In Notice 2015-10 (the “Notice”), the IRS announced that it and the Treasury will issue regulations to limit credits or refunds for withholding taxes under Chapter 3 (Sections 1441-1443) and Chapter 4 (Sections 1471-1472, aka FATCA) to the amount actually deposited by withholding agents. The hope is that this “deposit limitation” will lessen the Treasury’s financial risk of crediting or refunding more tax, based on Form 1042-S reporting, than it collects or can collect.

The Notice previews regulatory amendments to provide that a credit or refund for withheld tax is available only to the extent that the relevant tax has been deposited or otherwise paid to the Treasury. For partial deposits, the new rules would apply a pro rata allocation based on a withholding agent’s “deposit percentage” (i.e., the agent’s deposits divided by the amounts reported as withheld). For credit and refund claim purposes, each claimant is treated as if the withholding agent made a deposit equal to the amount reported on the claimant’s Form 1042-S multiplied by the deposit percentage.

The Notice acknowledges that more guidance will be needed, such as procedures concerning the timing for computing and re-computing the deposit percentage, notification, and how claimants may be allowed additional credit or refund if a relevant deposit percentage increases. The IRS and Treasury are also evaluating “potential” exceptions to the general deposit limitation rules in the Notice, specifically whether exceptions are administrable and minimize the risk of fraud or intentional under-deposit.

The government’s concern over the gap between withholding reported on Forms 1042-S and tax deposited is reasonable, especially when recovery of improperly granted credits or refunds is unlikely (e.g., made to persons outside the US). The Notice, however, does not directly address deposit shortfalls or fraudulent claims. The Notice’s rules would penalize taxpayers subject to withholding for the failures of withholding agents—with the implied expectation that affected taxpayers would pressure withholding agents to satisfy their deposit obligations. While that expectation may play out eventually, it seems unfair to deny an otherwise valid credit or refund claim in the meantime—particularly when the relevant non-compliant withholding agent is domestic.