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Role of qualified intermediary agreement in US taxation system

Qualified intermediary agreement represents a new withholding tax system by which foreign financial institutions, or foreign branches of a US financial institution, can receive favourable withholding tax treatment. This system is designed to simplify withholding and reporting obligations under new Treasury Regulations relating to the withholding of income tax on certain US-source payments to foreign persons.1 The Revenue Procedure enumerates the application procedures for becoming a QI and reproduces the text of the final QI withholding agreement.

Under the QI rules, a financial intermediary who becomes a QI agrees to obtain reliable documentation from each of its account holders and to present that information in aggregate form to withholding agents. Strict requirements are set forth in the Qualified Intermediary Agreement to ensure that the documentation provided by account holders to a QI is trustworthy. Each prospective QI must submit an application to the IRS that contains, required information.2

A QI’s withholding and reporting obligations under the Agreement vary depending on whether it elects to assume primary withholding responsibilities. However, whether or not this responsibility is assumed, a QI remains liable for certain information reporting and backup withholding.

A QI is generally permitted to enter into a private agreement with another intermediary under which the other intermediary agrees to perform all of the obligations of the QI. Notwithstanding, this does not relieve the QI of its liability for the performance of any of its obligations under the Qualified Intermediary Agreement.

Reduced withholding and protection of an account holder’s identity will be possible if a QI can reliably associate a payment with valid documentation from the account holder that is collected in accordance with the applicable “know-your-customer” rules. Specific types of documentation are required for Qualified Intermediary Agreement in order to take advantage of certain reduced rates of withholding.3

US account holders who are not exempt from reporting must permit the disclosure of their identities by signing waivers of foreign bank secrecy laws. If a US non-exempt recipient does not provide such a waiver, the QI must either: backup withhold on all reportable payments paid to the account holder and report those payments,4 or sell the account holder’s US investments depending on the date in which an account was opened.

Compliance with terms of the Qualified Intermediary Agreement is monitored by mandated external auditing, and the QI must agree to permit the IRS to communicate with and examine the external auditor’s work papers. The external auditor is required to issue a report to the IRS; the report contains its audit findings. To ease administrative burdens, an external auditor can rely on a QI’s internal audit procedures if the auditor reviews and verifies those procedures, including the examination of statistical samples of accounts and/or account holders. The external auditor is not required to divulge the identity of the QI’s account holders to the IRS.

A QI can terminate the Qualified Intermediary Agreement at any time by sending a written notice to the IRS. The IRS can terminate the Qualified Intermediary Agreement where there has been a significant change in circumstances.5 In this regard, rules have been formulated for the following types of documentation:

—- treaty documentation;

—- documentation for international organisations entitled to an exemption from withholding;6

—- documentation for foreign governments and foreign central banks of issue claiming an exemption from withholding;7

—- documentation for foreign tax-exempt organisations claiming a reduced rate of withholding;8

—- documentation from intermediaries or flow-through entities, including both qualified and non-qualified intermediaries, foreign partnerships, and private arrangement intermediaries;

—- documentation for US-exempt recipients; and

—- documentation for US non-exempt recipients.9

The Qualified Intermediary Agreement contains guidelines for (1) determining the validity of documents provided to a QI, (2) determining how long such documents are valid and (3) how long documents should be maintained and retained by the QI.10

Presumption Rules are to be applied if a QI cannot reliably associate a payment with valid documentation from an account holder. Generally, a QI can reliably associate a payment with documentation when it holds valid documentation from an account holder other than a non-qualified intermediary or flow-through entity,11 it can reliably determine how much of the payment relates to the valid documentation provided by the account holder, and it has no actual knowledge or reason to know that any of the information or statements in the documents are incorrect.

The Presumption Rules are as follows:

(1) An amount that is subject to NRA withholding and is paid outside the United States to an account that is maintained outside the United States and is presumed to be made to an undocumented foreign account holder. QI treats the amount as subject to withholding at a rate of 30 per cent on the gross amount paid and reported to an unknown account holder.12

(2) An amount of US source deposit interest (other than an amount that is part of the purchase price of a certificate of deposit sold in a transaction other than a redemption) or an amount of US source interest or original issue discount on the redemption of a short-term obligation that is paid outside the United States to an offshore account is presumed to be made to an undocumented US non-exempt recipient account holder. QI must backup withholding at 31 per cent and report13 that amount unless it has provided sufficient information for another payer from which it receives such amounts to backup or withhold and report the payments and QI does not know that the other payer has failed to backup withhold or report.

(3) QI shall presume that the following payments are made to an exempt recipient, and are thus not subject to withholding or reporting, provided that such amounts are paid outside the United States to an account maintained outside the United States:

—- foreign source income;

—- broker proceeds;

—- original issue discount paid in a sale other than a redemption;

—- interest paid as part of the purchase price of an obligation when the instrument is sold between interest payment dates;

—- amounts held on deposit with banks or other financial institutions for 2 weeks or less;

—- amounts of original issue discount arising from a sale and repurchase transaction that is completed within 2 weeks or less; or

—- amounts described in Treas.14

(4) Any payment not covered in (1)-(3) above shall generally be presumed made to a US non-exempt recipient and therefore shall be subject to Form 1099 reporting and to backup withholding.15

The Qualified Intermediary16 solves a number of problems. It moves the withholding burden with respect to omnibus accounts back to foreign financial institutions. It also protects the identify of foreign account holders from competitors. It streamlines the new compliance procedures that are likely to arise as a result of the new regulations.

The Qualified Intermediary Agreement also adds a new dimension to taxpayer compliance. For the first time ever, external auditors assume the responsibility for auditing the taxpayer. It will be interesting to see how the new experience develops.

Despite the advantages of being a QI, many financial institutions that deal with non-qualified intermediaries will be unwilling or perhaps unable to undertake the responsibilities called for by the new system. This will certainly be the case where the intermediary deals with non-qualified intermediaries. In addition, if a country does not have acceptable K-Y-C rules, QI status will not be available.

Since both Switzerland and Liechtenstein did submit know your customer rules and the same stood approved by IRS, hence both the countries fall within the ambit of approved jurisdictions.17

(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)

1. Revenue Procedure 2000-12.

2. The itemised information is set forth in Revenue Procedure 2000-12. Information about the requirements and enforcement of the “know-your-customer” rules of the prospective QI’s country must also be provided.

3. (eg to take advantage of treaty benefits).

4. See Form 1099.

5. In case of default, IRS can terminate the agreement.

6. Under IRS § 892.

7. Under Sections 892 or 895 of the Code.

8. under Section 501(c) of the Code

9. See Sec. 5.03-5.09 of the Model Agreement.

10. See Sec. 5.10-5.12 of the Model Agreement.

11. Sec. 5.13(b)(1)-(5) of the Model Agreement describe whether a payment is reliably associated with documentation if the payment is made to an intermediary or flow-through entity.

12. See Form 1042-S.

13. On form 1099

14. Reg. §§1.6049-5(b)(7), (10) and (11).

15. Sec. 5.13(C) of the Model Agreement.

16. Revenue Procedure 2000-12 provides guidance for entering into a qualified intermediary known as Q1. This Q1 regime became effective from 1-1-2001.

17. http://www.irs.gov/Businesses/International-Businesses/List-of-Approved-KYC-Rules.

Zafar Azeem, "Role of qualified intermediary agreement in US taxation system," Business recorder. 2013-01-17.
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