct of a trade or business in the United States.” To me this sounds like, “If you get shenmadongxi, then fill out Form W-8ECI because you get shenmadongxi” - which is logically obvious but still meaningless to me, because I don’t know if I really am receiving “shenmadongxi”.

Then there is this 77-word beauty of a sentence: A withholding agent or payer of the income may rely on a properly completed Form W-8ECI to treat the payment associated with the Form W-8ECI as a payment to a foreign person who beneficially owns the amounts paid and is either entitled to an exemption from withholding under sections 1441 or 1442 because the income is effectively connected with the conduct of a trade or business in the United States or subject to withholding under section 1446.

I try to cut it down to: [strike]A withholding agent or payer of the income[/strike] [The US Buyer] [strike]]may rely on[/strike] [can use] [strike]a properly completed[/strike] Form W-8ECI [strike]to treat the payment associated with the Form W-8ECI[/strike] [for] [strike]as a payment to[/strike] a foreign [strike]person who beneficially owns the amounts paid[/strike] [Seller] and is either entitled to an exemption from withholding [strike]under sections 1441 or 1442[/strike] because the income is effectively connected with the conduct of a trade or business in the United States or subject to [tax] withholding [strike]under section 1446[/strike].

[The US buyer] can use the Form W-8ECI for their payment to a foreign [Seller] and is either entitled to an exemption from withholding because the income is effectively connected with the conduct of a trade or business in the United States or subject to tax withholding.

So, the little words (“in the” United States) are critical, because the transaction happens INSIDE the US, so the withholding taxes are not necessary.

The phrase “… the conduct of a trade or business in the US” sounds odd to me, because I normally think of “conduct” as a verb, than as a noun (as in, “conduct unbecoming an officer of the armed forces”). So, in this sense, does this “conduct” mean “the act of doing business in the US”?

And further below in the document, there is this definition:

[quote]Effectively connected income. Generally, when a foreign person engages in a trade or business in the United States, all income from sources in the United States other than fixed or determinable annual or periodical (FDAP) income (for example, interest, dividends, rents, and certain similar amounts) is considered income effectively connected with a U.S. trade or business. FDAP income may or may not be effectively connected with a U.S. trade or business. Factors to be considered to determine whether FDAP income and similar amounts from U.S. sources are effectively connected with a U.S. trade or business include whether:

• The income is from assets used in, or held for use in, the conduct of that trade or business, or
• The activities of that trade or business were a material factor in the realization of the income.

Effectively connected income, after allowable deductions, is taxed at graduated rates applicable to U.S. citizens and resident aliens, rather than at the 30% rate. You must report this income on your annual U.S. income tax or information return.[/quote]

If I remove the part about FDAP (since in my case, my company isn’t a bank, but something that made something and is selling it to a customer in the US), then it looks like

[quote]Effectively connected income. Generally, when a foreign person engages in a trade or business in the United States, all income from sources in the United States other than fixed or determinable annual or periodical (FDAP) income [strike](for example, interest, dividends, rents, and certain similar amounts)[/strike]is considered income effectively connected with a U.S. trade or business. [strike]FDAP income may or may not be effectively connected with a U.S. trade or business. Factors to be considered to determine whether FDAP income and similar amounts from U.S. sources are effectively connected with a U.S. trade or business include whether:

• The income is from assets used in, or held for use in, the conduct of that trade or business, or
• The activities of that trade or business were a material factor in the realization of the income.[/strike]

Effectively connected income, after allowable deductions, is taxed at graduated rates applicable to U.S. citizens and resident aliens, rather than at the 30% rate. You must report this income on your annual U.S. income tax or information return.[/quote]
OK, so since I am with a Taiwan company - that is, a foreign company to the US - our effectively connected income is not subject to US tax (or the 30% rate), right?

I’m certainly no accountant… but, I believe that your understanding above is correct. If your company is a foreign company, i.e., not incorporated in or acting (conducting trade/business) IN the US, then your company’s effectively connected income is probably not subject to US tax (or the 30% rate).

This seems like it should be similar to my firm’s situation. We are frequently requested by client firms or companies in the US to provide a W-8BEN Form. However, the W-8BEN Form does not apply to my (Taiwanese) firm, as the services my firm provides are exempt from withholding in the US because our services are provided outside of the US. We always ask them to send us instead a W-8IMY Form, which we complete as a non-withholding foreign (to the US) partnership.

Thank you. In our case, we were sent 3 W-8 forms (W-8BEN, W8-IMY and the W-8ECI) - we had sold something we made to an American buyer in the US; it was the procurement department of the buyer who sent us the forms.

Because your firm represents client firms, you may be regarded as acting as an “intermediary”, so therefore you may use the W-8IMY (irs.gov/pub/irs-pdf/iw8imy.pdf) and the companies in the US do not need to withhold tax. For us, we are a foreign manufacturer who made something (actually, we had something made in the US) and now have a buyer (in the US) who we are selling to. Based on my understanding of the W-8ECI, US taxes may be withheld from us because it happened “in” the US - but according to the W-8ECI, just as you noted, we are not subject to the 30% rate. This is confusing, since in the first place no tax rate may be assigned to us as a wholly foreign company without any US operations.

Our finance team says they will consult our expensive tax accountants. I’m writing up my notes for them in case it helps. Cheers, again!

Seems like a good idea. :2cents: