What Is a Portfolio Interest Exemption?

Picture of coins simbolizing lower interest rates thanks to portofolio interest exemptions

Under Internal Revenue Code §§ 871 and 881, nonresident alien individuals and foreign corporations are typically subject to a 30% withholding tax on U.S sourced income that is not connected with U.S. trade or business. This income is also known as fixed or determinable annual or periodical (“FDAP”) income, and typically includes interest, dividends, rents, royalties, etc.

However, portfolio interest is exempt from this 30% tax. Therefore, foreign lenders can avoid the withholding tax on interest paid to them by U.S. borrowers on issued loans, but only if specific requirements are met.

What is a Portfolio Interest?

Generally, a portfolio interest is non-effectively connected interest that would typically be taxable under the Internal Revenue Code and is paid on specific debt obligations, like a loan.   “Non-effectively connected interest” refers to interest incurred on U.S. sourced income connected with U.S. trade or business.

For a loan to qualify as portfolio interest, the following requirements must be met:

  1. The lender must be a foreign person or corporation,
  2. The borrower must be a U.S. person or corporation,
  3. The debt must be in “registered form,”
  4. The loan cannot be from a bank lending in the ordinary course of business,
  5. The lender cannot own 10% or more of the voting stock of the borrowing corporation, if applicable, and
  6. The interest payments cannot be contingent. Contingent interest is interest in which the amount is calculated in reference to any of the following categories:
    • Receipts, sales, or cash flow of the debtor;
    • The income or profits of the debtor;
    • Any change in value of the property of the debtor;
    • Dividends, distributions, or like payments made by the debtor.

Foreign individuals or corporations lending to U.S. borrowers can qualify under the portfolio interest loan exemption if they meet the qualifications mentioned above, which will be an involved, fact-specific determination. The interest may still be exempt under an applicable income tax treaty if the exception does not apply.

EPGD Business Law is located in beautiful Coral Gables, West Palm Beach and historic Washington D.C. Call us at (786) 837-6787, or contact us through the website to schedule a consultation.

*Disclaimer: this blog post is not intended to be legal advice. We highly recommend speaking to an attorney if you have any legal concerns. Contacting us through our website does not establish an attorney-client relationship.*

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Eric Gros-Dubois

Eric P. Gros-Dubois founded EPGD Business Law in 2013 and is the current head of the firm’s corporate, estate planning, and tax practice, and manages the firm’s Washington D.C. office. With a JD and MBA, and a specialization in finance, Eric is able to step back and view the legal world through a commercial lens while also acting as a trusted business advisor for his clients. He does his best to be solutions oriented, and tries to think like a business owner, not just a lawyer.


*The following comments are not intended to be treated as legal advice. The answer to your question is limited to the basic facts presented. Additional details may heavily alter our assessment and change the answer provided. For a more thorough review of your question please contact our office for a consultation.

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